In conjunction with the Kaiser-Texas acquisition, the Company purchased eight medical and office facilities with approximately 323,000 square feet of clinical facilities and approximately 175,000 square feet of administrative facilities. These buildings are subject to a deed of trust note securing a $34.7 million note balance. In addition, the Company leases additional office and clinical space in Texas totaling approximately 24,000 square feet and 56,000 square feet, respectively. The above properties are utilized primarily for the managed care operations. The workers' compensation subsidiary is headquartered in Nevada and occupies approximately 25% of the 198,000 square foot administrative building as well as leases approximately 64,000 square feet of office space in California. The Company leases approximately 150,000 square feet of office space in other various states as needed for the military subsidiary's administrative headquarters, for TRICARE service centers and for other regional operations.
The Company owns real estate and a building in Park City, Utah purchased in 1996 to provide entertainment and a meeting environment for significant current and prospective clients, brokers and others who assist in the Company's marketing efforts.
The following selected consolidated financial data of Sierra Health Services, Inc., and subsidiaries (the "Company"), for each of the fiscal years in the five-year period ended December 31, 1999 should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information which appears elsewhere in this Annual Report on Form 10-K. The selected consolidated financial data below has been derived from the audited Consolidated Financial Statements of the Company.
(1) The Company recorded certain identifiable impairment, settlement and other costs. See Note 15 of Notes to the Consolidated Financial Statements.
On October 31, 1998, Sierra Health Services, Inc. ("Sierra") and one of its subsidiaries, Texas Health Choice, L.C. (formerly HMO Texas L.C.) completed the acquisition of certain assets of Kaiser Foundation Health Plan of Texas ("Kaiser-Texas"), a health plan operating in Dallas/Ft. Worth, and Permanente Medical Association of Texas ("Permanente"), a medical group with approximately 150 physicians. The purchase price was $124 million, which was net $20 million in operating cost support paid to Sierra by Kaiser Foundation Hospitals in four quarterly installments following the closing of the transaction. The purchase price allocation included a premium deficiency reserve of $25 million for estimated losses on the contracts acquired from Kaiser-Texas. The purchase price also included amounts for real estate and eight medical and office facilities with approximately 500,000 square feet. In December 1998, certain accreditation goals were met by the health plan resulting in a purchase price increase of $3.0 million to $127 million. The purchase price may increase up to an additional $27 million over three years if certain growth and member retention goals are met by the health plan; however, preliminary results indicate these goals were not met for the first year. Sierra assumed no prior liabilities for malpractice or other litigation, or for any unanticipated future adjustments to claims expenses for periods prior to closing. The transaction was financed with a five-year revolving credit facility and a $35.2 million note payable to Kaiser Foundation Health Plan of Texas. The note is secured by the acquired real estate. Approximately $110 million of the $200 million revolving credit facility was used to fund the transaction.
On September 30, 1997, Sierra Military Health Services, Inc. ("SMHS"), a wholly owned subsidiary of the Company, was awarded a TRICARE contract to provide managed health care coverage to eligible
Impairment, settlement and other costs represent identifiable incremental costs the Company has incurred primarily in connection with various mergers, acquisitions and planned dispositions as well as expenses associated with the Company's proposal to serve TRICARE beneficiaries in Region 1 and the ultimate cost to settle the bid protest. Start-up expenses associated with the proposal to serve TRICARE beneficiaries were charged to operations upon notification of award. (See Note 15 of Notes to the Consolidated Financial Statements).
Specialty product revenue decreased $54.1 million, or 36.5%, for the year ended December 31, 1999 compared to the prior year. Of the decrease, $51.1 million was due to a decrease in revenue in the workers' compensation operations segment and $3.0 million was due to a decrease in administrative services revenue. The decrease in specialty product revenues related to the workers' compensation insurance segment was primarily due to a full year of additional ceded reinsurance premiums on the low level reinsurance agreement effective July 1, 1998, totaling $60.7 million. This agreement was entered into in the fourth quarter of 1998. In addition, ongoing price competition, especially in California, is contributing to the reduction in revenue. The decrease in administrative services revenue was primarily attributable to a decrease in membership.
Adverse Development and Contractual Adjustments. In the fourth quarter of 1999, the Company recorded approximately $18.0 million in non-recurring medical expenses, of which $11.2 million primarily related to an adjustment to the estimate for medical expenses recorded in previous periods. The remaining non-recurring amount primarily relates to contractual settlements with providers of medical services. (See Note 15 of Notes to the Consolidated Financial Statements).
Impairment, Settlement and Other Costs. In March 1999, the Company closed all inpatient operations at Mohave Valley Hospital, a 12-bed acute care facility in Bullhead City, Arizona, and terminated approximately 45 employees. The Company recorded a charge of $4.3 million related primarily to the write-off of goodwill associated with the Mohave Valley operations. The Company also incurred $450,000 for certain legal and contractual settlements and $400,000 to provide for the Company's portion of the write-off of start-up costs at the Company's equity investee, TriWest HealthCare Alliance in accordance with Statement of Position 98-5.
During the fourth quarter of 1999, the Company recorded $13.7 million of non-recurring costs. Of this amount $11.0 million was recorded in conjunction with a premium deficiency accrual for contracts in the Texas market and represents general and administrative costs, in excess of those covered by premiums, the Company will incur to service these contracts. The remaining expense is primarily related to contractual settlements.
Income Taxes. For 1999, the Company recorded approximately $5.9 million of tax benefit compared to a tax expense of $13.8 million in the prior year. Due to a change in tax law, which took effect in 1999, the Company was able to utilize a $1.6 million net operating loss carryover that had previously not been recognized in the financial statements due to uncertainty about its realization. Excluding the effect of this change, the effective tax rate was 41.3% compared to 25.8% in 1998. Including the effect of this change, the effective tax rate for 1999 was 56.2%. The difference between the effective tax rate, excluding the change in the deferred tax valuation allowance, and the statutory rate is due to income earned on tax preferred investments. The effective tax rate for the year 2000 is projected to range from 33% to 35%. The difference between the anticipated tax rate and the statutory tax rate is due primarily to investments in tax preferred investments offset by state income taxes.
Medical premium revenue from the Company's HMO and managed indemnity insurance subsidiaries increased $95.5 million, or 18.6%. Excluding the effect of the Kaiser-Texas acquisition in the fourth quarter of 1998, premium revenue increased $66.9 million, or 13.0%. The $66.9 million increase in premium revenue reflects a 3.4% increase in member months. Medicare member months increased 20.1% which contributed to the increase in medical premium revenue. Such growth in Medicare member months contributes significantly to the increase in premium revenues as the Medicare per member premium rates are over three times higher than the average commercial premium rate. The Company's premium rates increased an average of 3% to 4% for its HMO commercial groups and in excess of 10% for managed indemnity commercial groups. The Company also realized a slight increase in its capitation rate established by HCFA.
Medical and Specialty Product Expenses. The Medical Care Ratio increased from 76.9% to 78.4% for the year ended December 31, 1998 compared to the prior year. The increase in the medical care ratio was due to an increase in Medicare members as a percentage of fully-insured members, continued expansion in Texas, northern Nevada and Arizona which have higher medical care ratios, higher pharmacy costs and the acquisitions of THC and two medical clinics for which costs of operations are included in medical expenses. The cost of providing medical care to Medicare members generally requires a greater percentage of the premiums received. Pharmacy costs increased as the management of the pharmacy benefit was transitioned from a capitated pharmacy benefits contract to in-house management in the third quarter of 1998. The costs under such capitation contract were substantially below actual claims experience. Included in medical expenses is the reversal of $4.4 million of premium deficiency reserve that was used to offset losses on contracts from the Kaiser-Texas operations that were acquired on October 31, 1998.
The combined ratio for the workers' compensation insurance business was 98.7% compared to 101.9% for the prior year. The reduction was due to a 198 basis point decrease in the LAE ratio and a 122 basis point decrease in the underwriting expense ratio. The decrease in the loss ratio was largely due to the new reinsurance agreement for losses occurring on and after July 1, 1998 and as a result of the Company's ability to overlay and implement managed care techniques to the workers' compensation claims. The combined ratio excluding the effect of the new reinsurance agreement was 101.6% for the year ended December 31, 1998. In addition, favorable loss development on prior accident years totaled $9.6 million for the year ended December 31, 1998, compared to net favorable loss development of $9.0 million for the prior year. The favorable loss development is largely due to actual paid losses being below projected losses. There can be no assurance that favorable development, or the magnitude thereof, will continue in the future. The reduction in the expense ratio was largely due to a reduction in agents' commissions, as a result of a ceding commission related to the new reinsurance agreement and from lower salaries and related benefits expenses.
Military Contract Expenses. The military contract expenses are comprised of those expenses incurred in 1998 for five months of contract implementation and seven months of health care delivery. This expense consists primarily of costs to provide managed health care services to eligible beneficiaries in accordance with the Company's TRICARE contract. Under the contract, SMHS provides health care services to dependents of active duty military personnel and military retirees and their dependents through subcontractor partnerships and individual providers. Health care costs are recorded in the period when services are provided to eligible beneficiaries, including estimates for provider costs which have been incurred but not reported to the Company. Also, included in military contract expenses are costs incurred to perform specific administrative services, such as health care appointment scheduling, enrollment, network management and health care advice line services, and other administrative functions of the military health care subsidiary.
General, Administrative and Marketing Expenses. G&A cost increased $16.8 million, or 17.9%, compared to 1997. As a percentage of revenues, G&A costs for 1998 decreased to 10.7% from 13.0% during 1997. The decrease in the G&A ratio is primarily due to the addition of military contract revenues offset in part by costs for additional infrastructure needed to support overall Company growth. Excluding military revenues, G&A as a percentage of revenues was 13.3% in 1998. Of the $16.8 million increase in G&A, $3.2 million was due to additional G&A related to the acquired HMO business in the Dallas/Ft. Worth area. The remaining increase of $13.6 million consisted of $3.8 million increased compensation expense, resulting primarily from additional employees supporting expanded services and new benefit programs for management. Broker, third party administration and premium tax expense increased approximately $900,000 due to increased membership. In addition, depreciation expense increased $1.7 million.
On March 18, 1997, the Company announced it had terminated its merger agreement with Physician Corporation of America, Inc. and recorded expenses of $11.0 million, $8.4 million after tax, for merger-related costs. During the third quarter of 1997, SMHS was awarded a contract to serve TRICARE eligible beneficiaries in Region 1. Development expenses of $18.4 million, $10.6 million after tax, were recorded in the third quarter primarily for expenses associated with the Company's proposal to serve TRICARE Region 1. Such expenses had been deferred until award notification.
Interest Expense and Other. Interest expense and other increased approximately $2.7 million for the year ended December 31, 1998, compared to the prior year due to an increase in debt as a result of the Kaiser- Texas acquisition.
Income Taxes. For 1998, the Company recorded approximately $13.8 million of tax expense for an effective tax rate of 25.8% compared to 23.9% in 1997, excluding the tax effects of identifiable integration, settlement and other costs. The Company's low operating tax rate is primarily a result of tax-preferred investments and the change in the deferred tax valuation allowance, which is due primarily to the ability to use a portion of net operating loss carryovers.
The Company had negative cash flows from operating activities of $7.7 million for the twelve months ended December 31, 1999, resulting primarily from a net change in assets and liabilities of $41.9 and a net loss of $4.6 million, offset by $28.1 million in depreciation and amortization, $7.2 million in provision for doubtful accounts and a $3.5 million provision for goodwill impairment. The decrease in cash flow resulting from the change in assets and liabilities was primarily due to increases in reinsurance recoverable of $69.8 million, as well as the utilization of premium deficiency reserves. The increase in reinsurance recoverable is primarily due to the low level reinsurance agreement implemented by the Company's workers' compensation insurance business in the fourth quarter of 1998. Offsetting the cash outflows related to changes in assets and liabilities is a $32.1 million increase in the reserve for workers' compensation losses and loss adjustment expense due to increased business as well as a $9.9 million adjustment related to adverse development on prior accident years. Additionally, medical claims payable increased $13.6 million due to overall growth of the Company and military accounts receivable decreased $8.9 million due to payments received from DoD.
Net cash used for investing activities during 1999 included $58.5 million in capital expenditures associated with continued implementation of three new computer systems, as well as construction, furniture, equipment and other capital needs to support the Company's growth. Additionally, in the first quarter of 1999, $3.0 million was paid to Kaiser Foundation Health Plan of Texas in accordance with the purchase agreement as certain accreditation goals were met by the health plan. The purchase price may increase up to an additional $27 million over three years if certain goals are met by the health plan; however, preliminary results indicate these goals were not met for the first year. Offsetting the above cash outflows was $29.9 million net change in investments.
Cash flows from financing activities included net proceeds from long-term borrowings (proceeds less payments) of $15.9 million. In 1998 the Company utilized a five-year revolving credit facility to finance the Kaiser-Texas acquisition. As of December 31, 1999, the Company had $160 million in borrowings on the $200 million line of credit. Interest under the credit facility is variable and based on the London Interbank Offering Rate ("LIBOR") plus a margin determined by reference to the Company's leverage ratio. In addition, $50 million of the outstanding balance is covered by interest-rate swap agreements. The average cost of
During 1999, the Company used $8.0 million to buy back Company stock on the open market. Under the current terms of the Company's revolving credit facility, the Company may not continue to buy back its stock without the consent of the lenders or until after December 31, 2000 if certain covenant ratios are met.
In the second quarter of 1997, the Company's Board of Directors authorized a $3.0 million line of credit from the Company to the Company's Chief Executive Officer ("CEO"). The CEO borrowed a total of $650,000 in 1998 and $2 million in 1997 at an interest rate equal to the rate at which the Company is able to borrow funds under the credit facility at the time of the borrowing plus 10 basis points. During the first quarter of 1999, the CEO repaid approximately $360,000 of the line of credit. The line of credit is collateralized by certain of the CEO's rights to compensation from the Company and is due and payable no later than August 15, 2001.
In September 1991, CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. The Debentures bear interest at 7 1/2% which is due semi-annually on March 15 and September 15. Each $1,000 in principal is convertible into 25.382 shares of the Company's common stock at a conversion price of $39.40 per share. Unamortized issuance costs of $362,000 are included in other assets on the balance sheet and are being amortized over the life of the Debentures. The Debentures are general unsecured obligations of CII only and are not guaranteed by Sierra Health Services, Inc. ("Sierra"). At December 31, 1999, CII had total assets of $402.4 million, consisting primarily of investments and reinsurance recoverable, and total liabilities of $336.3 million, consisting primarily of reserves for losses and loss adjustment expense and the debentures. For the year ended December 31, 1999, CII had net premiums earned of $82.9 million and investment and other revenue of $15.4 million, and total operating expenses of $91.0 million. During the twelve months ended December 31, 1999, the Company purchased $753,000 of the Debentures on the open market.
The holding company may receive dividends from its HMO and insurance subsidiaries which generally must be approved by certain state insurance departments. During 1999, the holding company received $9.7 million in dividends from its HMO and insurance subsidiaries. The Company's HMO and insurance subsidiaries are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The Company had restricted assets on deposit in various states totaling $21.7 million as of December 31, 1999. The HMO and insurance subsidiaries must also meet requirements to maintain minimum stockholder's equity, on a statutory basis, ranging from $1.1 million to $5.2 million. In addition, in conjunction with the Kaiser-Texas acquisition, Texas Health Choice, L.C. ("TXHC") entered into a letter agreement with the Texas Department of Insurance whereby TXHC agreed to maintain a net worth of $20.0 million. Of the $274.9 million of cash and cash equivalents and current investments held at December 31, 1999, $267.5 million is designated for use only by the regulated subsidiaries. Such amounts are available for transfer to the holding company from the HMO and insurance subsidiaries only to the extent that they can be remitted in accordance with the terms of existing management agreements and by dividends. Remaining amounts are generally available on an unrestricted basis.
The National Association of Insurance Commissioners ("NAIC") has adopted minimum capitalization requirements for HMOs, health care insurance entities and other risk-bearing health care entities. The state of Nevada has not adopted these regulations as of December 31, 1999. If the regulations were adopted as
The Company has a 2000 capital budget of approximately $25 million, primarily for computer hardware and software, furniture and equipment and other requirements due to the Company's computer system conversion and projected growth and expansion. The Company's liquidity needs over the next 12 months will primarily be for the capital items noted above, debt service and expansion of the Company's operations, including potential acquisitions. The Company believes that existing working capital, operating cash flow and, if necessary, mortgage financing, equipment leasing, divestitures of certain non-core assets, and amounts available under its credit facility should be sufficient to fund its capital expenditures and debt service. Additionally, subject to unanticipated cash requirements, the Company believes that its existing working capital and operating cash flow and, if necessary, its access to new credit facilities, should enable it to meet its liquidity needs on a longer term basis.
The Year 2000 issue existed because many computer systems and applications used two-digit date fields to designate a year. As the century date change occurred, date-sensitive non-compliant systems may have recognized the year 2000 as 1900, or not at all. This inability to recognize or properly treat the Year 2000 may have caused systems to process critical financial and operational information incorrectly.
In March 1998, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants ("AcSEC") issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of Computer Software Developed For or Obtained For Internal Use". SOP 98-1 requires certain computer software costs to be capitalized and amortized over the software's estimated useful life. In June 1998, the AcSEC issued Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up Activities". This standard requires organization costs and costs associated with start-up activities to be expensed as incurred. Both statements are effective for years beginning after December 15, 1998. The Company adopted SOP 98- 1 and SOP 98-5 for the fiscal year ending December 31, 1999. These statements did not have a material impact on its financial statements.
In June 1998, The Financial Accounting Standards Board issued "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 is effective for fiscal years beginning after June 15, 2000. FAS 133 addresses the accounting for derivative instruments including certain derivative instruments embedded in other contracts, and hedging activities. The Company does not believe this statement will have a material impact on its financial statements.
We have audited the accompanying consolidated balance sheets of Sierra Health Services, Inc., and its subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the index at Item 14 (a)(2). These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
The acquisition has been recorded using purchase accounting and the excess of the purchase price over the fair value of the assets acquired was recorded as goodwill. Total goodwill, in the amount of $126.8 million, is being amortized on a straight line basis over 40 years.
Principles of Consolidation. All significant intercompany transactions and balances have been eliminated. Sierra's consolidated subsidiaries include: Health Plan of Nevada, Inc. ("HPN") and TXHC, licensed HMOs; Sierra Health and Life Insurance Company, Inc. ("SHL"), a health and life insurance company; Southwest
Premium Deficiency Reserves. Premium deficiency expenses are recognized when it is probable that the future costs associated with a group of existing contracts will exceed the anticipated future premiums on those contacts. The Company calculates expected premium deficiency expense based on budgeted revenues and expenses. Premium deficiency reserves are evaluated quarterly for adequacy.
Military Contract Expenses. This expense consists primarily of costs to provide managed health care services to eligible beneficiaries in accordance with the Company's TRICARE contract. Under the contract, SMHS provides health care services to approximately 610,000 dependents of active duty military personnel and military retirees and their dependents through subcontractor partnerships and individual providers. Health care costs are recorded in the period when services are provided to eligible beneficiaries including estimates for provider costs which have been incurred as of the balance sheet date but not reported to the Company. Also included in military contract expenses are costs incurred to perform specific administrative services, such as health care appointment scheduling, enrollment, network management and health care advice line services, and other administrative functions of the military health care subsidiary.
Reserve for Losses and Loss Adjustment Expense. The reserve for workers' compensation losses and LAE consists of estimated costs of each unpaid claim reported to the Company prior to the close of the accounting
Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many different industries. These customers are primarily located in the states in which the Company operates. Such operations are principally in California, Nevada and Texas. However, the Company is licensed and does business in several other states as well. As of December 31, 1999, the Company has receivables outstanding from the federal government related to its TRICARE contract in the amount of $60.3 million. The Company also has receivables from certain reinsurers. Reinsurance contracts do not relieve the Company from its obligations to enrollees or policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. All reinsurers that the Company has reinsurance contracts with are rated A- or better by the A.M. Best Company.
Recently Issued Accounting Standards. In June 1998, The Financial Accounting Standards Board issued "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). FAS 133 is effective for fiscal years beginning after June 15, 2000. FAS 133 addresses the accounting for derivative instruments including certain derivative instruments embedded in other contracts, and hedging activities. The Company does not believe this statement will have a material impact on its financial statements.
Reclassifications. Certain amounts in the Consolidated Financial Statements for the years ended December 31, 1998 and 1997 have been reclassified to conform with the current year presentation.
The following table provides a reconciliation of basic and diluted earnings per share ("EPS"):
Options to purchase 3,904,000 shares of common stock were outstanding at December 31, 1999 but were not included in the computation of 1999 diluted earnings per share because the Company had a net loss for 1999 and their inclusion would have been antidilutive.
CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. Each $1,000 in principal is convertible into 25.382 shares of the Company's common stock at a conversion price of $39.40 per share. The Debentures were not included in the computation of EPS because their effect would be anti-dilutive. At December 31, 1999, common stock shares reserved for potential issuance in connection with the subordinated debentures were 1,442,000.
Investments that the Company has the intention and ability to hold to maturity are stated at amortized cost and categorized as held-to-maturity. The remaining investments have been categorized as available-for-sale and are stated at their fair value. Fair value is estimated primarily from published market values as of the balance sheet date. Unrealized holding gains and losses on available-for-sale securities are included as a separate component of stockholders' equity until realized. Gross realized gains on investments in 1999, 1998 and 1997 were $334,000, $4,789,000 and $2,878,000, respectively. Gross realized losses on investments in 1999, 1998 and 1997 were $733,000, $2,511,000 and $2,373,000, respectively. Realized gains and losses are calculated using the specific identification method and are included in net income.
The following table summarizes the Company's current, long-term restricted investments as of December 31, 1999:
Of the cash and cash equivalents and current investments that total $274.9 million in the accompanying Consolidated Balance Sheet at December 31, 1999, $267.5 million is limited for use only by the Company's regulated subsidiaries. Such amounts are available for transfer to Sierra from the regulated subsidiaries only to the extent that they can be remitted in accordance with terms of existing management agreements and by dividends, which customarily must be approved by regulating state insurance departments. The remainder is available to Sierra on an unrestricted basis.
At December 31, 1999 and 1998, the amount of reinsurance recoverable under prospective reinsurance contracts for unpaid losses and loss adjustment expenses for CII was $110,089,000 and $37,797,000, respectively. At December 31, 1999 and 1998, the amount of reinsurance recoverable under the retroactive reinsurance contract was $14,842,000 and $18,710,000, respectively. The amount of reinsurance receivable for paid losses and loss adjustment expenses was $6,931,000 and $1,917,000, at December 31, 1999 and 1998, respectively.
The following table provides workers' compensation prospective reinsurance information for the three years ended December 31, 1999:
The following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and LAE. The loss estimates are subject to change in subsequent accounting periods and any change to the current reserve estimates would be accounted for in future results of operations.
Revolving Credit Facility. On October 31, 1998, the Company replaced its prior line of credit with a $200 million credit facility under which it has $160 million in borrowings outstanding as of December 31, 1999. Interest under the credit facility is variable and based on the London Interbank Offering Rate plus a margin determined by reference to the Company's leverage ratio. Of the outstanding balance, $50 million is covered by interest-rate swap agreements. To mitigate the risk of interest rate fluctuation on the credit facility, the Company entered into a five-year $50 million interest-rate swap agreement during the fourth quarter of 1998. The intent of the agreement is to keep the Company's interest rate on $50 million of the borrowing relatively fixed. The average cost of borrowing on this line of credit for 1999, including the impact of the swap agreements, was approximately 7.8%. The terms of the credit facility contain a mandatory payment schedule
7 1/5% Mortgage Note. In January 1998, the Company obtained a $15,000,000 loan from Bank of America, Nevada at an interest rate of 7 1/5%. This loan is secured by a deed of trust, assignment of rents and leases, and a security agreement and fixture filing covering a portion of the Company's administrative headquarters complex and underlying real property.
Scheduled maturities of the Company's notes payable and future minimum payments under capital leases, together with the present value of the net minimum lease payments at December 31, 1999, are as follows:
The fair value of the Debentures at December 31, 1999 was $35,601,000, which was determined based on the estimated market price on December 31, 1999. Excluding the Debentures, the fair value of long-term debt, including the current portion, is estimated to be approximately $209,446,000 based on the borrowing rates currently available to the Company .
At December 31, 1999, the Company had approximately $29,530,000 of regular tax net operating loss carryforwards. The net operating loss carryforwards can be used to reduce future taxable income until they expire through the year 2019. In addition to the net operating loss carryforwards, the Company has alternative minimum tax credits of approximately $7,216,000 which can be used to reduce regular tax liabilities in future years. There is no expiration date for the alternative minimum tax credits.
A valuation allowance was established to reflect the Company's inability to use tax benefits from certain acquisitions currently or in the near future. Due to a change in tax laws and the Company's ability to realize tax benefits for which a valuation allowance had been previously established, the Company reduced its valuation allowance by $1,575,000, $4,691,000 and $4,663,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Included in other current receivables in the December 31, 1999 balance sheet is a tax receivable of $10,518,000.
Litigation and Legal Matters. The Company is subject to various claims and other litigation in the ordinary course of business. Such litigation includes claims of medical malpractice, claims for coverage or payment for medical services rendered to HMO members and claims by providers for payment for medical services rendered to HMO members. Also included in such litigation are claims for workers' compensation and claims by providers for payment for medical services rendered to injured workers. In the opinion of the Company's management, the ultimate resolution of pending legal proceedings should not have a material adverse effect on the Company's financial condition.
The Company expensed $289,000, $78,000 and $27,000 in the years ended December 31, 1999, 1998 and 1997 respectively, for legal fees to a Nevada law firm of which a non-employee director of the Company is a shareholder.
Defined Contribution Plan. The Company has a defined contribution pension and 401(k) plan (the "Plan") for its employees. The Plan covers all employees who meet certain age and length of service requirements. For the years ended December 31, 1998 and 1997 and for the six months ended June 30, 1999, the Company contributed a maximum of 2% of eligible employees' compensation and matched 50% of a participant's elective deferral up to a maximum of either 10% of an employee's compensation or the maximum allowable under current IRS statute. Effective July 1, 1999, the Plan was modified such that the Company matches 50%-100% of an employee's elective deferral and the maximum Company match is 6% of a participant's annual compensation, subject to Internal Revenue Service limits. The Plan does not require additional Company contributions. Expense under the plan totaled $6,736,000, $4,522,000 and $3,929,000 in 1999, 1998 and 1997, respectively.
Supplemental Retirement Plans. The Company has Supplemental Retirement Plans (the "SRPs") for certain officers, directors and highly compensated employees. The SRPs are non-qualified deferred compensation plans through which participants may elect to postpone the receipt and taxation of all or a portion of their salary and bonuses received from the Company. The Company also matches 50% of those contributions that participants are restricted from deferring, if any, under the Company's pension and 401(k) plan. As contracted with the Company, the participants or their designated beneficiaries may begin to receive benefits under the SRPs upon participant death, disability, retirement, termination of employment or certain other circumstances including financial hardship.
Supplemental Executive Retirement Plan ("SERP"). Effective July 1, 1997, the Company adopted a defined benefit retirement plan covering certain key employees. The Company is funding the benefits through the purchase of certain life insurance policies. Benefits are based on, among other things, the employee's average earnings over the five-year period prior to retirement or termination, and length of service. Benefits attributable to service prior to the adoption of the plan are amortized over the estimated remaining service period for those employees participating in the plan. In 1998, the Company expanded the SERP to include more participants. The effect of adding these participants is included in plan amendments in the reconciliation below.
Stockholders' Rights Plan. Each share of Sierra common stock, par value $.005 per share, contains one right (a "Right"). Each Right entitles the registered holder to purchase from Sierra a unit consisting of one one- hundredth (.001) of a share of the Sierra Series A Junior Participating Preferred Shares (a "Unit"), par value $.01 per share, or a combination of securities and assets of equivalent value, at a purchase price of $100.00 per Unit, subject to adjustment. The Rights have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire Sierra on terms not approved by Sierra's Board of Directors, except pursuant to an offer conditioned on a substantial number of Rights being acquired. The Rights should not interfere with any merger or other business combination approved by the Board of Directors since Sierra may redeem the Rights at the price of $.02 per Right prior to the time that a person or group has acquired beneficial ownership of 20% or more of Sierra common stock.
Employee Stock Purchase Plans. The Company has employee stock purchase plans (the "Purchase Plans") whereby employees may purchase newly issued shares of stock through payroll deductions at 85% of the fair market value of such shares on specified dates as defined in the Purchase Plans. As of December 31, 1999, the Company had 294,000 shares reserved for purchase under the Purchase Plans. During 1999, a total of 163,000 shares were purchased at prices of $17.85 and $11.70 per share. During January 2000, 164,000 shares were purchased by employees at $5.68 per share in connection with the Purchase Plans.
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1999, 1998 and 1997, respectively: dividend yield of 0% for all years; expected volatility of 43%, 37% and 35%; risk-free interest rates of 5.87%, 4.46% and 5.89%; and expected lives of four to five years. The weighted average fair value of options granted in 1999, 1998 and 1997 was $3.77, $9.92 and $8.27, respectively.
Due to the fact that the Company's stock option programs vest over many years and additional awards are made each year, the above pro forma numbers are not indicative of the financial impact had the disclosure provisions of FAS 123 been applicable to all years of previous option grants. The above numbers do not include the effect of options granted prior to 1995.
Medical expenses reported in the first quarter of 1999 included a premium deficiency charge of $8.1 million related to losses in under-performing markets primarily in Arizona and rural Nevada. In the fourth quarter of 1999, the Company recorded a premium deficiency charge of $21.0 million related to HMO contracts in the Texas market. Of this amount, $10.0 million was recorded in medical expenses and $11.0 million was recorded in the impairment, settlement and other costs line item. The $11.0 million is an estimate of general and administrative costs, in excess of those covered by premiums, the Company will incur to service the Dallas/Ft. Worth contracts. Also recorded in medical expenses during the fourth quarter is $11.2 million primarily related to an adjustment to the estimate for medical expenses recorded in previous years, and $6.8 million primarily related to contractual settlements with providers of medical services.
The remaining $7.8 million of impairment, settlement and other costs consists of charges in the first quarter of $5.1 million and additional charges of $2.7 million in the fourth quarter. In the first quarter of 1999, the Company recorded a charge of $4.3 million related primarily to the write-off of goodwill associated with the Mohave Valley operations. During the first quarter of 1999, the Company closed all inpatient operations at Mohave Valley Hospital, a 12-bed acute care facility in Bullhead City, Arizona, and terminated approximately 45 employees. The Company also incurred $450,000 for certain legal and contractual settlements and $400,000 to provide for the Company's portion of the write-off of start-up costs at the Company's equity investee, TriWest Healthcare Alliance. The remaining charges in the fourth quarter of 1999 consist primarily of legal and contractual settlements.
During the fourth quarter of 1998, the Company incurred settlement expenses totaling $8 million, $5.9 million after tax, related to the settlement of a competitor's protest for the Region 1 TRICARE contract. All of this amount was paid during fiscal year 1998. On September 30, 1997, SMHS was awarded a five-year, $1.2 billion contract to administer managed health care services to military families and retirees in 13 northeastern states and Washington, D.C. A competing bidder
During 1997, the Company recorded and paid expenses of approximately $11.0 million, $8.4 million after tax, for merger- related costs. On March 18, 1997, the Company announced it had terminated its merger agreement with Physician Corporation of America. The original agreement had been entered into in November 1996.
During the third quarter of 1997, SMHS was notified it had been awarded a TRICARE managed care contract by the Department of Defense to serve eligible beneficiaries in Region 1. This region includes more than 600,000 beneficiaries in 13 northeastern states and the District of Columbia. Development expenses of $18.4 million, $10.6 million net of taxes, were recorded in the third quarter, primarily for expenses associated with the Company's proposal to serve TRICARE beneficiaries in Region 1. Such expenses had been deferred until award notification. SMHS began health care delivery on June 1, 1998.
16. UNAUDITED QUARTERLY INFORMATION (Amounts in thousands, except per share data)
Information concerning the operations of the reportable segments is as follows: (Amounts in thousands)