The table below presents our selected consolidated financial information for the years indicated. The table 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 2001 Form 10-K. The selected consolidated financial data below has been derived from our audited Consolidated Financial Statements.
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES.......................... 26,269 (51,668) 12,732 58,819 29,987
(PROVISION) BENEFIT FOR INCOME TAXES........................ (8,803) 12,875 (2,209) (13,796) (3,234) --------- --------- --------- -------- -------
NET INCOME (LOSS)........................................... $ 3,486 $ (199,915) $ (4,631) $ 39,596 $ 24,241 ========= ========= ========= ======== =======
(1) We recorded certain identifiable asset impairment, restructuring, reorganization and other costs. See Note 17 of Notes to the Consolidated Financial Statements.
(2) Adjusted to account for three-for-two stock split of our common stock to stockholders of record as of May 18, 1998. -----------------
We derive revenues from our health maintenance organizations, managed indemnity, military health care services and workers' compensation insurance subsidiaries. To a lesser extent, we also derive additional specialty product revenues from non-HMO and insurance products (consisting of fees for workers' compensation administration, utilization management services and ancillary products), professional fees (consisting primarily of fees for providing health care services to non-members and co-payment fees received from members), and investment and other revenue.
Our principal expenses consist of medical expenses, military contract expenses, specialty product expenses, and general, administrative and marketing expenses. Medical expenses represent capitation fees and other fee-for-service payments paid to independently contracted physicians, hospitals and other health care providers to cover members, as well as the aggregate expenses to operate and manage our wholly owned multi-specialty medical group and other provider subsidiaries. As a provider of health care management services, we seek to positively affect quality of care and expenses by contracting with physicians, hospitals and other health care providers at negotiated price levels, by adopting quality assurance programs, monitoring and managing utilization of physicians and hospital services and providing incentives to use cost-effective providers. Military contract expenses represent payments to providers for health care services rendered under the TRICARE program, as well as administrative costs to operate the military health care subsidiary. Specialty product expenses primarily consist of losses and loss adjustment expenses, policy acquisition expenses and other general and administrative expenses associated with our workers' compensation insurance subsidiaries. General, administrative and marketing expenses generally represent operational costs other than those directly associated with the delivery of health care services, military contract services and specialty products.
In addition to the most critical accounting policies and estimates discussed above, other areas requiring us to use judgment, assumptions and estimates include, but are not limited to, allowance for retroactive health care premium revenue adjustments, workers' compensation earned but unbilled premiums, contractual discounts on professional fee revenue, allowances for doubtful receivables, litigation and legal settlement costs and accruals, other accrued liabilities, accrued payroll and taxes, unearned premium revenue and contingent assets and liabilities.
OPERATING REVENUES: Medical Premiums........................................ 55.7% 55.0% 57.3% Military Contract Revenues.............................. 26.2 28.5 27.7 Specialty Product Revenues ............................. 14.2 11.7 9.1 Professional Fees....................................... 2.2 2.9 4.0 Investment and Other Revenues .......................... 1.7 1.9 1.9 ----- ----- ----- Total................................................ 100.0 100.0 100.0 ----- ----- -----
OPERATING EXPENSES: Medical Expenses........................................ 47.1 49.7 51.5 Military Contract Expenses ............................. 25.7 27.9 26.6 Specialty Product Expenses.............................. 14.6 13.2 9.3 General, Administrative and Marketing Expenses.......... 9.1 9.1 9.1 Asset Impairment, Restructuring, Reorganization and Other Costs....................... 2.9 .7 ----- ----- ----- Total................................................... 96.5 102.8 97.2 ----- ----- -----
INTEREST EXPENSE AND OTHER, NET.............................. (1.4) (1.7) (1.6) ----- ----- -----
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES .................................... 2.1 (4.5) 1.2
(PROVISION) BENEFIT FOR INCOME TAXES........................ (0.7) 1.2 (0.2) ----- ----- -----
Total Operating Revenues for 2001 increased approximately 11.4% to $1.29 billion from $1.16 billion for 2000. Medical premium revenues accounted for approximately 55.7% and 55.0% of our total revenues for the years ended December 31, 2001 and 2000, respectively.
Military Contract Revenues increased $8.6 million or 2.6%. The increase in revenue is primarily the result of additive change order work and is significantly offset by increased military contract expenses associated with those change orders. The Congressionally approved DoD fiscal year 2001 budget included several sweeping changes to the TRICARE program. In April 2001, SMHS began implementation of a prescription drug program for beneficiaries over age 65 and the implementation of a waiver of co-payments for active duty family members. Both of these program modifications resulted from Congressional changes to the program. Likewise, in October 2001, SMHS implemented TRICARE for Life which is a comprehensive health care benefit to those retired military beneficiaries over age 65. SMHS only administers the expanded benefits to the over age 65 retiree military population. SMHS does not directly fund claims payment or bear any risk for the actual level of health care service utilization. Revenues associated with these new programs will carry forward into 2002.
If all five option periods of the contract with the DoD are exercised and no extensions of the performance period are made, health care delivery will end on May 31, 2003, followed by an additional eight month phase out of the Region 1 managed care support contract. The DoD has extended expiring TRICARE contracts in other regions and SMHS has recently begun negotiations with the DoD about a possible extension to the base contract.
Specialty Product Revenues increased $47.5 million or 34.9%. Revenue increased in the workers' compensation insurance segment by $48.4 million, which was offset by a slight decrease in administrative services revenue of $900,000. The increase in the workers' compensation insurance segment was primarily due to a lower amount of ceded reinsurance premiums.
As compared to the low level reinsurance agreement that expired on June 30, 2000, the new reinsurance agreement results in higher net earned premium revenues, as we retain more of the premium dollars, but also leads to our keeping more of the incurred losses. This resulted in a higher loss and loss adjustment expense ratio, or LAE ratio, as the percentage increase in the additional incurred losses was greater than the percentage increase in the additional premiums retained. The effect on the balance sheet of the new reinsurance agreement compared to the low level agreements will eventually result in a lower amount of reinsurance recoverables, and due to the length of time over which claims expenses are typically paid, we expect to see an increase in future operating cash flow and amounts available to be invested.
Professional Fees decreased $4.2 million or 12.4% due primarily to the closing of our affiliated medical group in Arizona during 2000.
Medical expenses reported in the first quarter of 2000 included $1.0 million of prior period reserve strengthening. In the second quarter of 2000, we recorded changes in estimate charges of $15.5 million for reserve strengthening primarily due to adverse development on prior years' medical claims and $9.5 million of other non-recurring medical costs primarily relating to the write-down of certain medical subsidiary assets.
Military Contract Expenses increased $8.4 million or 2.6%. The increase is consistent with the increase in revenues discussed previously. Health care delivery expense consists primarily of costs to provide managed health care services to eligible beneficiaries in accordance with Sierra's TRICARE contract. Under the contract, SMHS provides health care services to approximately 639,000 dependents of active duty military personnel and military retirees under the age of 65 and their dependents through a network of nearly 50,000 health care providers and certain other subcontractor partnerships. 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. These administrative services are performed for active duty personnel and family members as well as retired military families.
Specialty Product Expenses increased $35.8 million or 23.5%. Expenses increased in the workers' compensation operations by approximately $38.3 million as a direct result of the costs associated with the increase in workers' compensation premiums and associated loss and loss adjustment expenses. This increase was offset by a decrease in administrative services expense of $2.5 million.
The increase in the workers' compensation insurance segment expenses is primarily due to the following:
o In 2001, we recorded $8.7 million of net adverse loss development for prior accident years compared to net adverse loss development of $23.3 million recorded in 2000. The net adverse development recorded was largely attributable to higher costs per claim, or claim severity, in California. Higher claim severity has had a negative impact on the entire California workers' compensation industry.
o We established a higher loss and LAE ratio for the 2001 accident year, which has resulted in an increase of approximately $12.5 million. The majority of the increase is due to the termination of the low level reinsurance agreement on June 30, 2000, which results in a higher risk exposure on policies effective after that date and a higher amount of net incurred loss and LAE.
The net adverse loss development on prior accident years included those years that were covered by our low level reinsurance agreement. This results in an increase in the reinsurance recoverable balance which is then reduced by amounts collected from reinsurers. Net reinsurance recoverable decreased by $29.1 million in 2001 while they increased by $115.3 million in 2000.
In February 2002, California enacted Assembly Bill 749. This new legislation will increase benefits paid to injured workers starting January 1, 2003. The Workers' Compensation Insurance Rating Organization of California, or WCIRB, has preliminarily estimated that the new legislation will increase the loss costs for accident year 2003 by approximately 7%. Increased loss costs, such as benefit increases, are normally built into the rating-making process so that premiums are increased to cover the increase in costs. Although we intend to increase our premiums, there is no assurance that our increase will be sufficient or that the WCIRB's estimate is accurate.
The loss and LAE reserves recorded as of December 31, 2001 reflect our best estimate of the ultimate loss costs for reported and unreported claims occurring in accident year 2001 as well as those occurring in accident years prior to 2001 and is slightly in excess of our independent actuary's estimate. Workers' compensation claim payments are made over several years from the date of the claim. Until the final payments for reported claims are made, reserves are invested to generate investment income.
Under our low level reinsurance agreement, we reinsured 30% of the first $10,000 of each claim, 75% of the next $40,000 and 100% of the next $450,000. The maximum net loss retained on any one claim ceded under this agreement was $17,000. This agreement covered all policies in force at July 1, 1998 and continued until June 30, 2000, when we exercised an option to extend coverage to all policies in force as of June 30, 2000. The termination of the low level agreement will result in our keeping more retained losses and LAE. However, our California premium rates have been increasing, which we believe will largely mitigate the loss of this favorable reinsurance protection. The premium rate increases on policies renewed in California during 2001 were approximately 38%. For policies effective from July 1, 2000, we obtained excess of loss reinsurance for 100% of the losses above $250,000 and less than $500,000. This agreement terminated on June 30, 2001 and only covered claims with dates of injury occurring by that date. We already had an existing excess of loss reinsurance agreement that covered 100% of the losses above $500,000. The latter reinsurance agreement is a fixed rate multi-year contract that will expire December 31, 2002. We intend to execute an option to extend the coverage for all policies in force as of December 31, 2002 until they expire.
The combined ratio is a measurement of the workers' compensation underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 106.1% compared to 115.8% for 2000. The decrease was primarily due to significantly higher prior year adverse loss development recorded during 2000. Excluding adverse loss development, the combined ratio would have been 101.1% for 2001 and 97.3% for 2000. The increase in the accident year loss and LAE ratio was primarily due to the run off of the low level reinsurance, which is resulting in our retaining more of the incurred losses. The underwriting expense ratio decreased primarily due to higher retained net earned premiums.
General, Administrative and Marketing Expenses, or G&A, increased $12.4 million or 11.8%. As a percentage of revenues, G&A expenses were 9.1% for both periods. As a percentage of medical premium revenue, G&A expenses were 16.4% for 2001 compared to 16.5% for 2000.
Provision for Income Taxes was recorded at $8.8 million for 2001 compared to a tax benefit of $12.9 million for 2000. The effective tax rate for 2001 was 33.5% compared to 24.9% for 2000. The effective tax rate for 2000 reflects the non-deductibility of certain portions of goodwill impairment expense recorded during the period. Excluding the effect of the goodwill impairment expense, the effective tax rate for both periods was approximately 33.5%. Our ongoing effective tax rate is less than the statutory rate due primarily to tax preferred investments.
Discontinued Operations consist entirely of our Texas HMO health care operations. See Note 10 of the Notes to the Consolidated Financial Statements. We elected to early adopt Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", or SFAS No. 144, effective January 1, 2001. In the third quarter of 2001, we decided to exit the Texas HMO health care market and received approval from the Texas Department of Insurance in mid-October 2001. We will cease providing HMO health care coverage on April 17, 2002. In accordance with SFAS No. 144, our Texas HMO health care operations are now reclassified as a discontinued operation. The net loss from discontinued operations was $14.0 million in 2001 compared to $161.1 million in 2000. Included in the 2001 loss are estimated costs to exit the Texas HMO health care market of $17.1 million. Included in the 2000 loss were the following: (a) asset impairment charges of $126.4 million for impaired goodwill; (b) $36.5 million for impaired real estate and other fixed assets; (c) medical expenses of $14.7 million, primarily for adverse development on prior periods' medical claims; (d) $15.5 million for premium deficiency medical costs; (e) $10.4 million for premium deficiency maintenance costs; and (f) other restructuring, reorganization and other costs of $13.3 million. The utilization of prior premium deficiency reserves were $23.3 million in 2001 and $32.4 million in 2000.
Total Operating Revenues for 2000 increased approximately 11.6% to $1.16 billion from $1.04 billion for 1999. Medical premium revenues accounted for approximately 55.0% and 57.3% of our total revenues for the years ended December 31, 2000 and 1999, respectively. The decrease in medical premiums as a percentage of total revenues in 2000 is primarily due to the increase in specialty product and military contract revenues.
Professional Fees decreased $9.0 million or 21.3%. The revenue for 1999 included the inpatient operations at the Mohave Valley Hospital until they were closed during the first quarter of 1999. The fees in 2000 also reflect staffing reductions and subsequent closure of our affiliated medical group in Arizona.
Medical Expenses increased $42.1 million or 7.9%. Excluding the effects of changes in estimate charges, medical expenses increased approximately $38.2 million or 7.5%. Medical expenses as a percentage of medical premiums and professional fees increased from 80.5% to 82.1%, excluding changes in estimate charges and premium deficiency as described below. The increase is primarily due to an increase in Medicare members as a percentage of fully-insured members. The cost of providing medical care to Medicare members generally requires a greater percentage of the premiums received.
Specialty Product Expenses increased $56.2 million or 58.3%. Of the increase, approximately $32.1 million is a direct result of the costs associated with the increase in workers' compensation premiums and associated loss and loss adjustment expenses.
We recorded net adverse loss development for prior accident years of $23.3 million in 2000 compared to $9.9 million in 1999. The net adverse development recorded in 1999 and 2000 for prior accident years was largely attributable to higher costs per claim, or claim severity, in California. Higher claim severity has had a negative impact on the entire California workers' compensation industry. The majority of the adverse loss development occurred on accident years that were not covered by our low level reinsurance agreement. While the low level reinsurance agreement was in run-off effective July 1, 2000, California premium rates have been increasing, which we believe will largely mitigate the loss of this very favorable reinsurance protection. The premium rate increases on policies renewed in California during the year ended December 31, 2000 were approximately 26% and for the second half of the year alone, averaged approximately 36%.
Asset Impairment, Restructuring, Reorganization and Other Costs for 1999 and 2000 are discussed below.
In assessing the asset impairment of the long-lived assets, we first allocated a portion of related goodwill to the fixed assets to be disposed of, in accordance with SFAS No. 121. The fixed assets were then written down to estimated fair value less costs to sell, which was determined from independent valuations. The remainder of the related goodwill was then assessed for recoverability in accordance with APB No. 17 based on projected discounted cash flows.
During the second quarter of 2000, we wrote-off capitalized costs of $3.0 million related to the application development of an information system software project for the workers' compensation operations, which was canceled because the vendor was unable to fulfill its contractual obligations. The amounts written off included software and consulting costs of $1.6 million and capitalized internal personnel costs of $1.4 million.
Restructuring and Reorganization. In the first quarter of 1999, we incurred $450,000 for certain legal and contractual settlements and $400,000 to provide for our portion of the write-off of start-up costs at our equity investee, TriWest Healthcare Alliance.
In the second quarter of 2000, we adopted a plan and announced additional restructuring of the Arizona managed health care operations. As a result of this restructuring, we recorded charges in accordance with Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring)" of approximately $2.0 million. Of the costs recorded, $1.2 million was for severance, $400,000 was related to clinic closures and lease termination and $400,000 was for other costs.
The table below presents a summary of asset impairment, restructuring, reorganization and other costs for the years indicated.
Restructuring Asset and (In thousands) Impairment Reorganization Other Total ---------- -------------- ----- -----
Charges recorded............................... $ 3,509 $ 850 3,449 7,808 Cash used...................................... (850) (2,819) (3,669) Noncash activity............................... (3,509) (3,509) Changes in estimate............................ - ------- ------ ------ ------- Balance, December 31, 1999..................... - - 3,449 3,449
Interest Expense and Other, Net increased $2.9 million or 17.3% due primarily to an increase in the average balance of outstanding debt and an increase in the average cost of borrowing. Our average credit facility debt balance was $183 million in 2000 compared to $164 million in 1999 and our average interest rate on the credit facility was 9.9% in 2000 compared to 7.8% in 1999.
Discontinued Operations consist entirely of our Texas HMO health care operations as previously discussed and described in Note 10 of the Notes to Consolidated Financial Statements. The net loss from discontinued operations was $161.1 million in 2000 compared to $15.2 million in 1999. Included in the 2000 loss were the following: (a) asset impairment charges of $126.4 million for impaired goodwill; (b) $36.5 million for impaired real estate and other fixed assets; (c) medical expenses of $14.7 million, primarily for adverse development on prior periods' medical claims; (d) $15.5 million for premium deficiency medical costs; (e) $10.4 million for premium deficiency maintenance costs; and (f) other restructuring, reorganization and other costs of $13.3 million. Included in the 1999 loss was a premium deficiency medical charge of $14.0 million and $11.0 million in premium deficiency maintenance costs. The utilization of prior premium deficiency reserves were $32.4 million in 2000 and $18.2 million in 1999.
We had cash flows from operating activities for continuing operations of $124.5 million for the year ended December 31, 2001 compared to $25.2 million in 2000. We used the majority of the cash flows to make cash payments for debt reductions of $81.0 million. Overall, discontinued operations used cash of $34.0 million in 2001 compared to providing cash of $11.6 million in 2000. The improvement in continuing operations over 2000 is primarily attributable to cash from earnings and the change in assets and liabilities.
o a source of cash due to the decrease in reinsurance recoverable of $31.6 million primarily from our workers' compensation business
o a source of cash due to the increase in the reserve for losses and loss adjustment expense of $11.2 million
o a source of cash due to the increase in medical claims payable of $7.3 million
o various other changes in assets and liabilities accounting for the remaining source of cash of $2.6 million
SMHS receives monthly cash payments equivalent to one-twelfth of its annual contractual price with the Department of Defense, or DoD. SMHS accrues health care revenue on a monthly basis for any monies owed above its monthly cash receipt based on the number of at-risk eligible beneficiaries and the level of military direct care system utilization. The contractual bid price adjustment, or BPA, process serves to adjust the DoD's monthly payments to SMHS, because the payments are based in part on 1996 DoD estimates for beneficiary population and beneficiary population baseline health care cost, inflation and military direct care system utilization. As actual information becomes available for the above items, quarterly adjustments are made to SMHS' monthly health care payment in addition to lump sum adjustments for past months. In addition, SMHS accrues change order revenue for DoD directed contract changes. During the second, third, and fourth quarters of 2001, SMHS received $22.2 million, $9.9 million and $4.6 million, respectively, as partial payments from the BPA process covering the period June 1, 1999 through August 31, 2001. As a result of preliminary data accumulated from the BPA process, SMHS received a partial upward adjustment of approximately $4.1 million to its monthly DoD payments for January 2001 through December 2001. Our business and cash flows could be adversely affected if the timing or amount of the BPA and change order reimbursements vary significantly from our expectations.
Our revolving credit facility balance decreased from $135 million to $89 million during the year. As a result of the asset impairment and other changes in estimate charges, we were not in compliance with our financial covenants at June 30, 2000. On December 15, 2000, we entered into an amended and restated credit agreement, which terminates on September 30, 2003, and are now in compliance with all covenants of the amended agreement. The restated agreement was amended in April 2001 to allow for the completion of the CII debenture exchange offer and again in October 2001 to provide a limited waiver for covenants affected by exiting the Texas HMO health care market. The availability under the credit facility has been reduced to $117 million at December 31, 2001 from $135 million at the end of 2000 due to reductions required in the agreement. At December 31, 2001, we had $28 million available under the credit facility, however the total availability will be reduced by $6.0 million on June 30, 2002 and December 31, 2002 and finally by $10.0 million on June 30, 2003.
The average cost of borrowing on the credit facility for 2001, including the amortization of deferred financing fees and the impact of the swap agreement, was 10.6%. The terms of the amended and restated credit agreement contain certain covenants including a minimum fixed charge coverage ratio, a minimum interest coverage ratio, a maximum leverage ratio, maximum loss ratios and maximum capital expenditure amounts. We believe that we are in compliance with these covenants at December 31, 2001.
Going forward, under certain circumstances, we will be required to make prepayments on the credit facility and the amount available to us under the credit facility will be further reduced. For example, 80% of any excess cash flow that we have in each year must be applied to a repayment of the credit facility. In addition, if we or one of our subsidiaries (other than a regulated subsidiary and other specified subsidiaries) engage in an asset sale or a sale-leaseback transaction (with the exception of assets specified in the amended credit agreement), 80% of the net cash proceeds must be applied to a repayment of the credit facility and a reduction of the amount available under the credit facility. In addition, 100% of the net cash proceeds of a debt issuance (excluding issuances by CII Financial, a wholly-owned subsidiary) must be applied to a repayment of the credit facility and a reduction in the amount available under the credit facility.
Subject to normal qualifications and exceptions, Sierra and CII Financial have covenants that, among other things, restrict our ability to dispose of assets, incur indebtedness, pay dividends, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, or make capital expenditures and which otherwise restrict certain corporate activities. At January 31, 2002, our credit facility had outstanding borrowings of $81 million. Unused credit facility balances are primarily reserved for our working capital purposes. Any availability under the credit facility generated from our excess cash flow must be converted annually to permanent reductions in accordance with the terms of the credit facility.
At September 30, 2000, CII Financial, Inc. had approximately $47.1 million of subordinated debentures that were due on September 15, 2001. These subordinated debentures were neither assumed nor guaranteed by Sierra and were subordinated to Sierra's credit facility debt. In December 2000, CII Financial commenced an offer to exchange the subordinated debentures for cash and/or new debentures. On May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its outstanding subordinated debentures. CII Financial purchased $27.1 million in principal amount of subordinated debentures for $20.0 million in cash and issued $15.0 million in new 9 1/2% senior debentures, due September 15, 2004, in exchange for $15.0 million in subordinated debentures. The transaction was accounted for as a restructuring of debt; therefore all future cash payments, including interest, related to the debentures will be reductions of the carrying amount of the debentures and no future interest expense will be recognized. Accordingly, the new 9 1/2% senior debentures have a carrying amount of $19.2 million consisting of principal of $15.0 million and $4.2 million in future accrued interest.
Our 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 HMO and insurance subsidiaries had restricted assets on deposit in various states totaling $26.0 million at December 31, 2001. The HMO and insurance subsidiaries must also meet requirements to maintain minimum stockholders' equity, on a statutory basis, as well as minimum risk-based capital requirements, which are determined annually. Additionally, in conjunction with the Kaiser-Texas acquisition, TXHC entered into a letter agreement with the Texas Department of Insurance whereby TXHC agreed to maintain a net worth of $20.0 million, on a statutory basis, until certain income levels were achieved. In conjunction with the exit from the Texas HMO health care market, the Texas Department of Insurance approved a plan of withdrawal and TXHC is now required to maintain deposits and net worth of at least $3.5 million. We believe we are in compliance with our regulatory requirements. We are limited by our credit facility in the amount of funds we can invest in our Texas operations as previously discussed.
Of the $115.8 million in cash and cash equivalents held at December 31, 2001, $84.1 million was designated for use only by the regulated subsidiaries. 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. The holding company will not receive dividends from its regulated subsidiaries if such dividend payment would cause violation of statutory net worth and reserve requirements.
Long-Term Capital Operating Debt Leases Leases Total -------------- ------------ ----------- --------- (In thousands) Continuing Operations Payments due in less than 1 year................ $ 11,781 $115 $ 8,805 $ 20,701 Payments due in 1 to 3 years.................... 127,841 204 12,685 140,730 Payments due in 4 to 5 years.................... 21,646 61 9,899 31,606 Payments due after 5 years...................... 105,996 184 26,965 133,145 ------- --- ------ ------- Total Continuing Operations................ $ 267,264 $564 $58,354 $326,182 ======= === ====== =======
Included in long-term debt payments for continuing operations is $158.2 million for our net financing obligation related to the sale-leaseback transaction. We expect the transaction will qualify as a sale by the end of 2002 at which time the future payments due will be categorized as operating leases. In conjunction with the remainder of the transaction qualifying as a sale, we will receive proceeds of $21.2 million, primarily from notes receivable due to us. See Note 4 and Note 8 of Notes to the Consolidated Financial Statements for a more detailed discussion of the sale-leaseback transaction.
The amount included in long-term debt payments for discontinued operations is for a mortgage loan secured by certain underlying real estate assets of the discontinued operations. We are actively seeking a buyer for the assets and anticipate selling them by the end of 2002. As the assets are sold, we are required to make reductions on the mortgage note and completely satisfy the obligation once all of the assets have been sold.
In addition to the items described above, we urge you to review carefully the section "Risk Factors" in this 2001 Form 10-K for a more complete discussion of the risks associated with an investment in our securities. See "Note on Forward-Looking Statements and Risk Factors" under Item 1.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sierra Health Services, Inc. and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 (In thousands, except per share data)
2001 2000 1999 ---------- ---------- ----------- OPERATING REVENUES: Medical Premiums..................................................... $ 718,994 $ 637,769 $ 594,966 Military Contract Revenues........................................... 338,918 330,352 287,398 Specialty Product Revenues........................................... 183,306 135,844 94,221 Professional Fees.................................................... 28,985 33,102 42,069 Investment and Other Revenues ....................................... 21,298 22,513 20,411 --------- --------- --------- Total............................................................. 1,291,501 1,159,580 1,039,065 --------- --------- ---------
INTEREST EXPENSE AND OTHER, NET...................................... (18,563) (19,362) (16,511) --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES.................................................. 26,269 (51,668) 12,732
LOSS FROM DISCONTINUED OPERATIONS (net of income tax benefit of $7,046, $61,350 and $8,144)....... (13,980) (161,122) (15,154) --------- --------- ---------
EARNINGS PER COMMON SHARE: Net Income (Loss) From Continuing Operations..................... $0.63 $(1.43) $ 0.39 Loss from Discontinued Operations................................ (0.50) (5.94) (0.56) ----- ----- ----- Net Income (Loss)................................................ $0.13 $(7.37) $(0.17) ==== ===== ====
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 2001, 2000 and 1999 (In thousands)
Comprehensive Income: Net Loss.................... Other Comprehensive Loss, Net of Tax: Unrealized Holding Loss on Available- for-sale Investments. Reclassification Adjustment for Losses Included in Net Loss Comprehensive Loss............. Common Stock Issued in Connection with Stock Plans............ 164 1 2,331 Purchase of Treasury Stock..... (7,968) Income Tax Benefit Realized Upon Exercise of Stock Options... 1 ------ --- ------- ------ ------- BALANCE, DECEMBER 31, 1999..... 28,400 142 175,915 - (22,789)
Comprehensive Income: Net Loss.................... Other Comprehensive Loss, Net of Tax: Unrealized Holding Gain on Available- for-sale Investments. Reclassification Adjustment for Gains Included in Net Loss Comprehensive Loss............. Common Stock Issued in Connection with Stock Plans............ 415 2 1,578 ------ --- ------ ------ ------- BALANCE, DECEMBER 31, 2000..... 28,815 144 177,493 - (22,789)
Comprehensive Income: Net Loss.................... $ (4,631) (4,631) (4,631) Other Comprehensive Loss, Net of Tax: Unrealized Holding Loss on Available- for-sale Investments... (15,295) (15,295) (15,295) Reclassification Adjustment for Losses Included in Net Loss 259 259 259 ------- Comprehensive Loss............. $(19,667) ======= Common Stock Issued in Connection with Stock Plans............ 2,332 Purchase of Treasury Stock..... (7,968) Income Tax Benefit Realized Upon Exercise of Stock Options... 1 ------- -------- ------- BALANCE, DECEMBER 31, 1999..... (16,063) 141,207 278,412
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2001, 2000 and 1999 (In thousands) 2001 2000 1999 ---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES: Capital Expenditures...................................... (9,462) (15,513) (49,629) Property and Equipment Dispositions....................... 7,293 10,558 981 Purchase of Available-for-Sale Investments................ (849,061) (209,234) (358,281) Proceeds from Sales/Maturities of Available-for-Sale Investments........................ 790,611 226,980 358,792 Purchase of Held-to-Maturity Investments.................. (1,265) (1,662) (7,133) Proceeds from Maturities of Held-to-Maturity Investments.. 8,585 5,466 36,077 -------- -------- -------- Net Cash (Used for) Provided by Continuing Operations. (53,299) 16,595 (19,193) -------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from Long-term Borrowing......................... 91,459 79,000 Payments on Debt and Capital Leases....................... (81,041) (42,686) (62,419) Purchase of Treasury Stock................................ (7,968) Exercise of Stock in Connection with Stock Plans.......... 2,090 1,580 2,332 -------- -------- -------- Net Cash (Used for) Provided by Continuing Operations. (78,951) 50,353 10,945 -------- -------- --------
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.................................................. 157,564 53,867 71,514 -------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR........................ $ 115,754 $ 157,564 $ 53,867 ======== ======== ========
Medical Expenses. The Company contracts with hospitals, physicians and other independently contracted providers of health care under capitated or discounted fee-for-service arrangements including hospital per diems to provide medical care services to enrollees. Capitated providers are at risk for the cost of medical care services provided to the Company's enrollees in the relevant geographic areas; however, the Company is ultimately responsible for the provision of services to its enrollees should the capitated provider be unable to provide the contracted services. Health care costs are recorded in the period when services are provided to enrolled members, including estimates for provider costs which have been incurred as of the balance sheet date but not reported to the Company. Any subsequent changes in estimate for a prior year would be reflected in the current year's operating results.
Loss and LAE reserves have a significant degree of uncertainty when related to their subsequent payments. Although reserves are established on the basis of a reasonable estimate, it is not only possible but probable that reserves will differ from their related subsequent developments. Underlying causes for this uncertainty include, but are not limited to, uncertainty in development patterns and unanticipated inflationary trends affecting the services covered by the insurance contract. This uncertainty can result in both adverse as well as favorable development of actual subsequent activity when compared to the reserve established. Any subsequent change in loss and LAE reserves established in a prior year would be reflected in the current year's operating results.
Investments. Investments consist principally of U.S. Government and its agencies securities and municipal bonds, as well as corporate and mortgage-backed securities. All non-restricted investments that are designated as available-for-sale are classified as current assets. These investments are available for use in the current operations regardless of contractual maturity dates. Non-restricted investments designated as held-to-maturity are classified as current assets if expected maturity is within one year of the balance sheet date. Otherwise, they are classified as long-term investments. Realized gains and losses are calculated using the specific identification method and are included in net income. Unrealized holding gains and losses on available-for-sale securities are included as a separate component of stockholders' equity until realized.
During 2001, SMHS adopted SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities", which provides accounting and reporting standards for securitizations and other transfers of financial assets and extinguishments of liabilities. On November 16, 2001, SMHS entered into a securitization arrangement with General Electric Capital Corporation. The arrangement provides for the sale of SMHS' Federal Government accounts receivable to SMHS Funding, LLC. SMHS Funding is a special purpose limited liability company owned by SMHS and was formed for the purpose of purchasing all receivables of SMHS. This entity is fully consolidated into SMHS. SMHS Funding, LLC may sell an undivided interest in certain of the receivables to a subsidiary of General Electric Capital Corporation in the event that additional financing by SMHS is warranted.
Reinsurance Recoverable. In the normal course of business, the Company seeks to reduce the effects of catastrophic and other events that may cause unfavorable underwriting results by reinsuring certain levels of risk with other reinsurers. Reinsurance recoverable for ceded paid claims is recorded in accordance with the terms of the agreements and reinsurance recoverable for unpaid losses and LAE and medical claims payable is estimated in a manner consistent with the claim liability associated with the reinsurance policy. Reinsurance receivables, including amounts related to paid and unpaid losses, are reported as assets rather than a reduction of the related liabilities.
Property and Equipment. Property and equipment are stated at cost less accumulated depreciation. Maintenance and repairs that do not significantly improve or extend the life of the respective assets are charged to operations. Depreciation and amortization is computed using the straight-line method over the estimated service lives of the assets or terms of leases if shorter. Estimated useful lives are as follows:
Starting in 2002, goodwill will be evaluated in accordance with Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which is effective January 1, 2002. In accordance with SFAS No. 142, the Company will no longer amortize its goodwill. Amortization expense, from continuing operations, associated with goodwill was $805,000, $1,131,000 and $1,463,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
Medical Claims Payable and Military Health Care Payable. Medical claims payable and military health care payable include the estimated cost for unpaid claims for which health care services have been provided to enrollees and to TRICARE eligibles. Such provisions include an estimate for the costs of claims that have been incurred but have not been reported.
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 contracts. The Company calculates expected premium deficiency expense based on budgeted revenues and expenses. Premium deficiency reserves are evaluated quarterly for adequacy. See Note 10 and Note 16 for a description of premium deficiency expenses and balances for the years ended December 31, 2001, 2000 and 1999. The premium deficiency accruals as of December 31, 2001 and 2000 were related to the discontinued operations.
Concentration of Credit Risk. The Company's financial instruments that are exposed to credit risk consist primarily of investments and accounts receivable. The Company maintains cash and cash equivalents and investments with various financial institutions. These financial institutions are located in many different regions and company policy is designed to limit exposure with any one institution.
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 and are principally in California, Nevada and Texas. However, the Company is licensed and does business in several other states. As of December 31, 2001, the Company had receivables outstanding from the federal government related to its TRICARE contract in the amount of $40.2 million. The Company also has receivables from its 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 with whom the Company has reinsurance contracts are rated AA and A+ or better by Fitch Ratings and the A.M. Best Company, respectively.
Derivatives. The Company's only derivative instrument is an interest rate swap agreement used to minimize interest rate risk. As of January 1, 2001, the Company implemented Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). The implementation did not result in an adjustment. At December 31, 2001 we recorded the swap agreement to its fair market value. The fair market value was determined based on what the Company would need to pay, $685,000, to terminate the swap agreement at December 31, 2001. Sierra accounts for derivative instruments on the balance sheet at fair value with changes in fair values reported as part of net income.
Recently Issued Accounting Standards. In July 2001, the FASB issued SFAS No. 142 which is effective January 1, 2002. SFAS No. 142 requires, among other things, the discontinuance of goodwill amortization. In addition, the pronouncement includes provisions for the reclassification of certain existing recognized intangibles as goodwill, reassessment of the useful lives of existing recognized intangibles, reclassification of certain intangibles out of previously reported goodwill and the identification of reporting units for purposes of assessing potential future impairments of goodwill. SFAS No. 142 also requires us to complete a transitional goodwill impairment test six months from the date of adoption. The net amortized goodwill balance at December 31, 2001 was $14.8 million and goodwill amortization expense during the year was $805,000 and would have been approximately the same amount in 2002 under current accounting standards. The Company has performed an evaluation of the impact of SFAS No. 142 on our operations and has determined that the recorded goodwill was not impaired under the guidelines of the pronouncement.
In October 2001, the FASB issued SFAS No. 144 which is effective for fiscal years beginning after December 15, 2001 with early adoption recommended. SFAS No. 144 requires that long-lived assets that are to be sold within one year must be separately identified and carried at the lower of carrying value or fair value less costs to sell. Long-lived assets expected to be held longer than one year are subject to depreciation and must be written down to fair value upon impairment. Long-lived assets no longer expected to be sold within one year, such as foreclosed real estate, must be written down to the lower of current fair value or fair value at the date of foreclosure adjusted to reflect depreciation since acquisition. As discussed in Note 4 of Notes to the Consolidated Financial Statements the Company elected to adopt early SFAS No. 144 effective January 1, 2001 and present the Texas HMO health care operations as discontinued.
Use of Estimates and Assumptions in the Preparation of Financial Statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management must exercise its judgment taking into consideration the facts and circumstances in selecting assumptions and other factors in calculating its estimates. On an on-going basis, management re-evaluates its assumptions and the methods of calculating its estimates. Estimates and assumptions include, but are not limited to, medical and specialty product expenses, military revenue and expenses and goodwill recoverability. Actual results may materially differ from estimates.
Reclassifications. Certain amounts in the Consolidated Financial Statements for the years ended December 31, 2000 and 1999 have been reclassified to conform with the current year presentation.
Earnings per common share assuming dilution: Income (loss) from continuing operations....................... $ 0.61 $ (1.43) $ 0.39 Loss from discontinued operations............................... (0.49) (5.94) (0.56) ------ -------- ------- Net income (loss)............................................... $ 0.12 $ (7.37) $ (0.17) ====== ======== =======
Weighted average common shares outstanding...................... 27,685 27,142 26,927 Weighted average common shares outstanding assuming dilution...................................... 28,509 27,142 26,996
Options to purchase 4,250,000 shares of common stock were outstanding at December 31, 2000 but were not included in the computation of diluted earnings per share because the Company had a net operating loss for the year and their inclusion would have been anti-dilutive.
CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. Each $1,000 in principal was convertible into 25.382 shares of the Company's common stock at a conversion price of $39.398 per share. The Debentures were paid off in September 2001 and they have not been included in the computation of EPS during the years presented because their effect would be anti-dilutive.
The Company capitalizes interest expense as part of the cost of construction of facilities and the implementation of computer systems. Interest expense capitalized in 2001, 2000 and 1999 was $29,000, $67,000 and $2,140,000, respectively. Depreciation expense, from continuing operations, in 2001, 2000 and 1999 was $24,742,000, $23,847,000 and $18,961,000, respectively.
Assets held for sale on the balance sheet at December 31, 2000 consisted of real estate in Arizona which the Company sold during 2001.
The following table summarizes the Company's current, long-term and restricted investments as of December 31, 2001:
Classified as Restricted: U.S. Government and its Agencies........................... 17,677 352 317 17,712 Municipal Obligations......................... 2,326 38 2,364 Corporate Bonds............................... 1,495 35 1,530 Other......................................... 2,029 2,029 ------- ----- ------ ------- Total Restricted................................. 23,527 425 317 23,635 ------- ----- ------ ------- Total Available-for-Sale................ $290,057 $1,706 $10,365 $281,398 ======= ===== ====== =======
Held-to-Maturity Investments: Classified as Current: Corporate Bonds................................ $ 2,999 $ 22 $ 3,021 ------- ----- -------
Classified as Long-term: U.S. Government and its Agencies........................... 5,608 $ 258 5,350 Municipal Obligations......................... 328 15 313 Corporate Bonds............................... 2,498 175 2,673 ------- ----- ------ ------- Total Long-term ................................. 8,434 175 273 8,336 ------- ----- ------ -------
Classified as Restricted: U.S. Government and its Agencies........................... 15,862 69 207 15,724 Municipal Obligations......................... 2,637 49 27 2,659 Corporate Bonds............................... 1,192 16 16 1,192 Other......................................... 2,509 2,509 ------- --- ----- ------- Total Restricted .......................... 22,200 134 250 22,084 ------- --- ----- ------- Total Available-for-Sale ............... $237,110 $571 $9,450 $228,231 ======= === ===== =======
Classified as Long-term: U.S. Government and its Agencies........................... 11,230 262 $ 689 10,803 Municipal Obligations......................... 2,381 53 2,434 Corporate Bonds............................... 4,482 117 160 4,439 ------- --- ----- ------- Total Long-term ................................. 18,093 432 849 17,676 ------- --- ----- -------
The contractual maturities of available-for-sale investments at December 31, 2001 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.
The contractual maturities of held-to-maturity investments at December 31, 2001 are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations.
Amortized Cost Fair Value --------------- -------------- (In thousands) Due in one year or less...................................... $ 4,065 $ 4,111 Due after one year through five years........................ 3,171 3,389 Due after five years through ten years....................... Due after ten years through fifteen years.................... Due after fifteen years...................................... 6,573 6,270 ------ ------ Total................................................... $13,809 $13,770 ====== ======
In addition to the low level reinsurance, effective January 1, 2000 CII entered into a reinsurance contract that provides statutory (unlimited) coverage for workers' compensation claims in excess of $500,000 per occurrence. The contract is in effect for claims occurring on or after January 1, 2000 through December 31, 2002. There is a twelve month run out provision in the contract which the Company intends to exercise. The reinsurer, National Union Fire Insurance Company, is rated AAA and A++ by Fitch Ratings and the A.M. Best Company, respectively.
All of the reinsurance recoverables are due from reinsurers rated AA and A+ by Fitch Ratings and the A.M. Best Company, respectively, and all amounts are considered to be collectible.
The following table provides workers' compensation prospective reinsurance information for the three years ended December 31, 2001:
Year Ended December 31, 2000: Low level reinsurance carrier................... $53,408 $100,240 $74,071 Excess of loss reinsurance carriers............. 2,324 8,428 3,449 ------ ------- ------- Total .......................................... $55,732 $108,668 $77,520 ====== ======= ======
Net Ending Losses and LAE Reserve ........................ 198,252 155,797 134,305 Reinsurance Recoverable .................................. 187,453 218,757 110,089 ------- ------- -------
Revolving Credit Facility. On October 31, 1998, the Company replaced its prior line of credit with a $200 million credit facility. As a result of the asset impairment and other changes in estimate charges, the Company was not in compliance with its financial covenants at June 30, 2000. On December 15, 2000, the Company entered into an amended and restated credit agreement, which terminates on September 30, 2003. The Company believes it is now in compliance with all covenants of the amended agreement. The restated agreement was subsequently amended in April 2001 to allow for the completion of the CII debenture exchange offer and again in October 2001 to provide a limited waiver for covenants affected by exiting the Texas HMO health care market.
Subject to normal qualifications and exceptions, Sierra has covenants that, among other things, restrict its ability to dispose of assets, incur indebtedness, pay dividends, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, or make capital expenditures and which otherwise restrict certain corporate activities. Any availability under the credit facility generated from excess cash flow must be converted annually to permanent reductions in accordance with the terms of the credit facility.
The amended and restated credit agreement restricts the amount of funds that can be invested in the Texas and SMHS operations. The maximum we can invest in the Military operations is $5 million, we have not invested any of the $5 million as of December 31, 2001. After September 30, 2001, we can invest an additional $5.0 million in the Texas operations and replace the Texas real estate assets with cash and notes up to $46 million. Under the terms of the amended and restated agreement, the use of Sierra funds to pay the outstanding Texas mortgage note of $29.2 million is not considered an investment in the Texas operations. During the fourth quarter of 2001, we invested in Texas the full $5.0 million allowed under the amended and restated agreement. If we had to invest more than we are allowed, we would be required to get a waiver or an amendment to our agreement or be out of compliance. If additional funds are needed by our discontinued Texas HMO health care operations and we do not transfer such funds they may be in violation of certain insurance regulations and we may be required to get a waiver or an amendment to our agreement or be out of compliance. There is no assurance that if we needed a bank waiver or amendment that we would be able to obtain it. Based on the current estimated Texas HMO healthcare run-out costs and recorded reserves, we believe we have adequate funds available and the ability to invest adequate funds in Texas to meet the anticipated obligations.
We are not allowed to pay or declare any cash dividends on our common stock under the terms of our amended and restated credit agreement. We have not paid or declared any cash dividends since inception. We anticipate that future earnings will be retained for our current operations; therefore, we do not plan to pay or declare any dividends on our common stock in the foreseeable future.
Debentures. At September 30, 2000, CII Financial, Inc. had approximately $47.1 million of subordinated debentures outstanding that were due on September 15, 2001. These subordinated debentures were neither assumed nor guaranteed by Sierra and were subordinated to Sierra's credit facility debt. In December 2000, CII Financial commenced an offer to exchange the subordinated debentures for cash and/or new debentures. On May 7, 2001, CII Financial closed its exchange offer on $42.1 million of its outstanding subordinated debentures. CII Financial purchased $27.1 million in principal amount of subordinated debentures for $20.0 million in cash and issued $15.0 million in new 9 1/2% senior debentures, due September 15, 2004, in exchange for $15.0 million in subordinated debentures. The remaining $5.0 million in subordinated debentures were paid at maturity.
Other. The Company has obligations under capital leases with interest rates from 8.0% to 12.2%. In addition, the Company has term loans with the City of Baltimore and the State of Maryland. Scheduled maturities of the Company's notes payable, net financing obligations and future minimum payments under capital leases, together with the present value of the net minimum lease payments at December 31, 2001, are as follows:
A summary of the provision for income taxes for the years ended December 31, is as follows:
(In thousands) 2001 2000 1999 ---------- ---------- ----------- Provision (Benefit) for Income Taxes: Current..................................... $(1,131) $ (795) $ 0 Deferred.................................... 9,934 (12,080) 2,209 ------ ------- ----- Total....................................... $ 8,803 $(12,875) $2,209 ====== ======= =====
At December 31, 2001, the Company had approximately $154,942,000 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 2020. In addition to the net operating loss carryforwards, the Company has alternative minimum tax credits of approximately $4,258,000, which can be used to reduce regular tax liabilities in future years. There is no expiration date for the alternative minimum tax credits.
The Company does not have a valuation allowance at December 31, 2001 or 2000. Included in other current receivables in the December 31, 2001 and 2000 balance sheets are income tax receivables of $2,265,000 and $1,326,000, respectively.
Throughout 2001, the Company continued to focus on making the Texas HMO health care operations profitable. Significant premium rate increases were made on renewing membership and during the third quarter the Company embarked on a recontracting effort to reduce medical costs. It was during this recontracting effort that unsustainable cost increases were identified, including the fact that the operations' primary hospital contract, if renewed, would be at a substantially higher rate than was previously indicated by the hospital.
The Company has elected to early adopt SFAS No. 144 effective January 1, 2001. In accordance with SFAS No. 144, the Company's Texas HMO health care operations have been reclassified as discontinued operations. The Company has received a limited waiver under its revolving credit facility agreement for covenants affected by exiting the Texas HMO health care market.
Year Ended December 31 (In thousands) 2001 2000 1999 ---- ---- ---- Operating Revenues.............................................. $181,132 $ 233,398 $244,746 ------- -------- -------
Asset impairment, restructuring, reorganization and other costs for the year ended December 31, 2000 include the following: (a) asset impairment charges of $126.4 million for impaired goodwill; (b) $36.5 million for impaired real estate and other fixed assets; (c) $10.4 million for premium deficiency maintenance costs; and (d) other restructuring, reorganization and other costs of $13.3 million.
Charges recorded................... $ 11,000 $ 11,000 Cash used.......................... Noncash activity................... - Changes in estimate................ - -------- ------ ------- ----- -------- Balance, December 31, 1999......... - - 11,000 - 11,000
Charges recorded................... $ 162,937 $11,509 10,358 $1,800 186,604 Cash used.......................... (7,754) (12,080) (200) (20,034) Noncash activity................... (162,937) (800) (163,737) Changes in estimate................ - -------- ------ ------- ----- -------- Balance, December 31, 2000......... - 3,755 9,278 800 13,833
December 31 December 31 (In thousands) 2001 2000 ---- ---- ASSETS Cash and Cash Equivalents.................................. $ 0 $ 3,742 Accounts Receivable, Net................................... 1,402 6,433 Other Assets............................................... 6,895 4,534 Property and Equipment, Net................................ 20,107 21,483 ------- ------- TOTAL ASSETS............................................... 28,404 36,192 ------- -------
Property and equipment consists mainly of real estate properties located in the Dallas/Fort Worth metroplex areas. TXHC acquired these properties from Kaiser Foundation Health Plan of Texas ("Kaiser-Texas"), for $44 million as part of the acquisition of certain assets of Kaiser-Texas in October 1998. In June 2000, as part of its restructuring and reorganization of the Texas HMO health care operations, the Company announced its intentions to sell these properties. The real estate was written down to its estimated fair value and the Company took an asset impairment charge of $27 million. The real estate is encumbered by a mortgage loan to Kaiser-Texas.
(In thousands) Years Ending December 31, ------------------------------------------------- 2002................................................... $ 8,805 2003................................................... 6,834 2004................................................... 5,851 2005................................................... 5,348 2006................................................... 4,551 Thereafter............................................. 26,965 ------ Total............................................. $58,354 ======
Rent expense totaled $9,430,000, $8,788,000 and $7,725,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company is a guarantor on a mortgage loan which has a carrying value of $29.2 million, consisting of a principal balance of $22.7 million and $6.5 million in future accrued interest. The mortgage loan is related to the property of the discontinued operations as described in Note 10.
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. Until July 1, 1999 the Company matched 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 a participant's death, disability, retirement, termination of employment or certain other circumstances including financial hardship.
A reconciliation of ending year balances is as follows: Years Ended December 31, 2001 2000 1999 ---------- ---------- ----------- (In thousands) Change in Benefit Obligation: Projected Benefit Obligation at Beginning of Period.... $13,693 $12,808 $14,198 Service Cost .......................................... 322 365 365 Interest Cost ......................................... 1,162 887 829 Plan Amendments........................................ 335 166 Actuarial Losses (Gains)............................... 4,410 (340) (2,391) Benefits Paid ......................................... (784) (193) (193) ------ ------ ------ Benefit Obligation at End of Period.................... $19,138 $13,693 $12,808 ====== ====== ======
Change in Plan Assets: Fair Value of Plan Assets at Beginning of Period....... $ 8,439 $ 7,295 $ 4,493 Actual Return on Plan Assets .......................... (802) (445) 123 Company Contributions ................................. 2,678 1,589 2,679 ------ ------ ------ Fair Value of Plan Assets at End of Period............. $10,315 $ 8,439 $ 7,295 ====== ====== ======
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.
Stock Option Plans. The Company has several plans that provide common stock-based awards to employees and to non-employee directors. The plans provide for the granting of options, stock, and other stock-based awards. Awards are granted by a committee appointed by the Board of Directors. Options become exercisable at such times and in such installments as set by the committee. The exercise price of each option equals the market price of the Company's stock on the date of grant. Stock options generally vest at a rate of 20% - 33% per year. Options expire from one to seven years after the end of the vesting period.
Number of Option Weighted Shares Price Average Price --------------- ----------- ------------- (Number of shares in thousands) Outstanding January 1, 1999 2,730 $ 6.31 - $24.83 $18.89
Granted..................................... 1,436 6.69 - 21.00 9.44 Exercised................................... (2) 6.31 - 12.08 9.41 Canceled.................................... (260) 11.71 - 24.83 19.65 ------ Outstanding December 31, 1999.................. 3,904 6.31 - 24.69 15.37
Granted..................................... 2,458 3.13 - 7.19 3.87 Canceled.................................... (2,112) 3.75 - 24.69 18.17 ------ Outstanding December 31, 2000.................. 4,250 3.13 - 24.69 7.31
Exercisable at December 31, 2001............... 1,391 3.13 - 24.69 8.94 ======
(Number of options in thousands) Weighted Average Weighted Average Range of Exercise Contractual Life Options Exercise Price Prices Remaining in Days Outstanding Exercisable Outstanding Exercisable --------------------- ----------------- ----------- ----------- ----------- -----------
Accounting for Stock-Based Compensation. The Company uses the intrinsic value method in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized for its employee stock option plans nor the Purchase Plan. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans, the Company's net income and earnings per share for the years ended December 31, would have been reduced to the pro forma amounts indicated below:
Years Ended December 31, 2001 2000 1999 ---------- ---------- ---------- (In thousands, except per share data) Net Income (Loss) As reported $3,486 $(199,915) $(4,631) Pro forma (1,268) (203,293) (9,204)
Net Income (Loss) Per Share As reported $ .13 $ (7.37) $ (.17) Pro forma (.05) (7.49) (.34)
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 Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" been applicable to all years of previous option grants. The above numbers do not include the effect of options granted prior to 1995.
Non-cash Investing and Financing Activities: Retired Sale-Leaseback Assets, Liabilities and Financing Obligations......................... 14,552 Note Received for Sale of Investment................ 3,700 Stock Issued for Exercise of Options and Related Tax Benefits.......................... 97 1 Additions to Capital Leases......................... 1,835 Debentures Exchanged................................ 19,692
During the second quarter of 2000, the Company wrote-off capitalized costs of $3.0 million related to the application development of an information system software project for the workers' compensation operations, which was canceled because the vendor was unable to fulfill its contractual obligations. The amounts written off included software and consulting costs of $1.6 million and capitalized internal personnel costs of $1.4 million.
In the first quarter of 1999, the Company 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 table below presents a summary of asset impairment, restructuring and other costs for the years indicated.
Charges recorded............................... $ 3,509 $ 850 3,449 7,808 Cash used...................................... (850) (2,819) (3,669) Noncash activity............................... (3,509) (3,509) Changes in estimate............................ ------- ------ ------ ------- Balance, December 31, 1999..................... - - 3,449 3,449
Charges recorded............................... Cash used...................................... (594) (594) Noncash activity............................... Changes in estimate............................ ------- ----- ------ ------- Balance, December 31, 2001..................... $ - $ - $ 4,447 $ 4,447 ======= ====== ====== =======
The remaining other costs of $4.4 million are primarily related to legal claims. Management believes that the remaining reserves as of December 31, 2001 are adequate and that no revisions to the estimates are necessary at this time.
(In thousands, except per share data) March June September December 31 30 30 31 --------------- --------------- --------------- ---------------- Year Ended December 31, 2001 (1): Operating Revenues.................................... $303,228 $318,327 $330,854 $339,092 Operating Income from Continuing Operations........... 10,062 11,391 10,758 12,621 Net Income from Continuing Operations................. 3,466 3,777 4,572 5,651 Net Income (Loss)..................................... 3,205 2,795 (7,554) 5,040 Basic earnings per share: Income from Continuing Operations.................. $ 0.13 $ 0.14 $ 0.16 $ 0.20 Net Income (Loss).................................. 0.12 0.10 (0.27) 0.18 Diluted earnings per share: Income from Continuing Operations.................. $ 0.13 $ 0.13 $ 0.16 $ 0.19 Net Income (Loss).................................. 0.12 0.10 (0.26) 0.17
(1) The Company early adopted SFAS No. 144 effective January 1, 2001. All quarterly amounts have been reclassified to reflect the adoption of SFAS No. 144.
The Company has three reportable segments based on the products and services offered: managed care and corporate operations, military health services operations and workers' compensation operations. The managed care segment includes managed health care services provided through HMOs, managed indemnity plans, third-party administrative services programs for employer-funded health benefit plans, multi-specialty medical groups, other ancillary services and corporate operations. The military health services segment administers a five-year, managed care federal contract for the Department of Defense's TRICARE program in Region 1. The workers' compensation segment assumes workers' compensation claims risk in return for premium revenues and third party administrative services.
The Company evaluates each segment's performance based on segment operating profit. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies (except as described in the notes below). Certain changes in estimate charges for the years ended December 31, 2000 and 1999 have been reclassified to segment operation profit to conform with the current year presentation.
Year Ended December 31, 2000 Medical Premiums.............................. $637,769 $ 637,769 Military Contract Revenues.................... $330,352 330,352 Specialty Product Revenues.................... 8,822 $127,022 135,844 Professional Fees............................. 33,102 33,102 Investment and Other Revenues................. 7,091 905 14,517 22,513 ------- ------- ------- --------- Total Revenue.............................. $686,784 $331,257 $141,539 $1,159,580 ======= ======= ======= =========
Segment Assets................................ $479,786 $115,520 $533,602 $1,128,908 Capital Expenditures.......................... 13,957 717 839 15,513 Depreciation and Amortization................. 21,031 2,926 1,538 25,495
Segment Operating Profit (1).................. $ 28,153 $ 11,612 $ 11,171 $ 50,936 Interest Expense and Other.................... (12,345) (910) (3,256) (16,511) Changes in Estimate Charges (2)............... (13,885) (13,885) Asset Impairment, Restructuring, Reorganization and Other Costs........... (7,808) (7,808) ------- ------- ------- --------- Net (Loss) Income from Continuing Operations Before Income Taxes...................... $ (5,885) $ 10,702 $ 7,915 $ 12,732 ======= ======= ======= =========
(1) The segment operating profit excludes the effects of asset impairment, restructuring, reorganization and other costs.
(2) Represents changes in estimate charges in the current year for services or liabilities of a prior year that are reclassified to either Medical Expenses or Specialty Product Expenses for presentation in accordance with accounting principles generally accepted in the United States of America.