The Company derives revenues principally from premiums, which include capitation payments, received by its HMO and insurance subsidiaries. To a lesser extent, the Company also derives revenues from professional fees (consisting primarily of fees for providing health care services to non-members and co-payment fees received from members), specialty products (consisting of fees for administrative services and ancillary products) and investment and other revenue. Premium revenues accounted for approximately 91.1%, 93.2% and 93.0% of the Company's total revenues for 1994, 1993 and 1992, respectively. Continued premium revenue growth is principally dependent upon continued enrollment in the Company's plans and upon competitive and regulatory factors which are expected to limit the Company's ability to implement annual premium rate increases and, to a lesser extent, to result in declining premium rates. In addition, enrollment in the Company's managed indemnity plans has declined since 1990 principally due to increased competitive pressures and, more recently, the transfer of certain members to the Company's HMO Point of Service plan.
The Company's principal expenses consist of medical expenses and general and administrative expenses. Medical expenses represent the aggregate expenses of operating the Company's multi-specialty medical group and other provider subsidiaries as well as capitation fees and other payments paid to contracted physicians, hospitals and other health care providers. As a provider of managed care services, the Company seeks to manage medical expenses by employing or contracting with physicians, hospitals and other health care providers at negotiated price levels, by adopting quality assurance programs, by monitoring and managing utilization of physicians and hospital services and by providing incentives to use cost-effective providers. General, administrative and other expenses generally represent operational costs other than those associated with the delivery of health care services.
In 1993, G&A costs were $50.7 million, a 14.8% increase over 1992. As a percentage of revenues, 1993 G&A costs increased slightly to 19.7% from 18.9% in 1992. Compensation costs increased approximately $3.5 million resulting primarily from additional employees supporting expanding services. Other G&A expense increases were associated with ongoing operations and membership increases including, among other things, premium taxes and brokers' fees which together totaled $1.4 million. The increases in G&A costs were partially offset by a reduction in stock based incentive compensation expense of approximately $896,000. G&A cost decreases were also realized in legal and consulting services.
The Company's effective federal income tax rate for 1993 increased to 32.0% compared to 29.4% in 1992 due to the provisions of the Act (described above) along with reduced tax-exempt investment income which resulted from generally lower interest rates and decreased invested cash balances due to 1993 capital expenditures.
Net income for 1993 increased 28.2% to $17.4 million from $13.6 million in 1992. The $3.8 million increase in earnings is primarily due to increased operating revenues and an improved medical loss ratio offset by a slight increase in G&A expenses as a percentage of revenues and the increased effective federal income tax rate. During June 1992, the Company settled certain litigation with the Nevada Department of Insurance. Under the terms of the settlement, the Department of Insurance received $784,000 and released all claims against the Company, which resulted in a 1992 second quarter charge of approximately $567,000, net of taxes.
The Company's $38.1 million cash flow from operating activities during the twelve months ended December 31, 1994 resulted primarily from $22.2 million of net income and $7.4 million in depreciation and amortization and an $8.5 million net increase in working capital accounts. The increase in cash from fluctuations in working capital accounts is principally due to increased medical claims payable, unearned premium revenues and certain other accrued liabilities partially offset by increases in accounts receivable and other current assets.
In September 1994, the Company completed construction of a 44,000 square foot medical facility on land contiguous to its administrative headquarters in northwest Las Vegas. Construction and equipment costs were approximately $5.5 million. In addition, the Company has begun construction on a 28,000 square foot outpatient surgical facility in Las Vegas with an estimated total cost of $4.3 million. Completion is expected in mid-1995. The Company's liquidity needs over the next 12 months will primarily be for certain new computer, medical and other equipment, the acquisition and construction of medical clinics to support growing membership in Nevada, debt service and any expansion of the Company's operations. The Company has a 1995 capital budget of approximately $25.0 million. The Company believes that existing working capital, operating cash flow and, if necessary, equipment leasing, amounts available under its credit facility and the proceeds from the recent public offering will be sufficient to fund its capital expenditures, debt service and any expansion activities during the next 12 months.
The holding company may receive dividends from its HMO and insurance subsidiaries which generally must be approved by certain state insurance departments. 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 HMO and insurance subsidiaries had restricted assets on deposit in various states totaling $2.9 million, as of December 31, 1993 and December 31, 1994. The HMO and insurance subsidiaries also meet requirements to maintain minimum stockholder's equity of $200,000 and $3,000,000 respectively. Of the cash and cash equivalents and short-term securities held at December 31, 1994, $13.6 million is designated for use only by the insurance subsidiary and another $34.4 million only by the HMO. Such amounts are available for transfer to the holding company from the HMO and insurance subsidiary only to the extent that they can be remitted in accordance with terms of existing management agreements and by dividends. Remaining amounts are available on an unrestricted basis. The holding company will not receive dividends from its HMO or insurance subsidiary that would cause either to violate its statutory net worth and reserve requirements.
In June 1994, the Company renewed its $5.0 million unsecured line of credit from PriMerit Bank, F.S.B. for an additional one year term at an interest rate of prime plus 1%. The line of credit, if drawn upon, will be used for general corporate purposes and will be available for additional working capital, if necessary.
Management Report on Consolidated Financial Statements . . . . . . . . . . 22 Independent Auditors' Report . . . . . . . . . . . . . . . . . . . . . . . 23 Consolidated Balance Sheets at December 31, 1994 and 1993. . . . . . . . . 24 Statements of Consolidated Operations for the years ended December 31, 1994, 1993, and 1992. . . . . . . . . . . . . . . . . . . . 26 Statements of Changes in Consolidated Stockholders' Equity for the years ended December 31, 1994, 1993, and 1992. . . . . . . . . . . . 27 Statements of Consolidated Cash Flows for the years ended December 31, 1994, 1993, and 1992 . . . . . . . . . . . . . . . . . . . . 28 Notes to Consolidated Financial Statements . . . . . . . . . . . . . . . . 29
The accounting systems and controls of the Company are designed to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial records are reliable for preparing financial statements and maintaining accountability for assets, and that assets are safeguarded against losses from unauthorized use or disposition. Management believes that for the year ended December 31, 1994, such systems and controls were adequate to meet the objectives discussed herein.
The accompanying Consolidated Financial Statements have been audited by Deloitte & Touche LLP, Independent Certified Public Accountants, whose audits thereof were made in accordance with generally accepted auditing standards and included a review of internal accounting controls to the extent necessary to design audit procedures aimed at gathering sufficient evidence to provide a reasonable basis for their opinion on the fairness of presentation of the Consolidated Financial Statements taken as a whole.
We have audited the accompanying consolidated balance sheets of Sierra Health Services, Inc. and its subsidiaries as of December 31, 1994 and 1993, and the related statements of consolidated operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993
PRINCIPLES OF CONSOLIDATION. All significant intercompany transactions and balances have been eliminated. Sierra's wholly owned subsidiaries include a health maintenance organization, Health Plan of Nevada ("HPN"), a health and life insurance company, Sierra Health and Life Insurance Company ("SHL"), a multi-specialty medical group, Southwest Medical Associates, ("SMA"), a home health care agency, a hospice, an administrative services company and a company which has an interest in a building partnership. Sierra also owns a majority interest in a company that provides and manages mental health and substance abuse services, Behavioral Healthcare Options ("BHO"). In addition, Sierra manages and owns a 50% interest in HMO Texas L.C. ("HMO Texas"), a health maintenance organization which was licensed in February 1995 in the state of Texas. The remaining interests of BHO, HMO Texas and the other partners in the building partnership are reflected as Minority Interests in the accompanying Consolidated Balance Sheets.
MARKETABLE SECURITIES. Short- and Long-term Securities consist principally of U.S. Government Securities and municipal bonds, as well as corporate and mortgage backed securities. Short-term securities have maturities of one year or less. Long-term securities have maturities in excess of one year.
RESTRICTED CASH AND SECURITIES. HPN and SHL are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The Company also has certain other deposit requirements. The Company has restricted assets on deposit in various states ranging from $100,000 to $850,000 and totaling $3,771,000 at December 31, 1994. HPN and SHL also meet requirements to maintain minimum stockholder's equity of $200,000 and $3,000,000, respectively.
LAND, BUILDING AND EQUIPMENT are stated at cost. Maintenance and repairs that do not 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:
GOODWILL represents cost in excess of the fair value of net tangible assets acquired and is amortized on a straight-line basis over a period of 20 to 40 years. Accumulated amortization at December 31, 1994 and 1993 was $377,000 and $308,000, respectively.
FUNDS WITHHELD BY CEDING INSURANCE COMPANY AND FUTURE POLICY BENEFITS. SHL has a reinsurance agreement whereby it purchases actuarially determined life insurance reserves and thereby has an interest in a related life insurance premium pool. Funds Withheld by Ceding Insurance Company and Future Policy Benefits in connection with this agreement were $10,234,000 and $10,681,000 for December 31, 1994 and 1993, respectively.
The Company capitalizes interest expense as part of the cost of construction of facilities. Interest expense capitalized in 1994, 1993, and 1992 was $119,000, $700,000 and $42,000, respectively.
The following table summarizes the Company's short-term, long-term and restricted investments as of December 31, 1994:
The contractual maturities of short-term, long-term and restricted investments at December 31, 1994 were as follows:
In December, 1993, the Company obtained a $14,000,000 loan from Bank of America, Nevada. This loan is secured by a deed of trust, assignment of rents and leases, and a security agreement and fixture filing covering the Company's administrative headquarters complex and underlying real property. In March, 1994, the Company paid off a $2,789,000 note encumbering the underlying real property.
The Company has a $3,256,000 term loan which has an adjustable rate with an interest margin of 3% over the Federal Home Loan Bank Board 11th District Cost of Funds Index, a maximum interest rate of five percentage points above the initial rate of 11.85% and a minimum interest rate of 8%. The interest rate at December 31, 1994 was 8%. This term loan is secured by a medical facility.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992
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, 1994, are as follows:
Based on the borrowing rates currently available to the corporation for bank loans with similar terms and average maturities, the fair value of long-term debt, including the current portion, is $18,696,000.
The following reconciles the difference between the 1994, 1993 and 1992 current and statutory provision for income taxes.
The tax items comprising the Company's net deferred tax assets at December 31 which are included in Prepaid Expenses and Other Assets in the accompanying Consolidated Balance Sheet are as follows:
The Company is the lessee under several operating leases, most of which relate to equipment and office facilities. The rentals on these leases are charged to expense over the lease term as the Company becomes obligated for payment and, where applicable, provide for rent escalations based on certain costs and price index factors. The following is a schedule, by year, of the future minimum lease payments under existing operating leases:
Rent expense totaled $3,256,000, $5,410,000 and $4,953,000 in 1994, 1993 and 1992, respectively.
The Company is subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these legal proceedings will not materially impact the consolidated financial statements of the Company.
The Company has a Supplemental Retirement Plan (the "SRP") for certain officers, directors and highly compensated employees. The SRP is a non-qualified deferred compensation plan 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 SRP upon participant death, disability, retirement, termination of employment or certain other circumstances including financial hardship. The Company contributed $550,000, $408,000 and $445,000 to the SRP in 1994, 1993 and 1992, respectively.
The Company has an employee stock purchase plan (the "Purchase Plan") 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 Plan. As of December 31, 1994, the Company had 534,114 shares reserved for purchase under the Purchase Plan. During 1994, a total of 36,176 shares were purchased at prices of $17.00 and $19.23 a share. During January, 1995, 21,907 shares were issued to these employees at $19.98 per share in connection with the Purchase Plan.
The Company also has a Capital Accumulation Plan (the "CAP Plan") whereby share units or fractions thereof may be awarded by a disinterested committee appointed by the Board of Directors to designated key employees and executive officers of the Company which entitle the recipient to benefits based upon the increase, if any, in the fair market value of the common stock of the Company. The units vest over a five year period, subject to divestiture under certain circumstances. The amount payable is determined by a formula relating to the increase in fair market value of the common stock of the Company at the time of payment, not exceeding $11.94, over the fair market value of such stock at the grant date. All amounts are payable at the option of the Company in cash, shares of common stock, or a combination of both. At December 31, 1994, there were 435,983 shares reserved for issuance under the CAP Plan.
Total expense recorded for SARs and the CAP Plan was $280,000, $525,000 and $1,421,000 for 1994, 1993 and 1992, respectively.
All stock plans and the related information have been retroactively adjusted to account for the stock split discussed in Note 1.
On October 11, 1994 the Company completed a public offering of 1,800,000 shares of its Common Stock, $.005 par value per share (the "Common Stock"), at a price of $26.50 per share. Additionally, Anthony M. Marlon, M.D., the Company's Chairman and Chief Executive Officer, sold 500,000 shares of Common Stock in such offering. The net proceeds to the Company from the offering were approximately $44.6 million, after deducting the underwriting discounts and commissions and the offering expenses payable by the Company.
On June 14, 1994 the Board of Directors of Sierra authorized and declared a dividend distribution of one right (a "Right") for each share of Sierra common stock, par value $.005 per share (the "Common Shares"). The Rights were distributed to the holders of record of Common Shares of the close of business on June 30, 1994. Each Right entitles the registered holder to purchase from Sierra a unit consisting of one one-hundredth of a share of the Series A Junior Participating Preferred Shares (a "Unit"), par value $.01 per share, of Sierra, 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 the Common Stock.