The Company plans to begin construction of an approximately 59,000 square foot medical facility in Las Vegas with an estimated total cost of $7.3 million. Completion is expected in late 1996. The Company believes that current and planned clinical space will be adequate for its present needs. Additional clinical space may be required, however, if membership continues to expand.
The following selected consolidated financial data of Sierra Health Services, Inc., and subsidiaries (the "Company"), for the years ended December 31, 1995, 1994, 1993, 1992, and 1991 should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information which appears elsewhere in this Annual Report on Form 10-K. The selected consolidated financial data as of December 31, 1995, 1994, 1993, 1992, and 1991 and for each of the five years ended December 31, 1995 has been derived from the audited Consolidated Financial Statements of the Company and has been restated to include the results of CII Financial, Inc. ("CII") for all periods presented.
The following discussion and analysis provide information which management believes is relevant to an assessment and understanding of the Company's consolidated financial condition and results of operations. The discussion should be read in conjunction with the Consolidated Financial Statements and Related Notes thereto. Any forward looking information contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and any other sections of this 1995 Annual Report on Form 10-K should be considered in connection with certain cautionary statements detailed in a Form 8-K filing dated March 4, 1996. Such cautionary statements are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and identify important risk factors that could cause the Company's actual results to differ from those expressed in any projected, estimated or forward-looking statements relating to the Company.
On October 31, 1995, the Company acquired CII Financial, Inc., a workers' compensation insurance holding company, for approximately $76.3 million of common stock, in a transaction accounted for as a pooling of interests. The information contained in this discussion and analysis has been restated to include the results of CII for all periods presented.
The Company derives revenues from its health maintenance organization ("HMO"), managed indemnity and workers' compensation insurance subsidiaries. To a lesser extent, the Company also derives 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. Medical premium revenues accounted for approximately 68.4%, 67.0%, and 62.8% of the Company's total revenues for 1995, 1994 and 1993, respectively. Continued medical premium revenue growth is principally dependent upon continued enrollment in the Company's products and upon competitive and regulatory factors which are expected to limit the Company's ability to implement annual premium rate increases.
In connection with the merger of CII, the Company recorded acquisition and integration expenses of $11.6 million. Within two months of the combination, approximately two-thirds of the costs had been paid or otherwise charged against the associated accrual.
The following table sets forth selected operating data as a percentage of revenues for the periods indicated:
The Company's total operating revenues for 1995 increased 16.1% to $467.0 million from $402.1 million for 1994. The increase was primarily due to medical premium revenue increases of approximately $50.1 million, or 18.6% from the Company's HMO and managed indemnity insurance subsidiaries. Such premium growth resulted principally from a 12.5% increase in member months (the number of months of each year that an individual is enrolled in a plan). The Company experienced an overall rate increase for its Medicare members due to an approximate 7.5% increase in its capitation rate established by the Health Care Financing Administration ("HCFA"). Additionally, the Company realized minimal rate changes for the HMO subsidiary's commercial groups and managed indemnity insurance subsidiary. The Company's specialty product revenue increased slightly to $102.8 million in 1995 from $101.3 million in 1994. Specialty product revenue increased by $1.7 million in Nevada and $2.0 million in all other states excluding California. Such increases were offset by a $2.2 million decrease in the amount of specialty product revenue earned in California. The decrease in California specialty product revenues is primarily due to the abolishment of minimum premium rates in the California workers' compensation market and the commencement of open rating effective January 1, 1995, as well as a 16% rate decrease which had occurred October 1, 1994. Professional fees increased by $7.1 million, or 57.5% over 1994 due principally to the opening of three new medical clinics (one in the latter part of 1994 and two in 1995), a new surgery center, and the acquisition of a medical facility. Investment and other revenue increased $6.2 million, or 32.6%, primarily due to increased investment balances from the Company's common stock offering completed in October 1994.
Total medical expenses increased by approximately $21.7 million in 1994 compared to 1993. This 12.2% increase resulted from the consolidated member month growth discussed above, along with inflationary and other medical cost increases approximating .9%. These factors slightly increased the Company's medical loss ratio to 71.1% for the twelve months ended December 31, 1994, from 70.9% for the comparable twelve months in 1993. Specialty product expenses decreased $22.3 million from 1993. This decrease was primarily the result of a decrease in the specialty product revenue noted above as well as a reduced loss ratio for the 1994 accident year and favorable development of prior accident years. These decreases were offset in part by a $5.8 million increase in the new workers' compensation medical management contract discussed above. Such additional costs include utilization review and other administrative services.
In 1995 the Company spent $11.0 million on the acquisition of a medical facility and $20.5 million in capital expenditures. Capital expenditures were primarily for new facilities as well as the expansion of existing medical facilities and include the construction costs of a 28,000 square foot outpatient surgical facility in Las Vegas, medical equipment for the surgery center as well as equipment for two new leased medical facilities opened in 1995, and land purchased to build a medical facility in 1996. Such facilities accounted for $10.8 million of the total capital expenditures. Other capital expenditures were primarily for business expansion of the HMO and insurance operations, along with general corporate expansion. In addition, the Company reduced debt obligations by $11.9 million in 1995. Most of this debt reduction was a result of the Company paying off debt acquired in acquisitions or mergers which had terms and interest rates less favorable than those currently available to the Company. These cash out flows were partially offset by a decrease of $15.7 million in financed premiums receivable, as well as $3.8 million received in connection with the purchase of stock through the Company's stock plans.
In July 1995, the Company renewed its unsecured line of credit from PriMerit Bank, F.S.B. for an additional one year term at an interest rate of prime plus 1% and increased the available amount to $10.0 million. The line of credit, if drawn upon, will be used for general corporate purposes and will be available for additional working capital, if necessary.
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" ("FAS 121"). In accordance with FAS 121, long-lived assets to be held are reviewed for events or changes in circumstances which would indicate that the carrying value may not be recoverable. The adoption of FAS 121 had no effect on the consolidated financial statements.
Management Report on Consolidated Financial Statements...................... 25 Independent Auditors' Report................................................ 26 Consolidated Balance Sheets at December 31, 1995 and 1994................... 27 Consolidated Statements of Operations for the Years Ended December 31, 1995, 1994, and 1993........................................ 29 Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1995, 1994, and 1993.................... 30 Consolidated Statements of Cash Flows for the Years Ended December 31, 1995, 1994, and 1993........................................ 31 Notes to Consolidated Financial Statements.................................. 32
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1995 and 1994
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 1995, 1994 and 1993
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 1995, 1994 and 1993
Separate results of operations, excluding merger costs, for the periods prior to the merger with CII are as follows:
In connection with the merger and integration of CII, $11.6 million of costs and expenses ($9.7 million after tax, or $0.56 per share) were incurred and have been charged to expense in the fourth quarter of 1995. These costs include $6.4 million in professional fees, $1.7 million for the write-off of certain redundant hardware and software, $1.3 million for the cancellation of certain contractual obligations and other settlement costs, $.9 million related to transition and severance-related payments, and $1.3 million for other integration costs.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Years Ended December 31, 1995, 1994 and 1993
Principles of Consolidation. All significant intercompany transactions and balances have been eliminated. Sierra's wholly owned subsidiaries include Health Plan of Nevada, Inc. ("HPN"), a health maintenance organization, Sierra Health and Life Insurance Company, Inc. ("SHL"), a health and life insurance company, Southwest Medical Associates, Inc. ("SMA"), a multispecialty medical group, CII Financial, Inc. ("CII"), a holding company primarily engaged in writing workers' compensation insurance through its wholly owned subsidiaries, a home health care agency, a hospice, an administrative services company, a company that provides and manages mental health and substance abuse services, and others, including a company which has an interest in a building partnership. In addition, Sierra manages HMO Texas L.C. ("HMO Texas"), a health maintenance organization which was licensed in February 1995 in the state of Texas. Sierra owns 50% of the membership units in HMO Texas. Under the terms of the ownership agreement Sierra currently has a 51% voting interest in HMO Texas and has a majority of the Board seats. Such agreements provide for Sierra to control all decisions in the ordinary course of business. HMO Texas has an agreement with a key employee, however, where he may be granted up to a 5% equity interest in HMO Texas, if certain employment requirements are fulfilled in the future. The remaining interests of HMO Texas and the other partners in the building partnership are reflected as Minority Interests in the accompanying Consolidated Balance Sheets.
Specialty Product Revenue. These revenues consist primarily of workers' compensation premiums and other fees received for certain administrative services. Premiums are calculated by formula such that the premium written is earned pro rata over the term of the policy. Also included in specialty product revenues are administrative services and certain ancillary product revenues. Such revenues are recognized in the period in which the service is performed or the period that coverage for services is provided. Premiums written in excess of premiums earned are recorded as an unearned premium revenue liability. Premiums earned include an estimate for earned but unbilled premiums.
Professional Fees. Revenue for professional services is recorded on the accrual basis in the period in which the services are provided. Such revenue is recorded at established rates net of provisions for estimated contractual and charitable allowances.
Health Care Costs. Sierra contracts with hospitals, physicians and other 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. Losses on specific contracts, if any, are accrued when measurable.
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.
Land, Building and Equipment. 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:
New Accounting Standards. In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121 ("FAS 121"), "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed of." In accordance with FAS 121, long-lived assets to be held are reviewed for events or changes in circumstances which would indicate that the carrying value may not be recoverable. The adoption of FAS 121 had no effect on the consolidated financial statements.
In October 1995, Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" ("FAS 123") was issued. FAS 123 is effective for fiscal years that begin after December 15, 1995. When the Company adopts FAS 123 in 1996, the Company intends to continue to account for stock-based compensation in accordance with APB Opinion 25 as permitted by FAS 123. The additional information required by FAS 123 will be provided in a note to the consolidated financial statements. The Company has not determined the value of the stock compensation using the methods required by FAS 123 but believes the amounts could be significant.
Estimates and Assumptions. The preparation of financial statements in conformity with generally accepted accounting principles 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. Estimates and assumptions have been made in recording medical and specialty product expenses. Actual results may differ from estimates.
Land, building and equipment at December 31 consists of the following:
The following is an analysis of building and equipment under capital leases by classification:
Marketable debt securities that the Company has the intention and ability to hold to maturity are stated at amortized cost, and categorized as held to maturity. The remaining marketable debt and equity securities have been categorized as available-for-sale and as a result are stated at their fair value. Unrealized holding gains and losses on available-for-sale securities are included as a separate component of stockholders' equity until realized. Proceeds from the sales and maturities of available-for-sale securities during 1995 were $365,539,000. Gross realized gains and losses in 1995 were $970,000 and $671,000 respectively. Realized gains and losses are calculated using the specific identification method and are included in net income.
The contractual maturities of held-to-maturity short-term, long-term and restricted securities at December 31, 1995 were as follows:
Of the cash and cash equivalents that total $57,044,000 in the accompanying Consolidated Balance Sheet at December 31, 1995, $44,794,000 is limited for use only by the Company's regulated subsidiaries. Such amounts are available for transfer to Sierra from the regulated securities only to the extent that they can be remitted in accordance with terms of existing management agreements and by dividends which customarily must be approved by regulating state insurance departments. The remainder is available to Sierra on an unrestricted basis.
The Company is covered under a medical reinsurance agreement that provides coverage for 50-90% of hospital costs in excess of $75,000 per case, up to a maximum of $2,000,000 per member per lifetime for both SHL and HPN. Reinsurance premiums of $2,827,000, $2,234,000, and $2,097,000, net of reinsurance recoveries of $1,133,000, $584,000, and $363,000, are included in medical expense for 1995, 1994 and 1993, respectively. In addition, SHL maintains reinsurance on certain life insurance policies.
The following table provides workers' compensation reinsurance information by reinsurer for the three years ended December 31, 1995:
The following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and loss adjustment expenses. There can be no assurances that favorable development, or the magnitude of the development, will continue in the future.
In September 1991 CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. The Debentures bear interest at 7-1/2% which is due semi-annually on March 15 and September 15. Each $1,000 in principal is convertible into 16.921 shares of the Company's common stock at a conversion price of $59.097 per share. Unamortized issuance costs of $1,216,000 are included in other assets on the balance sheet and are being amortized over the life of the Debentures. Accrued interest on the Debentures as of both December 31, 1995 and 1994 was $1,243,000. The Debentures are redeemable by CII, in whole or in part, at redemption prices ranging from 103.75% in 1996 to 100.75% in 2000, plus accrued interest for the twelve month period beginning September 15 of the applicable year. The Debentures are general unsecured obligations of CII only and were not assumed or guaranteed by Sierra.
During 1994, the Company assumed a $4,860,000 mortgage note in conjunction with a related party transaction described in Note 10. Monthly installments of $36,144, including interest at 7.12%, are due through July 1996, at which time the balance of the note is due. This loan is secured by a medical facility.
In July 1995, the Company renewed its unsecured line of credit from PriMerit Bank, F.S.B. for an additional one year term at an interest rate of prime plus 1%, and increased the available amount to $10,000,000. The line of credit, if drawn upon, will be used for general corporate purposes and will be available for additional working capital, if necessary.
The following reconciles the difference between the 1995, 1994 and 1993 current and statutory provision for income taxes:
Leases. 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 $4,942,000, $4,873,000, and $4,942,000 in 1995, 1994 and 1993, respectively.
In March 1994, the Company purchased two companies which owned and operated medical buildings that were previously leased by the Company. The two companies and their predecessor limited partnerships were entities that were partially owned by affiliates of the Company. The Company's Chief Executive Officer had interests in both companies and another officer of the Company had an interest in one company. The Company purchased all the outstanding stock of the two companies for approximately $11.4 million which consisted of $4.0 million in cash and $7.4 million in assumed liabilities. The purchase price was based on the appraised value of the two companies' land and medical buildings; all other assets purchased were not material. The two companies were then merged into one of Sierra's subsidiaries. In August 1994, the Company paid off $2.4 million of the assumed liabilities. Lease payments to the affiliated entities for the year ended December 31, 1993 was $1,663,000.
Supplemental Retirement Plan. 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 $601,000, $550,000, and $408,000 to the SRP in 1995, 1994 and 1993, respectively.
Other CII Plans. Prior to the acquisition of CII, CII maintained various supplemental benefit, executive benefit, and profit sharing plans. Subsequent to the merger all such plans have been, or are in the process of being, discontinued, terminated, or merged into the Company's existing plans. During the years ended December 31, 1995, 1994 and 1993, CII expensed $1,574,000, $2,485,000, and $1,523,000, respectively, under the various plans. Eligible CII employees are included in the Company's plans discussed above.
Stock Option Plans. During 1995 the shareholders of the Company approved the 1995 Long-Term Incentive Plan ("LTIP"). The LTIP provides for the granting of Options, SARs, Restricted Stock, Deferred Stock, Stock and other stock-based awards. Under the LTIP 1.2 million shares were reserved along with remaining shares reserved from certain previous stock option and capital accumulation plans which have not been and will not be issued under those plans. 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 following table reflects the activity of the stock option plans: