HCA Healthcare - 10-Q quarterly report FY

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UNITED STATES

FORM 10-Q

(Mark One)

OR

Commission file number 1-11239

HCA Inc.

(615) 344-9551

Not Applicable

    Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x     NO o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES x     NO o

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock of the latest practicable date.

HCA INC.

FORM 10-Q

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HCA INC.

See accompanying notes.

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HCA INC.

See accompanying notes.

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HCA INC.

See accompanying notes.

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HCA INC.

     HCA Inc. is a holding company whose affiliates own and operate hospitals and related health care entities. The term “affiliates” includes direct and indirect subsidiaries of HCA Inc. and partnerships and joint ventures in which such subsidiaries are partners. At March 31, 2004, these affiliates owned and operated 184 hospitals, 79 freestanding surgery centers and provided extensive outpatient and ancillary services. Affiliates of HCA Inc. are also partners in joint ventures that own and operate seven hospitals and four freestanding surgery centers which are accounted for using the equity method. The Company’s facilities are located in 23 states, England and Switzerland. The terms “HCA” or the “Company,” as used in this Quarterly Report on Form 10-Q, refer to HCA Inc. and its affiliates unless otherwise stated or indicated by context.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative by HCA would include the HCA corporate office costs, which were $36 million and $35 million for the quarters ended March 31, 2004 and 2003, respectively. Operating results for the quarter ended March 31, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

     Certain prior year amounts have been reclassified to conform to the current year presentation.

     HCA applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations in accounting for its employee stock benefit plans. Accordingly, no compensation cost has been recognized for HCA’s stock options granted under the plans because the exercise prices for options granted were equal to the quoted market prices on the option grant dates and all option grants were to employees or directors.

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     As required by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), HCA has determined pro forma net income and earnings per share, as if compensation cost for HCA’s employee stock option and stock purchase plans had been determined based upon fair values at the grant dates. These pro forma amounts are as follows (dollars in millions, except per share amounts):

     For SFAS 123 purposes, the weighted average fair values of HCA’s stock options granted during the quarters ended March 31, 2004 and 2003 were $12.95 and $13.58 per share, respectively. The fair values were estimated using the Black-Scholes option valuation model with the following weighted average assumptions:

     The expected volatility is derived using weekly, historical data for periods preceding the date of grant. The risk-free interest rate is the approximate yield on four-year United States Treasury Strips on the date of grant. The expected life is an estimate of the number of years an option will be held before it is exercised. The valuation model was not adjusted for nontransferability, risk of forfeiture or the vesting restrictions of the options, all of which would reduce the value if factored into the calculation.

     In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS 150”). This statement generally requires liability classification for two broad classes of financial instruments. Under SFAS 150, instruments that represent, or are indexed to, an obligation to buy back the issuer’s shares, regardless whether the instrument is settled on a net-cash or gross physical basis are required to be classified as liabilities. Obligations that can be settled in shares, but either derive their value predominately from some

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other underlying, have a fixed value, or have a value to the counterparty that moves in the opposite direction as the issuer’s shares, are also required to be classified as liabilities under this statement. SFAS 150 must be applied immediately to instruments entered into or modified after May 31, 2003 and to all other instruments that exist as of the beginning of the first interim financial reporting period beginning after June 15, 2003. In October 2003, the FASB voted to defer for an indefinite period, the application of the SFAS 150 guidance to noncontrolling interests in limited-life subsidiaries. The FASB decided to defer this application of SFAS 150 to allow them the opportunity to consider possible implementation issues that would result from the proposed SFAS 150 guidance regarding measurement and recognition of noncontrolling interests. HCA will assess the impact of the FASB’s reconsiderations, if any, on the Company’s consolidated financial statements when they are finalized.

     Commencing in 1997, HCA became aware it was the subject of governmental investigations and litigation relating to its business practices. The investigations were concluded through a series of agreements executed in 2000 and 2003. In January 2001, HCA entered into an eight-year Corporate Integrity Agreement (“CIA”) with the Office of Inspector General of the Department of Health and Human Services.

     HCA remains the subject of a December 1997 formal order of investigation by the Securities and Exchange Commission (the “SEC”). HCA understands that the investigation includes the antifraud, insider trading, periodic reporting and internal accounting control provisions of the Federal securities laws.

     If HCA was found to be in violation of Federal or state laws relating to Medicare, Medicaid or similar programs or breach of the CIA, HCA could be subject to substantial monetary fines, civil and criminal penalties and/or exclusion from participation in the Medicare and Medicaid programs. Any such sanctions or expenses could have a material, adverse effect on HCA’s financial position, results of operation and liquidity.

     During the first quarter of 2003, HCA recorded $4 million of professional fees in connection with the governmental investigations.

NOTE 3 — ACQUISITIONS AND DISPOSITIONS

     During the first quarter of 2003, HCA recognized a net pretax gain of $74 million ($42 million after-tax) on the sales of two leased hospitals and one consolidating hospital. Proceeds from the sales were used to repay bank borrowings.

     During April 2003, HCA completed the acquisition of the Health Midwest system in Kansas City. The acquisition included 11 consolidating hospitals and one hospital operated through a management agreement. The results of operations of the Health Midwest system were consolidated with those of HCA beginning on April 1, 2003. The pro forma effect of HCA’s acquisition on its results of operations for the periods prior to the acquisition date was not significant.

NOTE 4 — INCOME TAXES

     HCA is currently contesting before the Appeals Division of the IRS, the United States Tax Court (the “Tax Court”), the United States Court of Federal Claims, and the United States Court of Appeals for the Sixth Circuit (the “Sixth Circuit”) certain claimed deficiencies and adjustments proposed by the IRS in conjunction with its examinations of HCA’s 1994-2000 Federal income tax returns, Columbia Healthcare Corporation’s (“CHC”) 1993 and 1994 Federal income tax returns, HCA-Hospital Corporation of America’s

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(“Hospital Corporation of America”) 1987 through 1988 and 1991 through 1993 Federal income tax returns and Healthtrust, Inc. — The Hospital Company’s (“Healthtrust”) 1990 through 1994 Federal income tax returns.

     During 2001, HCA filed an appeal with the Sixth Circuit with respect to two Tax Court decisions received in 1996 related to the IRS examination of Hospital Corporation of America’s 1987 through 1988 Federal income tax returns, contesting Tax Court decisions related to the method that Hospital Corporation of America used to calculate its tax reserve for doubtful accounts and the timing of deferred income recognition in connection with its sales of certain subsidiaries to Healthtrust. During 2003, a three-judge panel of the Sixth Circuit affirmed these Tax Court decisions. During February 2004, the Sixth Circuit denied HCA’s petition for rehearing. HCA is reviewing the Sixth Circuit’s decision and considering whether to undertake further appeals. Because of the volume and complexity of calculating the tax allowance for doubtful accounts, the IRS has not determined the amount of additional tax and interest that it may claim.

     Other disputed items include the timing of recognition of certain patient service revenues in 2000, the amount of insurance expense deducted in 1999 and 2000, and the amount of gain or loss recognized on the divestiture of certain noncore business units in 1998. The IRS is claiming an additional $384 million in income taxes and interest with respect to these issues through March 31, 2004.

     During the first quarter of 2004, the IRS began an examination of HCA’s 2001 through 2002 Federal income tax returns. HCA is presently unable to estimate the amount of any additional income tax and interest that the IRS may claim upon completion of this examination.

     Management believes that adequate provisions have been recorded to satisfy final resolution of the disputed issues. Management believes that HCA, CHC, Hospital Corporation of America and Healthtrust properly reported taxable income and paid taxes in accordance with applicable laws and agreements established with the IRS during previous examinations and that final resolution of these disputes will not have a material adverse effect on the results of operations or financial position.

NOTE 5 — EARNINGS PER SHARE

     Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding, plus the dilutive effect of outstanding stock options and other stock awards, computed using the treasury stock method.

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     The following table sets forth the computation of basic and diluted earnings per share for the quarters ended March 31, 2004 and 2003 (dollars in millions, except per share amounts and shares in thousands):

     A summary of the insurance subsidiary’s investments at March 31, 2004 and December 31, 2003 follows (dollars in millions):

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     The fair value of investment securities is generally based on quoted market prices. At March 31, 2004 and December 31, 2003, the investments of HCA’s insurance subsidiary were classified as “available for sale.” The aggregate common stock investment is comprised of 369 equity positions at March 31, 2004, with 341 positions reflecting unrealized gains and 28 positions reflecting unrealized losses (none of the individual unrealized loss positions exceed $2 million). Equity positions that had experienced a continuous decline from cost for more than one year at March 31, 2004 represented less than one million dollars of unrealized losses. The equity positions (including those with unrealized losses) at March 31, 2004, are not concentrated in any particular industries.

NOTE 7 — LONG-TERM DEBT

     HCA’s revolving credit facility (the “Credit Facility”) is a $1.75 billion agreement that expires April 2006. At March 31, 2004, HCA had $380 million outstanding under the Credit Facility.

     At March 31, 2004, interest on Credit Facility borrowings is payable generally at either LIBOR plus 0.7% to 1.5% (depending on HCA’s credit ratings), the prime lending rate or a competitive bid rate. The Credit Facility contains customary covenants which include (i) a limitation on debt levels, (ii) a limitation on sales of assets, mergers and changes of ownership and (iii) maintenance of minimum interest coverage ratios. As of March 31, 2004, HCA was in compliance with all such covenants.

     In March 2004, HCA issued $500 million of 5.75% notes due March 15, 2014. The proceeds from the issuance were used to repay a portion of the amounts outstanding under the Credit Facility.

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NOTE 8 — STOCK REPURCHASE PROGRAMS

     In April 2003, HCA announced an authorization to repurchase up to $1.5 billion of its common stock. HCA expects to repurchase its shares through open market purchases or privately negotiated transactions. During 2004, HCA repurchased 8.9 million shares of its common stock for $375 million, through open market purchases. Under this authorization, HCA has repurchased in 2003 and 2004 a total of 34.2 million shares of its common stock for $1.275 billion.

     In July 2002, HCA announced an authorization to repurchase up to 12 million shares of its common stock. HCA completed repurchases under this authorization during 2003. During the first quarter of 2003, HCA made open market purchases of 3.7 million shares for $148 million.

NOTE 9 — CONTINGENCIES

     HCA operates in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been and can be expected to be instituted or asserted against the Company (see Note 2 — Investigations and Settlement of Certain Government Claims). The resolution of any such lawsuits, claims or legal and regulatory proceedings could have a material, adverse affect on HCA’s results of operations and financial position in a given period.

     HCA is subject to claims and suits arising in the ordinary course of business, including claims for personal injuries or wrongful restriction of, or interference with, physicians’ staff privileges. In certain of these actions the claimants may seek punitive damages against HCA which may not be covered by insurance. It is management’s opinion that the ultimate resolution of these pending claims and legal proceedings will not have a material, adverse effect on HCA’s results of operations or financial position.

NOTE 10 — COMPREHENSIVE INCOME

     The components of comprehensive income, net of related taxes, for the quarters ended March 31, 2004 and 2003 are as follows (in millions):

     The components of accumulated other comprehensive income, net of related taxes are as follows (in millions):

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NOTE 11 — SEGMENT AND GEOGRAPHIC INFORMATION

     HCA operates in one line of business, which is operating hospitals and related health care entities. During the quarters ended March 31, 2004 and 2003, approximately 28% and 29%, respectively, of the Company’s patient revenues related to patients participating in the Medicare program.

     HCA’s operations are structured into two geographically organized groups: the Eastern Group includes 91 consolidating hospitals located in the Eastern United States and the Western Group includes 85 consolidating hospitals located in the Western United States. HCA also operates eight consolidating hospitals in England and Switzerland and these facilities are included in the Corporate and other group.

     Adjusted segment EBITDA is defined as income before depreciation and amortization, interest expense, gains on sales of facilities, investigation related costs, minority interests and income taxes. HCA uses adjusted segment EBITDA as an analytical indicator for purposes of allocating resources to geographic areas and assessing their performance. Adjusted segment EBITDA is commonly used as an analytical indicator within the health care industry, and also serves as a measure of leverage capacity and debt service ability. Adjusted segment EBITDA should not be considered as a measure of financial performance under generally accepted accounting principles, and the items excluded from adjusted segment EBITDA are significant components in understanding and assessing financial performance. Because adjusted segment EBITDA is not a measurement determined in accordance with generally accepted accounting principles and is thus susceptible to varying calculations, adjusted segment EBITDA, as presented, may not be comparable to other similarly titled measures of other companies. The geographic distributions of HCA’s revenues, equity in earnings of affiliates,

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adjusted segment EBITDA and depreciation and amortization are summarized in the following table (dollars in millions):

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF

Forward-Looking Statements

     This Quarterly Report on Form 10-Q contains disclosures which contain “forward-looking statements.” Forward-looking statements include all statements that do not relate solely to historical or current facts, and can be identified by the use of words like “may,” “believe,” “will,” “expect,” “project,” “estimate,” “anticipate,” “plan,” “initiative” or “continue.” These forward-looking statements are based on the current plans and expectations of HCA and are subject to a number of known and unknown uncertainties and risks, many of which are beyond HCA’s control, that could significantly affect current plans and expectations and HCA’s future financial position and results of operations. These factors include, but are not limited to, (i) increases in the amount and risk of collectability of uninsured accounts and deductibles and copay amounts for insured accounts, (ii) the highly competitive nature of the health care business, (iii) the efforts of insurers, health care providers and others to contain health care costs, (iv) possible changes in the Medicare and Medicaid programs that may impact reimbursements to health care providers and insurers, (v) the ability to achieve operating and financial targets, achieve expected levels of patient volumes and control the costs of providing services, (vi) the ability to attract and retain qualified management and other personnel, including affiliated physicians, nurses and medical support personnel, (vii) potential liabilities and other claims that may be asserted against HCA, (viii) fluctuations in the market value of HCA’s common stock, (ix) changes in accounting practices, (x) changes in general economic conditions, (xi) future divestitures which may result in charges, (xii) changes in revenue mix and the ability to enter into and renew managed care provider arrangements on acceptable terms, (xiii) the availability and terms of capital to fund the expansion of the Company’s business, (xiv) changes in business strategy or development plans, (xv) delays in receiving payments for services provided, (xvi) the possible enactment of Federal or state health care reform, (xvii) the outcome of pending and any future tax audits and litigation associated with HCA’s tax positions, (xviii) the outcome of HCA’s continuing efforts to monitor, maintain and comply with appropriate laws, regulations, policies and procedures and HCA’s corporate integrity agreement with the government, (xix) changes in Federal, state or local regulations affecting the health care industry, (xx) the impact of the charity care and self-pay discounting policy changes, (xxi) the ability to successfully integrate the operations of Health Midwest, (xxii) the ability to develop and implement the payroll and human resources information systems within the expected time and cost projections and, upon implementation, to realize the expected benefits and efficiencies, and (xxiii) other risk factors detailed in the Company’s Annual Report on Form 10-K and other filings with the Securities and Exchange Commission (“SEC”). As a consequence, current plans, anticipated actions and future financial position and results of operations may differ from those expressed in any forward-looking statements made by or on behalf of HCA. You are cautioned not to unduly rely on such forward-looking statements when evaluating the information presented in this report, including in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

First Quarter 2004 Operations Summary

     Increases in uninsured patient volumes continue to provide a significant challenge for HCA. On a same facility basis, uninsured admissions increased 13.7% for the first quarter of 2004 compared to the first quarter of 2003. While these admissions make up a relatively small amount of the Company’s total admissions, 4.3% of total same facility admissions for the first quarter of 2004 compared to 3.9% of same facility admissions in the first quarter of 2003, the increase in these uninsured admissions and uninsured revenues and the related impact on the provision for doubtful accounts provide a significant challenge to achieving growth in net income. For the first quarter of 2004, the provision for doubtful accounts increased to 11.7% of revenues from 8.1% in the first quarter of 2003. The difference between 11.7% and 8.1% of 2004 revenues is $213 million. Management expects these negative bad debt trends to remain significant challenges for HCA during 2004.

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     During the first quarter of 2004, same facility admissions increased 2.5%, compared to a 0.4% decrease during the first quarter of 2003. Same facility outpatient surgeries increased 1.8% during the first quarter 2004, compared to a decrease of 2.9% in the first quarter of 2003.

     During the first quarter of 2004, HCA was able to effectively manage salaries and benefits and other operating expenses. Salaries and benefits were reduced to 39.3% of revenues in the first quarter of 2004 compared to 39.8% of revenues in the first quarter of 2003. Other operating expenses were reduced to 16.1% of revenues in the first quarter of 2004 compared to 16.2% of revenues in the first quarter of 2003.

     While the Company faces operational challenges related to rising volumes from the uninsured, management believes that it is important to recognize that HCA generated cash provided by operating activities of $772 million and $755 million during the first quarters of 2004 and 2003, respectively.

Investigations and Settlement of Certain Government Claims

     Commencing in 1997, HCA became aware it was the subject of governmental investigations and litigation relating to its business practices. The investigations were concluded through a series of agreements executed in 2000 and 2003. In January 2001, HCA entered into an eight-year Corporate Integrity Agreement (“CIA”) with the Office of Inspector General of the Department of Health & Human Services.

     HCA remains the subject of a December 1997 formal order of investigation by the SEC. HCA understands that the investigation includes the antifraud, insider trading, periodic reporting and internal accounting control provisions of the Federal securities laws.

     If HCA was found to be in violation of Federal or state laws relating to Medicare, Medicaid or similar programs or breach of the CIA, HCA could be subject to substantial monetary fines, civil and criminal penalties and/or exclusion from participation in the Medicare and Medicaid programs. Any such sanctions or expenses could have a material adverse effect on HCA’s financial position, results of operation and liquidity.

Business Strategy

     HCA is committed to providing the communities it serves high quality, cost-effective, health care while maintaining consistency with HCA’s ethics and compliance program, governmental regulations and guidelines, and industry standards. As a part of this strategy, HCA’s management focuses on the following areas:

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Results of Operations

     HCA’s revenues depend upon inpatient occupancy levels, the ancillary services and therapy programs ordered by physicians and provided to patients, the volume of outpatient procedures and the charge and negotiated payment rates for such services.

     Revenues increased 12.6% from $5.273 billion in the first quarter of 2003 to $5.937 billion for the first quarter of 2004. The increase in revenues can be attributed to a 2.5% increase in same facility adjusted admissions, a 6.0% increase in same facility revenue per adjusted admission and $217 million of revenues from the eleven Kansas City hospitals that were acquired April 1, 2003.

     Consolidated admissions increased 6.4% and same facility admissions increased by 2.5% compared to 2003. Same facility outpatient surgeries increased 1.8% in 2004 compared to 2003.

     Admissions related to Medicare, managed care and other discounted plans, and Medicaid and uninsured for the quarters ended March 31, 2004 and 2003 are set forth below. Certain prior year amounts have been reclassified to conform to the 2004 presentation.

     Growth in volumes and revenues did not lead to growth in net income because the growth in overall volumes included significant growth in uninsured volumes. Of the 2.5% increase in same facility admissions during the first quarter of 2004 compared to the first quarter of 2003, 21.2% of that increase related to uninsured admissions. The increase in uninsured volume and uninsured revenues led to an increase in the provision for bad debts, as a percentage of revenues, to 11.7% in the first quarter of 2004 compared to 8.1% in the first quarter of 2003.

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     At March 31, 2004, HCA had 77 hospitals in the states of Texas and Florida. On a same facility basis, 52% of the Company’s total admissions and 50% of the Company’s revenues are generated by these hospitals. Uninsured admissions in Texas and Florida represent 61% of the Company’s total uninsured admissions.

     HCA believes the solution to the challenges posed by increasing uninsured volumes includes analyzing the various steps of its patient access and account collections cycle and developing and implementing improvements to these processes. While complying with all Federal and state laws and regulations, including but not limited to the Emergency Medical Treatment and Active Labor Act (“EMTALA”), and the Company’s commitment to providing quality patient care, the Company is reviewing the following areas: treating patients in the most clinically appropriate and cost-effective setting; collecting appropriate patient information at the appropriate times; improving cash collections earlier in the patient encounter and at the point of discharge.

     HCA’s health care facilities’ gross charges typically do not reflect what the facilities are actually paid. HCA’s health care facilities have entered into agreements with third-party payers, including government programs and managed care health plans, under which the facilities are paid based upon the cost of providing services, predetermined rates per diagnosis, fixed per diem rates or discounts from gross charges. HCA’s facilities have experienced revenue growth due to changes in patient mix and favorable pricing trends. HCA has experienced increases in same facility revenue per equivalent admission over the prior period of 6.0% and 9.6% for the first quarters of 2004 and 2003, respectively. There can be no assurance that HCA will continue to receive these levels of increases in the future. These increases were the result of renegotiating and renewing certain managed care contracts on more favorable terms, shifts of managed care admissions to more favorable plans and improved reimbursement from the government.

     One factor contributing to the moderation in the rate of increase in same facility revenue per equivalent admission in the first quarter of 2004 compared to the first quarter of 2003 is the Company’s implementation of the charity policies that were announced in March 2003. Beginning in the second quarter of 2003, patients treated at an HCA wholly-owned hospital for nonelective care, who have income at or below 200% of the Federal poverty level, are eligible for charity care. HCA estimates that 70% of its hospitals were previously using this charity care policy. In the fourth quarter of 2003, HCA implemented a sliding scale of discounts for uninsured patients treated at an HCA wholly-owned hospital for nonelective care who have income levels between 200% and 400% of the Federal poverty level. Charity discounts increased $36 million in the first quarter of 2004 compared to the first quarter of 2003 (from $182 million to $218 million); however, discounts related to patients with income between 200% and 400% of the Federal poverty level were less than HCA expected due to problems encountered in collecting patient income level documentation.

     The approximate percentages of the Company’s inpatient revenues related to Medicare, managed care and other discounted plans, and Medicaid and uninsured for the quarters ended March 31, 2004 and 2003 are set forth in the following table. Certain prior year amounts have been reclassified to conform to the 2004 presentation.

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     HCA receives a significant portion of its revenues from government health programs, principally Medicare and Medicaid, which are highly regulated and subject to frequent and substantial changes. Legislative changes have resulted in limitations and even reductions in levels of payments to health care providers for certain services under these government programs.

     Excluding the hospitals included in the Kansas City acquisition, HCA recorded $32 million and $70 million of revenues related to Medicare operating outlier cases for the first quarters in 2004 and 2003, respectively. These amounts represent 2.0% and 4.6% of Medicare revenues and 0.6% and 1.3% of total revenues for the first quarters of 2004 and 2003, respectively. There can be no assurances that HCA will continue to receive these levels of Medicare outlier payments in future periods.

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     The following are comparative summaries of results from operations for the quarters ended March 31, 2004 and 2003 (dollars in millions, except per share amounts):

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     Net income totaled $345 million, or $0.69 per diluted share, in 2004 compared to $469 million, or $0.90 per diluted share, in 2003. The operating results for 2003 include gains on sales of facilities of $74 million pretax, or $0.08 per diluted share, and investigation related costs of $4 million.

     In April 2003, HCA completed the acquisition of eleven hospitals in Kansas City. During the first quarter of 2004, the acquired Kansas City hospitals produced revenues of $217 million and a net loss of $7 million. The Kansas City hospitals are included in the Company’s Western Group.

     For the first quarter of 2004, admissions increased 6.4% and same facility admissions increased 2.5% compared to the first quarter of 2003. Outpatient surgical volumes increased 6.6% and 1.8% on a same facility basis compared to the first quarter of 2003.

     Salaries and benefits decreased, as a percentage of revenues, to 39.3% in the first quarter of 2004 from 39.8% in the same quarter of 2003. Excluding the acquired Kansas City hospitals, salaries and benefits, as a percentage of revenues, were 38.9% for 2004. The decreases reflect improvements in the utilization of contract labor. Contract labor per equivalent admission decreased 34% for 2004 compared to 2003.

     Supplies increased, as a percentage of revenues, from 16.0% in the first quarter of 2003 to 16.5% in the first quarter of 2004. Rising supply costs, particularly in the cardiac, orthopedic and pharmaceutical areas, continue to be a challenge for the Company.

     Other operating expenses, as a percentage of revenues, decreased to 16.1% in the first quarter of 2004 compared to 16.2% in the first quarter of 2003. Other operating expenses is primarily comprised of contract services, professional fees, repairs and maintenance, rents and leases, utilities, insurance (including professional liability insurance) and nonincome taxes. These expenses tend to decrease, as a percentage of revenues, when the Company experiences revenue increases, because the majority of these expenses are fixed in nature.

     Provision for doubtful accounts, as a percentage of revenues, increased to 11.7% in the first quarter of 2004 from 8.1% in the first quarter of 2003. The factors influencing this increase include the Company’s recent experience of increasing patient due or uninsured accounts and a continued deterioration in the collectability of these accounts. HCA believes the increases in uninsured patients and deterioration in the collectability of these accounts is caused by decreased medical benefits under certain plans, an increasing amount of patient financial responsibility, high unemployment levels in certain of HCA’s markets, growing numbers of employed individuals choosing not to buy health insurance and reductions in Medicaid benefits in certain states. The provision for doubtful accounts and the allowance for doubtful accounts relate primarily to uninsured amounts due directly from patients. At March 31, 2004, the Company’s allowance for doubtful accounts represented approximately 89% of the $3.209 billion total patient due accounts receivable balance.

     Gains on investments of $10 million in the first quarter of 2004 consist primarily of net gains on investment securities held by HCA’s wholly-owned insurance subsidiary.

     Equity in earnings of affiliates decreased from $58 million in the first quarter of 2003 to $46 million in the first quarter of 2004 due to a decline in operations at joint ventures accounted for under the equity method of accounting.

     Depreciation and amortization increased from 4.8% of revenues in the first quarter of 2003 to 5.0% in the first quarter of 2004. The increase of $42 million of depreciation and amortization is the result of $1.8 billion of capital spending for the year ended December 31, 2003, and $390 million of capital spending in the first quarter of 2004.

     Interest expense increased from $114 million in the first quarter of 2003 to $135 million in the first quarter of 2004. The increase was due to higher levels of debt in the first quarter of 2004 compared to the first

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quarter of 2003. HCA’s ratio of current and long-term debt to current and long-term debt and common and minority equity was 55.8% at March 31, 2004 compared to 53.6% at March 31, 2003.

     During 2003, HCA recognized a pretax gain of $74 million ($42 million after-tax) on the sales of two leased hospitals and one consolidating hospital. Proceeds from the sales were used to repay bank borrowings.

     During the first quarter of 2003, HCA incurred $4 million of professional fees (legal and accounting) related to the governmental investigations. The governmental investigations of the Company’s business practices, which commenced in 1997, were concluded in 2003.

Liquidity and Capital Resources

     Cash provided by operating activities totaled $772 million in the first quarter of 2004 compared to $755 million in the first quarter of 2003. Working capital totaled $2.095 billion at March 31, 2004 and $1.654 billion at December 31, 2003.

     Cash used in investing activities was $441 million in the first quarter of 2004 compared to $444 million in the first quarter of 2003. Excluding acquisitions, capital expenditures were $390 million in 2004 and $464 million in 2003. Annual planned capital expenditures in 2004 and 2005 are expected to approximate $1.8 billion and $1.6 billion, respectively. At March 31, 2004, there were projects under construction, which had estimated additional costs to complete and equip over the next five years of approximately $1.7 billion. HCA expects to finance capital expenditures with internally generated and borrowed funds.

     Cash used in financing activities totaled $298 million during the first quarter of 2004 compared to cash provided by financing activities of $618 million during the first quarter of 2003. The cash provided by financing activities in 2003 was primarily the result of the issuance of $500 million of 6.25% notes in February 2003 and additional borrowings under HCA’s $1.75 billion revolving credit facility (the “Credit Facility”). These borrowings were incurred to finance the purchase of the Health Midwest facilities on April 1, 2003.

     In addition to cash flows from operations, available sources of capital include amounts available under the Credit Facility ($1.3 billion available as of April 30, 2004) and anticipated access to public and private debt markets. Management believes that its available sources of capital are adequate to expand, improve and equip its existing health care facilities and to complete selective acquisitions.

     Investments of HCA’s professional liability insurance subsidiary to maintain statutory equity and pay claims totaled $2.145 billion and $2.065 billion at March 31, 2004 and December 31, 2003, respectively. Claims payments, net of reinsurance recoveries, during the next twelve months are expected to approximate $275 million. The estimation of the timing of claims payments beyond a year can vary significantly. HCA’s wholly-owned insurance subsidiary has entered into certain reinsurance contracts, and the obligations covered by the reinsurance contracts remain on the balance sheet as the subsidiary remains liable to the extent that the reinsurers do not meet their obligations under the reinsurance contracts. To minimize its exposure to losses from reinsurer insolvencies, HCA routinely monitors the financial condition of its reinsurers. The amounts receivable related to the reinsurance contracts of $110 million and $147 million at March 31, 2004 and December 31, 2003, respectively, are included in other assets.

     In March 2004, HCA issued $500 million of 5.75% notes due March 15, 2014. The proceeds from the issuance were used to repay a portion of the amounts outstanding under the Credit Facility. Of the $2.5 billion available under HCA’s shelf registration statement filed in July 2003, $1.1 billion of debt securities have been issued as of March 31, 2004.

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     HCA’s $2.5 billion credit agreement (the “2001 Credit Agreement”), which includes the Credit Facility, has a final maturity in April 2006. Interest under the 2001 Credit Agreement is payable at a spread to LIBOR, a spread to the prime lending rate or a competitive bid rate. The spread is dependent on HCA’s credit ratings. The 2001 Credit Agreement contains customary covenants which include (i) limitations on debt levels, (ii) limitations on sales of assets, mergers and changes of ownership, and (iii) maintenance of minimum interest coverage ratios. As of March 31, 2004, HCA was in compliance with all such covenants.

     Management believes that cash flows from operations, amounts available under the Credit Facility and HCA’s anticipated access to public and private debt markets are sufficient to meet expected liquidity needs during the next twelve months.

     In April 2003, HCA announced an authorization to repurchase up to $1.5 billion of its common stock. During the first quarter of 2004, HCA repurchased 8.9 million shares of its common stock for $375 million. As of March 31, 2004, HCA has $225 million remaining under this authorization. HCA expects to complete the authorization to repurchase its shares through open market purchases or privately negotiated transactions.

     In July 2002, HCA announced an authorization to repurchase up to 12 million shares of its common stock. HCA completed the authorization in 2003. During the first quarter of 2003, HCA repurchased 3.7 million shares for $148 million. The repurchases were intended to offset the dilutive effect of employee stock compensation programs.

     During 2003, HCA announced plans to discontinue activities associated with the development of a patient accounting software system, resulting in a pretax charge of $130 million. HCA had estimated that the patient accounting project would have required total expenditures of approximately $400 million to develop and install. The Company is now redirecting efforts in this area to the implementation of enhancements to its existing patient accounting system. HCA is also in the process of implementing projects to replace its payroll and human resources information systems. Management estimates that the payroll and human resources system projects will require total expenditures of approximately $330 million to develop and install. At March 31, 2004, project-to-date costs incurred were $222 million ($145 million of the costs incurred have been capitalized and $77 million have been expensed). Management expects that the system development, testing, data conversion and installation activities will continue through 2006. There can be no assurance that the development and implementation of these systems will not be delayed, that the total cost will not be significantly more than currently anticipated, that business processes will not be interrupted during implementation or that HCA will realize the expected benefits and efficiencies from the developed products.

     HCA is exposed to market risk related to changes in market values of securities. The investments in debt and equity securities of HCA’s wholly-owned insurance subsidiary were $1.407 billion and $738 million, respectively, at March 31, 2004. These investments are carried at fair value with changes in unrealized gains and losses being recorded as adjustments to other comprehensive income. The fair value of investments is generally based on quoted market prices. If the insurance subsidiary were to experience significant declines in the fair value of its investments, this could require additional investment by the Company to allow the insurance subsidiary to satisfy its minimum capital requirements.

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     HCA evaluates, among other things, the financial position and near term prospects of the issuer, conditions in the issuer’s industry, liquidity of the investment, changes in the amount or timing of expected future cash flows from the investment, and recent downgrades of the issuer by a rating agency to determine if and when a decline in the fair value of an investment below amortized cost is considered “other-than-temporary.” The length of time and extent to which the fair value of the investment is less than amortized cost and HCA’s ability and intent to retain the investment to allow for any anticipated recovery in the investment’s fair value are important components of management’s investment securities evaluation process. At March 31, 2004, HCA had a net unrealized gain of $219 million on the insurance subsidiary’s investment securities.

     HCA is also exposed to market risk related to changes in interest rates, and HCA periodically enters into interest rate swap agreements to manage its exposure to these fluctuations. HCA’s interest rate swap agreements involve the exchange of fixed and variable rate interest payments between two parties, based on common notional principal amounts and maturity dates. The notional amounts and interest payments in these agreements match the cash flows of the related liabilities. The notional amounts of the swap agreements represent balances used to calculate the exchange of cash flows and are not assets or liabilities of HCA. Any market risk or opportunity associated with these swap agreements is offset by the opposite market impact on the related debt. HCA’s credit risk related to these agreements is considered low because the swap agreements are with creditworthy financial institutions. The interest payments under these agreements are settled on a net basis. These derivatives and the related hedged debt amounts have been recognized in the financial statements at their respective fair values.

     With respect to HCA’s interest-bearing liabilities, approximately $1.792 billion of long-term debt at March 31, 2004 is subject to variable rates of interest, while the remaining balance in long-term debt of $6.961 billion at March 31, 2004 is subject to fixed rates of interest. Both the general level of U.S. interest rates and, for the 2001 Credit Agreement, the Company’s credit rating affect HCA’s variable interest rates. HCA’s variable rate debt is comprised of the Company’s Credit Facility, on which interest is payable generally at LIBOR plus 0.7% to 1.5% (depending on HCA’s credit ratings); a bank term loan, on which interest is payable generally at LIBOR plus 1% to 2%, and fixed rate notes on which interest rate swaps have been employed, on which interest is payable at LIBOR plus 1.6% to 2.4%. Due to decreases in LIBOR, the average rate for the Company’s Credit Facility decreased from 2.0% for the quarter ended March 31, 2003 to 1.8% for the quarter ended March 31, 2004, and the average rate for the Company’s term loans decreased from 2.3% for the quarter ended March 31, 2003 to 2.1% for the quarter ended March 31, 2004. The estimated fair value of HCA’s total long-term debt was $9.4 billion at March 31, 2004. The estimates of fair value are based upon the quoted market prices for the same or similar issues of long-term debt with the same maturities. Based on a hypothetical 1% increase in interest rates, the potential annualized reduction to future pretax earnings would be approximately $18 million. The impact of such a change in interest rates on the fair value of long-term debt would not be significant. The estimated changes to interest expense and the fair value of long-term debt are determined considering the impact of hypothetical interest rates on HCA’s borrowing cost and long-term debt balances. To mitigate the impact of fluctuations in interest rates, HCA generally targets a portion of its debt portfolio to be maintained at fixed rates.

     Foreign operations and the related market risks associated with foreign currency are currently insignificant to HCA’s results of operations and financial position.

Pending IRS Disputes

     HCA is currently contesting before the Appeals Division of the IRS, the United States Tax Court (the “Tax Court”), the United States Court of Federal Claims, and the United State Court of Appeals for the Sixth Circuit (the “Sixth Circuit”) certain claimed deficiencies and adjustments proposed by the IRS in

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conjunction with its examinations of HCA’s 1994-2000 Federal income tax returns, Columbia Healthcare Corporation’s (“CHC”) 1993 and 1994 Federal income tax returns, HCA-Hospital Corporation of America’s (“Hospital Corporation of America”) 1987 through 1988 and 1991 through 1993 Federal income tax returns and Healthtrust, Inc. — The Hospital Company’s (“Healthtrust”) 1990 through 1994 Federal income tax returns.

     During 2001, HCA filed an appeal with the Sixth Circuit with respect to two Tax Court decisions received in 1996 related to the IRS examination of Hospital Corporation of America’s 1987 through 1988 Federal income tax returns, contesting Tax Court decisions related to the method that Hospital Corporation of America used to calculate its tax reserve for doubtful accounts and the timing of deferred income recognition in connection with its sales of certain subsidiaries to Healthtrust. During the third quarter of 2003, a three-judge panel of the Sixth Circuit affirmed these Tax Court decisions. During February 2004, the Sixth Circuit denied HCA’s petition for rehearing. HCA is reviewing the Sixth Circuit’s decision and considering whether to undertake further appeals. Because of the volume and complexity of calculating the tax allowance for doubtful accounts, the IRS has not determined the amount of additional tax and interest that it may claim.

     Other disputed items include the timing of recognition of certain patient service revenues in 2000, the amount of insurance expense deducted in 1999 and 2000, and the amount of gain or loss recognized on the divestiture of certain noncore business units in 1998. The IRS is claiming an additional $384 million in income taxes and interest with respect to these issues through March 31, 2004.

     During the first quarter of 2004, the IRS began an examination of HCA’s 2001 through 2002 Federal income tax returns. HCA is presently unable to estimate the amount of any additional income tax and interest that the IRS may claim upon completion of this examination.

     Management believes that adequate provisions have been recorded to satisfy final resolution of the disputed issues. Management believes that HCA, CHC, Hospital Corporation of America and Healthtrust properly reported taxable income and paid taxes in accordance with applicable laws and agreements established with the IRS during previous examinations and that final resolution of these disputes will not have a material adverse effect on the results of operations or financial position.

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Operating Data

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     The information called for by this item is provided under the caption “Market Risk” under Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 4.     CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

     HCA’s chief executive officer and principal financial officer have reviewed and evaluated the effectiveness of HCA’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this quarterly report. Based on that evaluation, the chief executive officer and principal financial officer have concluded that HCA’s disclosure controls and procedures effectively and timely provide them with material information relating to HCA and its consolidated subsidiaries required to be disclosed in the reports HCA files or submits under the Exchange Act.

Changes in Internal Controls Over Financial Reporting

     During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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Part II: Other Information

Item 1:     Legal Proceedings

     HCA operates in a highly regulated and litigious industry. As a result, various lawsuits, claims and legal and regulatory proceedings have been and can be expected to be instituted or asserted against the Company. The resolution of any such lawsuits, claims or legal and regulatory proceedings could materially, adversely affect HCA’s results of operations and financial position in a given period.

Government Investigation, Claims and Litigation

     Commencing in 1997, HCA became aware it was the subject of governmental investigations and litigation relating to its business practices. The investigations were concluded through a series of agreements executed in 2000 and 2003. In January 2001, HCA entered into an eight-year Corporate Integrity Agreement (“CIA”) with the Office of Inspector General of the Department of Health and Human Services.

     HCA remains the subject of a December 1997 formal order of investigation by the Securities and Exchange Commission (the “SEC”). HCA understands that the investigation includes the antifraud, insider trading, periodic reporting and internal accounting control provisions of the Federal securities laws.

     If HCA was found to be in violation of Federal or state laws relating to Medicare, Medicaid or similar programs or breach of the CIA, HCA could be subject to substantial monetary fines, civil and criminal penalties and/or exclusion from participation in the Medicare and Medicaid programs. Any such sanctions or expenses could have a material adverse effect on HCA’s financial position, results of operations and liquidity.