HCA Healthcare - 10-Q quarterly report FY

     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 þ     No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ     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. 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 June 30, 2005, these affiliates owned and operated 183 hospitals, 84 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 eight 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 $45 million and $40 million for the quarters ended June 30, 2005 and 2004, respectively, and $86 million and $76 million for the six months ended June 30, 2005 and 2004, respectively. Operating results for the quarter and six months ended June 30, 2005, are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004.

      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. Income tax benefits associated with nonqualified stock option exercises of $72 million and $18 million for the quarters ended June 30, 2005 and 2004, respectively, and $155 million and $35 million for the six months ended June 30, 2005 and 2004, respectively, were recorded as increases to stockholders’ equity.

      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):

      The weighted average fair values of HCA’s stock options granted for the quarters ended June 30, 2005 and 2004 were $17.27 and $11.50 per share, respectively. For the six months ended June 30, 2005 and 2004 the weighted average fair values were $15.66 and $12.93 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 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 December 2004, HCA accelerated the vesting of all unvested stock options awarded to employees and officers which had exercise prices greater than the closing price at December 14, 2004 of $40.89 per share. Options to purchase approximately 19.1 million shares became exercisable immediately as a result of the vesting acceleration. In April 2005, the Securities and Exchange Commission amended the date for compliance with the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”), so that HCA will be required to apply the expense recognition provisions of SFAS 123R beginning January 1, 2006. Assuming SFAS 123R is adopted as expected, the decision to accelerate vesting of the identified stock options will result in the Company not being required to recognize share-based compensation expense, net of taxes, of approximately $36 million in 2006, $19 million in 2007, and $2 million in 2008. The elimination of the requirement to recognize compensation

expense in future periods related to the unvested stock options was management’s basis for the decision to accelerate the vesting. The effect of accelerating the vesting for all unvested options with exercise prices greater than $40.89 per share was an increase to the pro forma share-based employee compensation expense for the fourth quarter of 2004 of $112 million after-tax ($0.24 per basic share and $0.23 per diluted share).

      A substantial portion of HCA’s professional liability risks is insured through a wholly-owned insurance subsidiary, which is funded annually. Reserves for professional liability risks were $1.613 billion and $1.593 billion at June 30, 2005 and December 31, 2004, respectively. The current portion of the reserves, $310 million at June 30, 2005 and December 31, 2004, is included in “other accrued expenses” in the condensed consolidated balance sheet. Provisions for losses related to professional liability risks were $59 million and $35 million for the quarters ended June 30, 2005 and June 30, 2004, respectively, and $161 million and $128 million for the six months ended June 30, 2005 and June 30, 2004, respectively, and are included in “other operating expenses” in the Company’s condensed consolidated income statement. The Company recognized a reduction in its estimated professional liability insurance reserves of $36 million pretax, or $0.05 per diluted share, during the second quarter of 2005. Results for the second quarter of 2004 included a reduction in its estimated professional liability reserves of $59 million pretax, or $0.07 per diluted share. The malpractice reserve reductions in the second quarters of 2005 and 2004 reflect the recognition by HCA’s external actuaries of improving frequency and severity claim trends at HCA. This declining frequency and moderating severity can be primarily attributed to tort reforms enacted in key states, particularly Texas, and HCA’s risk management and patient safety initiatives, particularly in the areas of obstetrics and emergency services.

      HCA is currently contesting before the Appeals Division of the Internal Revenue Service (the “IRS”), the United States Tax Court (the “Tax Court”), and the United States Court of Federal Claims certain claimed deficiencies and adjustments proposed by the IRS in conjunction with its examinations of HCA’s 1994 through 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”) 1991 through 1993 federal income tax returns and Healthtrust, Inc. — The Hospital Company’s (“Healthtrust”) 1990 through 1994 federal income tax returns.

      During the second quarter of 2005, HCA reached a partial settlement with the IRS Appeals Division regarding the amount of gain or loss recognized on the divestiture of certain noncore business units. As a result of this settlement, HCA recorded an income tax benefit of $48 million, or $0.11 per diluted share, during the second quarter.

      During 2003, the United States Court of Appeals for the Sixth Circuit affirmed a 1996 Tax Court decision related to the IRS examination of Hospital Corporation of America’s 1987 and 1988 federal income tax returns, in which the IRS contested the method that Hospital Corporation of America used to calculate its tax allowance for doubtful accounts. HCA filed a petition for review by the United States Supreme Court, which was denied in October 2004. Due to 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 for subsequent taxable years. HCA made a deposit of $109 million during 2004 based on its estimate of additional tax and interest due for taxable periods through 2000.

      HCA expects the IRS to complete its examination of HCA’s 2001 and 2002 federal income tax returns during 2005. The IRS has not determined the amount of any additional income tax and interest that it 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 results of operations or financial position.

      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.

      The following table sets forth the computation of basic and diluted earnings per share for the quarters and six months ended June 30, 2005 and 2004 (dollars in millions, except per share amounts, and shares in thousands):

      A summary of the insurance subsidiary’s investments at June 30, 2005 and December 31, 2004 follows (dollars in millions):

      HCA’s revolving credit facility (the “Credit Facility”) is a $1.750 billion agreement that expires November 2009. At June 30, 2005, HCA had $1.693 billion available under the Credit Facility.

      At June 30, 2005, interest on Credit Facility borrowings is payable generally at either a spread to LIBOR, a spread to 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 June 30, 2005, HCA was in compliance with all such covenants.

      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 in the normal course of business. This includes, but is not limited to, personal injury claims, claims relating to wrongful restriction or interference with physician staff privileges, employment disputes, contractual disputes, and claims regarding billing or other business practices. Some of these matters include claims for which the Company is uninsured. Disputed facts and uncertainties in the law make it difficult to predict the outcome of individual matters with certainty, and unanticipated results in a particular matter or group of matters could have a material, adverse effect on HCA’s results of operations and financial position.

      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. Violation or breach of the CIA, or violation of federal or state laws relating to Medicare, Medicaid or similar programs, could subject the Company to substantial monetary fines, civil and criminal penalties and/or exclusion from participation in the Medicare and Medicaid programs. Alleged violations may be pursued by the government or through privatequi tam actions. Sanctions imposed against the Company as a result of such actions could have a material, adverse effect on the Company’s results of operations and financial position.

      The components of comprehensive income, net of related taxes, for the quarters and six months ended June 30, 2005 and 2004 are as follows (in millions):

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

      HCA operates in one line of business, which is operating hospitals and related health care entities. During each of the quarters and six months ended June 30, 2005 and 2004, approximately 28% of the Company’s revenues related to patients participating in the Medicare program.

      HCA’s operations are structured into two geographically organized groups: the Eastern Group includes 92 consolidating hospitals located in the Eastern United States and the Western Group includes 83 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, 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, adjusted segment EBITDA and depreciation and amortization are summarized in the following table (dollars in millions):

      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 copayment amounts for insured accounts, (ii) the ability to achieve operating and financial targets, achieve expected levels of patient volumes and control the costs of providing services, (iii) the highly competitive nature of the health care business, (iv) the efforts of insurers, health care providers and others to contain health care costs, (v) possible changes in the Medicare, Medicaid and other state programs that may impact reimbursements to health care providers and insurers, (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) the impact of HCA’s charity care and uninsured discounting policy changes, (x) changes in accounting practices, (xi) changes in general economic conditions, (xii) future divestitures which may result in charges, (xiii) changes in revenue mix and the ability to enter into and renew managed care provider arrangements on acceptable terms, (xiv) the availability and terms of capital to fund the expansion of the Company’s business, (xv) changes in business strategy or development plans, (xvi) delays in receiving payments for services provided, (xvii) the possible enactment of federal or state health care reform, (xviii) the outcome of pending and any future tax audits, appeals and litigation associated with HCA’s tax positions, (xix) 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, (xx) changes in federal, state or local regulations affecting the health care industry, (xxi) 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 (xxii) 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.”

      Net income totaled $405 million, or $0.90 per diluted share, for the quarter ended June 30, 2005, compared to $352 million, or $0.72 per diluted share, for the quarter ended June 30, 2004. The second quarter 2005 operating results include: a favorable tax settlement of $48 million, or $0.11 per diluted share, related to the Company’s divestiture of certain noncore business units in 1998 and 2001; the recognition of a previously deferred gain of $29 million, or $0.04 per diluted share, on the sale of certain medical office buildings; and additional depreciation expense of $30 million, or $0.04 per diluted share, related to reclassifying certain medical equipment from seven year depreciable lives to four year depreciable lives to correct accumulated depreciation at certain facilities and attain consistent application of the Company’s accounting policy for fixed assets. HCA’s shares used for diluted earnings per share for the quarter ended June 30, 2005 were 451.7 million shares, compared to 490.3 million shares for the quarter ended June 30, 2004.

      During the second quarter of 2005, same facility admissions decreased 0.3%, compared to the second quarter of 2004. Same facility outpatient surgeries increased 1.2% during the second quarter of 2005 compared to the second quarter of 2004.

      The Company recognized a reduction in its estimated professional liability insurance reserves of $36 million pretax, or $0.05 per diluted share, during the second quarter of 2005. Results for the second quarter of 2004 included a reduction in its estimated professional liability reserves of $59 million pretax, or $0.07 per diluted share.

      For the second quarter of 2005, the provision for doubtful accounts decreased to 8.9% of revenues from 11.3% in the second quarter of 2004. Adjusting for the effect of the uninsured discounts, the provision for doubtful accounts for the second quarter of 2005 was 11.6% of revenues. Same facility uninsured admissions, compared to the 2004 second quarter, increased 5.1%. Same facility uninsured emergency room visits increased 10.4% in the second quarter of 2005 compared to the second quarter of 2004.

      A substantial portion of HCA’s professional liability risks is insured through a wholly-owned insurance subsidiary, which is funded annually. Reserves for professional liability risks were $1.613 billion and $1.593 billion at June 30, 2005 and December 31, 2004, respectively. The current portion of the reserves, $310 million at June 30, 2005 and December 31, 2004, is included in “other accrued expenses” in the condensed consolidated balance sheet. Provisions for losses related to professional liability risks were $59 million and $35 million for the quarters ended June 30, 2005 and June 30, 2004, respectively, and $161 million and $128 million for the six months ended June 30, 2005 and June 30, 2004, respectively, and are included in “other operating expenses” in the Company’s condensed consolidated income statement. The Company recognized a reduction in its estimated professional liability insurance reserves of $36 million pretax, or $0.05 per diluted share, during the second quarter of 2005. Results for the second quarter of 2004 included a reduction in its estimated professional liability reserves of $59 million pretax, or $0.07 per diluted share. The malpractice reserve reductions in the second quarters of 2005 and 2004 reflect the recognition by HCA’s external actuaries of improving frequency and severity claim trends at HCA. This declining frequency and moderating severity can be primarily attributed to tort reforms enacted in key states, particularly Texas, and HCA’s risk management and patient safety initiatives, particularly in the areas of obstetrics and emergency services.

      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. HCA facilities’ gross charges typically do not reflect what the facilities are actually paid. HCA’s 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 does not pursue collection of amounts related to patients who meet the Company’s guidelines to qualify for charity care; therefore, they are not reported in revenues. On January 1, 2005, HCA modified its policies to provide discounts to uninsured patients who do not qualify for Medicaid or charity care. These discounts are similar to those provided to many local managed care plans.

      Revenues increased 4.1% from $5.833 billion in the second quarter of 2004 to $6.070 billion for the second quarter of 2005. The increase in revenues can be attributed to a 1.5% increase in equivalent admissions and a 2.6% increase in revenue per equivalent admission. HCA’s revised uninsured discount policy resulted in $184 million in discounts to the uninsured being recorded during the second quarter of 2005.

      Consolidated admissions decreased 0.7% and same facility admissions decreased 0.3% compared to the second quarter of 2004. Consolidated outpatient surgeries increased 1.5% and same facility outpatient surgeries increased 1.2% in the second quarter of 2005 compared to the second quarter of 2004.

      Admissions related to Medicare, Medicaid, managed Medicaid, managed care and other discounted plans and the uninsured for the quarters and six months ended June 30, 2005 and 2004 are set forth below. Certain prior year amounts have been reclassified to conform to the 2005 presentation.

      Same facility uninsured admissions increased 5.1% in the second quarter of 2005 compared to the second quarter of 2004 and increased 3.3% in the first quarter of 2005 compared to the first quarter of 2004. The trend of quarterly same facility admissions growth during 2004, compared to 2003, was 13.7% during the first quarter, 15.2% during the second quarter, 7.2% during the third quarter and 3.7% during the fourth quarter.

      At June 30, 2005, HCA had 76 hospitals in the states of Texas and Florida. During the second quarter of 2005, 51% of the Company’s admissions and 49% of the Company’s revenues were generated by these hospitals. Uninsured admissions in Texas and Florida represent 57% of the Company’s uninsured admissions.

      HCA facilities’ gross charges typically do not reflect what the facilities are actually paid. HCA’s 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. The recording of $184 million in discounts to the uninsured during the second quarter of 2005 lowered the rate of growth in revenue per equivalent admission in the second quarter of 2005, compared to the second quarter of 2004. Same facility revenue per equivalent admission increased 3.1% in the second quarter of 2005 compared to the 2004 second quarter. Adjusting for the effect of the new discount policy for the uninsured, same facility revenue per equivalent admission increased 6.2% for the second quarter of 2005. Charity care and discounts to the uninsured total $459 million in the second quarter of 2005, compared to $232 million in the second quarter of 2004.

      The approximate percentages of the Company’s inpatient revenues related to Medicare, Medicaid, managed Medicaid, managed care and other discounted plans and the uninsured for the quarters and six

months ended June 30, 2005 and 2004 are set forth in the following table. The uninsured discounts and continued increases in charity care resulted in a decline in uninsured inpatient revenues in the second quarter of 2005, compared to the second quarter of 2004. Certain prior year amounts have been reclassified to conform to the 2005 presentation.

      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.

      HCA recorded $39 million and $29 million of revenues related to Medicare operating outlier cases for the second quarters of 2005 and 2004, respectively. These amounts represent 2.4% and 1.8% of Medicare revenues and 0.6% and 0.5% of total revenues for the second quarters of 2005 and 2004, respectively. HCA recorded $75 million and $62 million of revenues related to Medicare operating outlier cases during the first six months of 2005 and 2004, respectively. These amounts represent 2.2% and 1.9% of Medicare net revenues and 0.6% and 0.5% of total net revenues for the first six months of 2005 and 2004, respectively. There can be no assurances that HCA will continue to receive these levels of Medicare outlier payments in future periods.

      The following are comparative summaries of results of operations for the quarters and six months ended June 30, 2005 and 2004(dollars in millions, except per share amounts):

      The results of operations for the quarter and six months ended June 30, 2005, adjusted for the impact of HCA’s revised uninsured discount policy, are presented below: