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, 2005, these affiliates owned and operated 183 hospitals, 84 freestanding surgery centers and facilities which 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 and are of a normal and recurring nature. 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 $41 million and $36 million for the quarters ended March 31, 2005 and 2004, respectively. Operating results for the quarter ended March 31, 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 $83.0 million and $16.8 million for the quarters ended March 31, 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

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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, 2005 and 2004 were $13.96 and $12.95 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 having a life equal to the expected option life 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

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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).

     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 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.

     Other disputed items include the deductibility of a portion of the 2001 government settlement payment, the timing of recognition of certain patient service revenues in 2000 through 2002, 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 has claimed an additional $585 million in income taxes and interest, through March 31, 2005, with respect to these issues.

     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, 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, 2005 and 2004 (dollars in millions, except per share amounts, and shares in thousands):

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

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     The fair value of investment securities is generally based on quoted market prices. At March 31, 2005 and December 31, 2004, the investments of HCA’s insurance subsidiary were classified as “available for sale.” The aggregate common stock investment is comprised of 495 equity positions at March 31, 2005, with 432 positions reflecting unrealized gains and 63 positions reflecting unrealized losses (none of the individual unrealized loss positions exceed $1 million). The equity positions (including those with unrealized losses) at March 31, 2005, are not concentrated in any particular industries.

     HCA’s revolving credit facility (the “Credit Facility”) is a $1.750 billion agreement that expires November 2009. At March 31, 2005, HCA had $1.663 billion available under the Credit Facility.

     At March 31, 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 March 31, 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,

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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 a given period.

     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 or financial position.

     The components of comprehensive income, net of related taxes, for the quarters ended March 31, 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 both quarters ended March 31, 2005 and 2004, approximately 29% 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 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.

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     Adjusted segment EBITDA is defined as income before depreciation and amortization, interest expense, 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):

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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) the increased leverage resulting from the financing of the 2004 tender offer, (ii) increases in the amount and risk of collectability of uninsured accounts, and deductibles and copayment amounts for insured accounts, (iii) the ability to achieve operating and financial targets, achieve expected levels of patient volumes and control the costs of providing services, (iv) the highly competitive nature of the health care business, (v) the efforts of insurers, health care providers and others to contain health care costs, (vi) possible changes in the Medicare, Medicaid and other state programs that may impact reimbursements to health care providers and insurers, (vii) the ability to attract and retain qualified management and other personnel, including affiliated physicians, nurses and medical support personnel, (viii) potential liabilities and other claims that may be asserted against HCA, (ix) fluctuations in the market value of HCA’s common stock, (x) the impact of HCA’s charity care and uninsured discounting policy changes, (xi) changes in accounting practices, (xii) changes in general economic conditions, (xiii) future divestitures which may result in charges, (xiv) changes in revenue mix and the ability to enter into and renew managed care provider arrangements on acceptable terms, (xv) the availability and terms of capital to fund the expansion of the Company’s business, (xvi) changes in business strategy or development plans, (xvii) delays in receiving payments for services provided, (xviii) the possible enactment of Federal or state health care reform, (xix) the outcome of pending and any future tax audits, appeals and litigation associated with HCA’s tax positions, (xx) 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, (xxi) changes in Federal, state or local regulations affecting the health care industry, (xxii) the ability to successfully effect the planned divestiture(s) of ten hospitals, (xxiii) 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, (xxiv) maintaining the increased quarterly cash dividend rate for the entire fiscal year, and (xxv) 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 2005 Operations Summary

     Net income totaled $414 million, or $0.95 per diluted share, for the quarter ended March 31, 2005, compared to $345 million, or $0.69 per diluted share, for the quarter ended March 31, 2004. HCA’s shares used for diluted earnings per share for the quarter ended March 31, 2005 were 435.7 million shares, compared to 497.6 million shares for the quarter ended March 31, 2004.

     Revenue per equivalent admission increased 2.3% in the first quarter of 2005 compared to the first quarter of 2004. HCA’s revised uninsured discount policy, which became effective January 1, 2005, resulted in $109 million in discounts to the uninsured being recorded during the first quarter of 2005. See “Supplemental Non-GAAP Disclosures, Operating Measures Adjusted for the Impact of Discounts for the Uninsured.”

     During the first quarter of 2005, HCA experienced a moderation in the rate of increase for uninsured patient admissions and emergency room visits. Same facility uninsured admissions, compared to the 2004 first

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First Quarter 2005 Operations Summary (continued)

quarter, increased 3.3%. Same facility uninsured emergency room visits increased 15.1% in the first quarter of 2005 compared to the first quarter of 2004.

     During the first quarter of 2005, same facility admissions increased 1.0%, compared to the first quarter of 2004. Same facility outpatient surgeries increased 1.5% during the first quarter of 2005 compared to the first quarter of 2004.

     For the first quarter of 2005, the provision for doubtful accounts decreased to 9.3% of revenues from 11.7% in the first quarter of 2004. Adjusting for the effect of the uninsured discounts, the provision for doubtful accounts for the first quarter of 2005 was 10.9% of revenues.

     While the Company continues to face operational challenges related to providing health care services for the uninsured, management believes it is important to recognize the generation of cash provided by operating activities of $823 million and $772 million during the first quarters of 2005 and 2004, respectively.

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. 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 $5.937 billion in the first quarter of 2004 to $6.182 billion for the first quarter of 2005. The increase in revenues can be attributed to a 1.8% increase in equivalent admissions and a 2.3% increase in revenue per equivalent admission. HCA’s revised uninsured discount policy, which became effective January 1, 2005, resulted in $109 million in discounts to the uninsured being recorded during the first quarter of 2005.

     Consolidated admissions increased 0.5% and same facility admissions increased 1.0% compared to the first quarter of 2004. Consolidated outpatient surgeries increased 1.7% and same facility outpatient surgeries increased 1.5% in the first quarter of 2005 compared to the first quarter of 2004.

     Admissions related to Medicare, Medicaid, managed Medicaid, managed care and other discounted plans and the uninsured for the quarters ended March 31, 2005 and 2004 are set forth below. Certain prior year amounts have been reclassified to conform to the 2005 presentation.

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     During the first quarter of 2005, HCA experienced a moderation in the rate of increase for uninsured patient volume. Same facility uninsured admissions 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 March 31, 2005, HCA had 76 hospitals in the states of Texas and Florida. During the first quarter of 2005, 52% of the Company’s admissions and 50% of the Company’s revenues were generated by these hospitals. Uninsured admissions in Texas and Florida represent 59% 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 $109 million in discounts to the uninsured during the first quarter of 2005 lowered the rate of growth in revenue per equivalent admission in the first quarter of 2005, compared to the first quarter of 2004. Same facility revenue per equivalent admission increased 2.5% in the first quarter of 2005 compared to the 2004 first quarter. Adjusting for the effect of the new discount policy for the uninsured, same facility revenue per equivalent admission increased 4.3% for the first quarter of 2005. Charity care and discounts to the uninsured total $393 million in the first quarter of 2005, compared to $218 million in the first 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 ended March 31, 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 first quarter of 2005, compared to the first 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 $36 million and $33 million of revenues related to Medicare operating outlier cases for the first quarters of 2005 and 2004, respectively. These amounts represent 2.1% and 2.0% of Medicare revenues and 0.6% of total revenues for the first quarters 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.

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     The following are comparative summaries of results from operations for the quarters ended March 31, 2005 and 2004 (dollars in millions, except per share amounts):

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Supplemental Non-GAAP Disclosures

     The results of operations for the quarter ended March 31, 2005, adjusted for the impact of HCA’s new uninsured discount policy, are presented below:

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     Net income totaled $414 million, or $0.95 per diluted share, in 2005 compared to $345 million, or $0.69 per diluted share, in 2004. HCA’s shares used for diluted earnings per share for the quarter ended March 31, 2005 were 435.7 million shares, compared to 497.6 million shares for the quarter ended March 31, 2004. The lower shares amount is due to the Company’s completion of a tender offer during the fourth quarter of 2004 in which 62.9 million shares of the Company’s common stock were repurchased.

     For the first quarter of 2005, admissions increased 0.5% and same facility admissions increased 1.0% compared to the first quarter of 2004. Outpatient surgical volumes increased 1.7% on a consolidated basis and 1.5% on a same facility basis compared to the first quarter of 2004.

     HCA’s revised uninsured discount policy, which became effective January 1, 2005, resulted in $109 million in discounts to the uninsured being recorded during the first quarter of 2005. The discounts to the uninsured had the effect of reducing revenues and the provision for doubtful accounts by generally corresponding amounts. The reduction of revenues caused expense items, other than the provision for doubtful accounts, to increase, as a percentage of revenues, compared to what they would have been if the uninsured discount policy had not been implemented.

     Salaries and benefits, as a percentage of revenues, were 39.5% in the first quarter of 2005 and 39.3% in the same quarter of 2004. Adjusting for the effect of the new discount policy for the uninsured, salaries and benefits, as a percentage of revenues, were 38.8% in the first quarter of 2005.

     Supplies increased, as a percentage of revenues, from 16.5% in the first quarter of 2004 to 17.0% in the first quarter of 2005. Adjusting for the effect of the new discount policy for the uninsured, supplies, as a percentage of revenues, were 16.7% in the first quarter of 2005. Supply costs continue to increase in the cardiac, orthopedic and pharmaceutical areas.

     Other operating expenses, as a percentage of revenues, decreased to 15.7% in the first quarter of 2005 compared to 16.1% in the first quarter of 2004. Adjusting for the effect of the new discount policy for the uninsured, other operating expenses, as a percentage of revenues, were 15.4% in the first quarter of 2005. 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, decreased to 9.3% in the first quarter of 2005 from 11.7% in the first quarter of 2004. Adjusting for the effect of the new discount policy for the uninsured, the provision for doubtful accounts, as a percentage of revenues, was 10.9% in the first quarter of 2005. The improvement in the provision for doubtful accounts, after adjusting for the effect of the uninsured discounts, can be primarily attributed to the results of the most recent quarterly hindsight review. The hindsight review showed a moderation in what has been an approximate two-year trend of continued deterioration in the collectability of uninsured patient accounts. The provision for doubtful accounts and the allowance for doubtful accounts relate primarily to uninsured amounts due directly from patients. At March 31, 2005, the Company’s allowance for doubtful accounts represented approximately 78% of the $3.816 billion total patient due accounts receivable balance.

     Gains on investments of $9 million in the first quarter of 2005 and $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 increased from $46 million in the first quarter of 2004 to $53 million in the first quarter of 2005 due to an increase in profits at joint ventures accounted for under the equity method of accounting.

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     Depreciation and amortization increased by $34 million from the first quarter of 2004 to the first quarter of 2005. The increase is primarily the result of $1.5 billion of net capital spending for the year ended December 31, 2004, and $317 million of net capital spending in the first quarter of 2005.

     Interest expense increased from $135 million in the first quarter of 2004 to $164 million in the first quarter of 2005. The increase was primarily due to higher levels of debt in the first quarter of 2005 compared to the first quarter of 2004. HCA’s average debt balance was $10.245 billion for first quarter of 2005 compared to $8.789 billion for the first quarter of 2004. The increase in the average debt balance was primarily due to borrowings related to the Company’s completion of a tender offer during the fourth quarter of 2004 in which 62.9 million shares of the Company’s stock were repurchased.

Liquidity and Capital Resources

     Cash provided by operating activities totaled $823 million in the first quarter of 2005 compared to $772 million in the first quarter of 2004. Working capital totaled $1.710 billion at March 31, 2005 and $1.509 billion at December 31, 2004.

     Cash used in investing activities was $386 million in the first quarter of 2005 compared to $441 million in the first quarter of 2004. Excluding acquisitions, capital expenditures were $288 million in first quarter of 2005 and $390 million in first quarter of 2004. Annual planned capital expenditures, including outpatient acquisitions, in 2005 and 2006 are expected to approximate $1.6 billion and $1.8 billion, respectively. At March 31, 2005, there were projects under construction which had estimated additional costs to complete and equip over the next five years of approximately $2.2 billion. HCA expects to finance capital expenditures with internally generated and borrowed funds. During the first quarter of 2005, HCA announced its intention to divest ten acute care hospitals located in six states.

     Cash used in financing activities totaled $422 million during the first quarter of 2005 compared to $298 million during the first quarter of 2004. During the first quarter of 2005, HCA repaid $670 million of borrowings under its Credit Facility. HCA received cash inflows of $377 million related primarily to the exercise of employee stock options during the first quarter of 2005.

     In addition to cash flows from operations, available sources of capital include amounts available under the Credit Facility ($1.693 billion available as of April 15, 2005) 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 are held to maintain statutory equity and provide the funding source to pay claims, and totaled $2.228 billion and $2.322 billion at March 31, 2005 and December 31, 2004, 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 $76 million and $79 million at March 31, 2005 and December 31, 2004, respectively, are included in other assets.

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     HCA’s $2.5 billion credit agreement (the “2004 Credit Agreement”) consists of a $750 million amortizing term loan which matures in 2009 (the “2004 Term Loan”) and a $1.750 billion revolving credit facility that expires in November 2009 (the “Credit Facility”). Interest under the 2004 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 2004 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, 2005, 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.

     In December 2004, HCA filed a shelf registration statement and prospectus with the Securities and Exchange Commission that allows the Company to issue, from time to time, up to $1.5 billion in debt securities. As of March 31, 2005, HCA has not issued any debt securities under this registration statement.

     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.

     During the first quarter of 2004, HCA repurchased 8.9 million shares of its common stock for $375 million. The Company did not repurchase any of its common stock during the first quarter of 2005.

     HCA is 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 $332 million to develop and install. At March 31, 2005, project-to-date costs incurred were $252 million ($152 million of the costs incurred have been capitalized and $100 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 $1.411 billion and $817 million, respectively, at March 31, 2005. 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.

     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

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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, 2005, HCA had a net unrealized gain of $174 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 $2.130 billion of long-term debt at March 31, 2005 is subject to variable rates of interest, while the remaining balance in long-term debt of $7.728 billion at March 31, 2005 is subject to fixed rates of interest. Both the general level of U.S. interest rates and, for the 2004 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 0.4% to 1.0% (depending on HCA’s credit ratings); a bank term loan, on which interest is payable generally at LIBOR plus 0.5% to 1.25%, and fixed rate notes on which interest rate swaps have been employed, on which interest is payable at LIBOR plus 1.39% to 2.39%. Due to increases in LIBOR, the average rate for the Company’s Credit Facility increased from 1.80% for the quarter ended March 31, 2004 to 3.37% for the quarter ended March 31, 2005, and the average rate for the Company’s term loans increased from 2.10% for the quarter ended March 31, 2004 to 3.70% for the quarter ended March 31, 2005. The estimated fair value of HCA’s total long-term debt was $10.032 billion at March 31, 2005. 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 $21 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 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”)

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

     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 for additional tax and interest, based on its estimate of additional tax and interest due for taxable periods through 2000.

     Other disputed items include the deductibility of a portion of the 2001 government settlement payment, the timing of recognition of certain patient service revenues in 2000 through 2002, 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 has claimed an additional $585 million in income taxes and interest, through March 31, 2005, with respect to these issues.

     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 the results of operations or financial position.

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Operating Data

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