Why did HCA's net income decline in 2006 despite revenue growth?

Net income fell to $1.036 billion from $1.424 billion mainly because of $442 million in Recapitalization transaction costs, higher interest expense of $955 million (up $300 million), and a higher effective tax rate of 37.6%. These were partly offset by $243 million of investment gains and $205 million of facility-sale gains, which are non-recurring.

How does the Recapitalization change HCA's financial profile?

The $33.0 billion transaction was financed with about $19.96 billion of new debt and $3.78 billion of equity contributions. Debt more than doubled to $28.4 billion, the equity base became a deficit, and the company is now highly leveraged, with much of its cash flow committed to debt service. Ownership is concentrated in the investor group, which holds about 97.5% of the common stock.

Is HCA's volume growing?

Not on a consolidated basis. Admissions fell 2.3% and equivalent admissions fell 2.4%, while same-facility admissions were flat to slightly up (+0.2%). Management cites unit closures, Medicare admission guideline changes, physician-owned heart hospital competition and stricter case management as headwinds. Revenue growth came primarily from pricing and payer mix.

What are the main regulatory and legal risks highlighted?

Key risks include Medicare and Medicaid reimbursement changes (including about $4.8 billion of DRA 2005 Medicaid cuts and a proposed $12.2 billion additional federal Medicaid reduction), a pending IRS dispute of about $678 million, the Battle Creek Medicare bad-debt case, an active eight-year Corporate Integrity Agreement, and a U.S. Attorney/SEC investigation related to trading in the company's securities, plus merger-related and shareholder class actions.

HCA 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 27, 2007. Cited figures are marked; the original filing is the authoritative source.

HCA Inc., now privately held after the November 17, 2006 $33.0 billion^a Recapitalization led by Bain Capital, KKR, Merrill Lynch Global Private Equity and Frist family affiliates, reported 2006 revenues of $25.477 billion (up 4.2%) and net income of $1.036 billion (down 27.2% from $1.424 billion).

Results were flattered by one-time items, including $243 million^b of investment gains and $205 million of facility-sale gains, and were reduced by $442 million of Recapitalization transaction costs. Underlying volume was soft: equivalent admissions fell 2.4% and same-facility admissions rose only 0.2%, while revenue per equivalent admission rose 6.8% (8.0% excluding the uninsured discount). Growth in revenue depended largely on pricing and the uninsured discount policy, and the provision for doubtful accounts rose to 10.4% of revenues (14.1% adjusted).

The balance sheet changed fundamentally. Total debt rose from $10.475 billion to $28.408 billion^c, and stockholders' equity swung from $4.863 billion to a deficit of $11.374 billion. Management expects 2007 interest expense of about $2.3 billion, versus $955 million in 2006, which will sharply compress pre-tax coverage.

Operating cash flow fell to $1.845 billion^d from $2.971 billion, mainly on higher tax payments and receivables build. Investors should note that the filing is a voluntary annual report from a company whose common stock no longer trades, that 97.5% of equity is held by Hercules Holding, and that the company faces significant regulatory, reimbursement and litigation exposure, including a $678 million IRS dispute and Medicare/Medicaid program changes.

02—Key points

Key Highlights

Revenue grew 4.2% to $25.477 billion, driven by a 6.8% increase in revenue per equivalent admission, which offset a 2.4% decline in equivalent admissions.
Net income fell 27.2% to $1.036 billion, but the decline is partly masked by one-time items: $243M of investment gains and $205M of facility-sale gains, offset by $442M of Recapitalization transaction costs.
Total debt rose to $28.408 billion from $10.475 billion after the Recapitalization, and stockholders' equity moved to a deficit of $11.374 billion from $4.863 billion.
Interest expense is expected to rise to roughly $2.3 billion in 2007 from $955 million in 2006, a major pressure on earnings and free cash flow.
Operating cash flow fell 38% to $1.845 billion, driven by higher income tax payments and receivables growth.
Provision for doubtful accounts rose to 10.4% of revenues (14.1% excluding uninsured discounts), reflecting growth in uninsured patients and deteriorating collectibility.
Same-facility admissions were essentially flat (+0.2%), and the company is exposed to Florida and Texas, which together produced about 51% of consolidated revenues.

03—Questions

Frequently Asked Questions

Why did HCA's net income decline in 2006 despite revenue growth?
Net income fell to $1.036 billion from $1.424 billion mainly because of $442 million in Recapitalization transaction costs, higher interest expense of $955 million (up $300 million), and a higher effective tax rate of 37.6%. These were partly offset by $243 million of investment gains and $205 million of facility-sale gains, which are non-recurring.
How does the Recapitalization change HCA's financial profile?
The $33.0 billion transaction was financed with about $19.96 billion of new debt and $3.78 billion of equity contributions. Debt more than doubled to $28.4 billion, the equity base became a deficit, and the company is now highly leveraged, with much of its cash flow committed to debt service. Ownership is concentrated in the investor group, which holds about 97.5% of the common stock.
Is HCA's volume growing?
Not on a consolidated basis. Admissions fell 2.3% and equivalent admissions fell 2.4%, while same-facility admissions were flat to slightly up (+0.2%). Management cites unit closures, Medicare admission guideline changes, physician-owned heart hospital competition and stricter case management as headwinds. Revenue growth came primarily from pricing and payer mix.
What are the main regulatory and legal risks highlighted?
Key risks include Medicare and Medicaid reimbursement changes (including about $4.8 billion of DRA 2005 Medicaid cuts and a proposed $12.2 billion additional federal Medicaid reduction), a pending IRS dispute of about $678 million, the Battle Creek Medicare bad-debt case, an active eight-year Corporate Integrity Agreement, and a U.S. Attorney/SEC investigation related to trading in the company's securities, plus merger-related and shareholder class actions.

04—Continue

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