Liquidity and Capital Resources

    The $22 million net decrease in 1998 as compared to 1997 was primarily attributable to: (i) a $37 million favorable increase in net income plus the addback of depreciation and amortization expense; (ii) an unfavorable $18 million increase in income tax payments, net of refunds; (iii) an unfavorable $14 million change in accrued insurance expense less commercial premiums paid and payments made in settlement of self-insurance claims; (iv) an unfavorable $22 million increase in other working capital accounts; (v) an $8 million increase in payments made to the Company’s non-contributory retirement plan, and; (vi) $3 million of other net favorable changes. The unfavorable change in accrued insurance less commercial premiums paid and payments made in settlement of self-insurance claims was due to the January, 1998 purchase of commercial insurance policies for general and professional liability coverage at most of the Company’s subsidiaries. These policies provide for coverage in excess of $1 million per occurrence, with an average annual aggregate of $6 million through 2001. Prior to January 1998, most of the Company’s subsidiaries were self-insured for professional and general liability claims up to $5 million per occurrence, with excess coverage maintained up to $100 million with major insurance carriers. Other working capital accounts as of December 31, 1998 (net of effects from acquisitions) increased $9 million as compared to December 31, 1997 while other working capital accounts as of December 31, 1997 decreased $13 million as compared to December 31, 1996. These changes in other working capital accounts were caused primarily by the timing of payments of accounts payable and other accrued expenses.

    During the second quarter of 1999, the Company acquired three behavioral health facilities located in Illinois, Indiana and New Jersey, for a combined purchase price of $27 million in cash plus contingent consideration of up to $3 million. Also during the second quarter of 1999, the Company acquired the operations of Doctor’s Hospital of Laredo in exchange for the assets and operations of its Victoria Regional Medical Center. In connection with this transaction, the Company also spent approximately $5 million to purchase additional land in Laredo, Texas on which it expects to construct a replacement hospital scheduled to be completed in 2001.

    During 1999, the Company received total cash proceeds of approximately $16 million generated primarily from the sale of the real property of two medical office buildings ($14 million). The net gain/loss resulting from these transactions did not have a material impact on the 1999 results of operations.

    During the third quarter of 1998, the Company’s Board of Directors approved a stock repurchase program authorizing the Company to purchase up to two million shares or approximately 6% of its outstanding Class B Common Stock. This initial repurchase program was completed during the third quarter of 1999. During the third and fourth quarters of 1999, the Board of Directors approved plans for the repurchase of up to an additional four million shares of the Company’s Class B Common Stock. Pursuant to the stock repurchase programs, the Company, from time to time and as conditions allow, may purchase a total of up to six million shares on the open market at prevailing market prices or in negotiated transactions off the market. Pursuant to the terms of these programs, the Company repurchased 580,500 shares at average repurchase price of $42.90 per share ($24.9 million in the aggregate) during 1998 and 2,028,379 shares at an average repurchase price of $35.10 ($71.2 million in the aggregate) during 1999. Since inception of the repurchase program in 1998 through December 31, 1999, the Company repurchased a total of 2,608,879 shares at an average repurchase price of $36.85 per share ($96.1 million in the aggregate).

    In conjunction with the Company’s stock repur-chase program during 1998 and 1999, the Company sold European-style put options which entitle the holder to sell shares of the Company’s Class B Common Stock to the Company at a specified price. The Company also purchased European-style call options which entitles the Company to purchase shares of the Company’s Class B Common Stock at a specified price. As of December 31, 1999 put options totaling 1,458,500 shares, with an average strike price of $28.47, were outstanding with various expiration dates in the second and third quarters of 2000. As of December 31, 1999 call options totaling 1,034,000 shares, with an average strike price of $28.47 per share, were outstanding with various expiration dates in the second and third quarters of 2000.

    During the first quarter of 1998, the Company acquired three acute care hospitals located in Puerto Rico for a combined purchase price of $187 million. The hos-pitals acquired are located in Bayamon (430-beds), Rio Piedras (160-beds) and Fajardo (180-beds). These acqui-sitions were financed with funds borrowed under the Company’s revolving credit facility. Also during the first quarter of 1998, the Company contributed substantially all of the assets, liabilities and operations of Valley Hospital Medical Center, a 417-bed acute care facility, and its newly-constructed Summerlin Hospital Medical Center, a 148-bed acute care facility in exchange for a 72.5% interest in a series of newly-formed limited liability companies (“LLCs”). Quorum Health Group, Inc. (“Quorum”) holds the remaining 27.5% interest in the LLCs. Quorum obtained its interest by contributing substantially all of the assets, liabilities and operations of Desert Springs Hospital, a 241-bed acute care facility and $11 million of net cash. The assets and liabilities contributed by the Company were recorded by the LLCs at carryover value. The LLCs applied purchase accounting to the assets and liabilities provided by Quorum and recorded them at fair market value. As a result of this partial sale transaction, the Company recorded a pre-tax gain of $55.1 million ($34.7 million after-tax) that was recorded as a capital contribution to the Company. This merger did not have a material impact on the 1998 results of operations. Also during 1998, the Company spent $2 million to purchase the property of a radiation therapy center located in California.

    During 1997 the Company acquired an 80% interest in a partnership which owns and operates The George Washington University Hospital, a 501-bed acute care facility located in Washington, DC. The George Washington University (“GWU”) holds a 20% interest in the partnership. In connection with this acquisition, the Company provided an immediate commitment of $80 million, consisting of $40 million in cash which has been invested and is restricted for construction (balance of $41.5 million as of December 31, 1999) and a $40 million surety bond. The Company and GWU are planning to build a newly constructed 371-bed acute care facility which is scheduled to be completed in 2002. The total cost of this new facility is estimated to be approximately $96 million, of which the Company intends to provide a total of $83 million (including the $80 million commitment mentioned above) with the remainder being provided by GWU and the interest earnings on the $40 million of funds restricted for construction. During the third and fourth quarters of 1997, the Company completed construction and opened the following facilities: (i) a 129-bed acute care facility located in Edinburg, Texas; (ii) a medical complex located in Summerlin, Nevada including a 148-bed acute care facility, and; (iii) two newly constructed specialized women’s health centers located in Austin, Texas and Lakeside, Oklahoma of which subsidiaries of the Company owns interests in limited liability companies (“LLCs”) which own and operate the facilities. During 1997, the LLC which operates the specialized women’s health center in Lakeside, Oklahoma sold the real and personal property of this facility which was then leased-back pursuant to the terms of a 20-year lease. The Company spent $71 million during the year (net of $8 million of proceeds received for sale-leaseback of the specialized women’s health center located in Oklahoma and $4 million received for sale of a minority interest in the specialized women’s health center located in Austin, Texas) for completion of these newly constructed facilities. Also during the year, the Company spent an additional $11 million to acquire various behavioral healthcare related businesses.

    Capital expenditures, net of proceeds received from sale or disposition of assets were $68 million in 1999 (excluding $16 million of cash proceeds generated primarily from the sale of two medical office buildings as mentioned above), $97 million in 1998 (excluding $11 million of net cash contributed by Quorum as mentioned above) and $129 million in 1997 (including $71 million spent on the newly constructed facilities mentioned above). Capital expenditures for capital equipment, renovations and new projects at existing hospitals and completion of major construction projects in progress at December 31, 1999 are expected to total approximately $169 million in 2000. The Company believes that its capital expenditure program is adequate to expand, improve and equip its existing hospitals.

    Total debt as a percentage of total capitalization was 40% at December 31, 1999 and 1998 and 35% at December 31, 1997. The increase during 1998 as compared to 1997 was due primarily to the 1998 purchase transactions mentioned above, which were financed with borrowings under the Company’s revolving credit facility.

    As of December 31, 1999, the Company had $222 million of unused borrowing capacity under the terms of its $400 million revolving credit agreement which matures in July 2002 and provides for interest at the Company’s option at the prime rate, certificate of deposit plus 3/8% to 5/8%, Euro-dollar plus 1/4% to 1/2% or a money market rate. A facility fee ranging from 1/8% to 3/8% is required on the total commitment. The margins over the certificate of deposit, the Euro-dollar rates and the facility fee are based upon the Company’s leverage ratio.

    As of December 31, 1999, the Company had $10 million of unused borrowing capacity under the terms of its $100 million, annually renewable, commercial paper program. A large portion of the Company’s accounts receivable are pledged as collateral to secure this program. This annually renewable program, which began in 1993, is scheduled to expire or be renewed on October 30th of each year.

    As of December 31, 1999 and 1998, the Company had two interest rate swap agreements that fixed the rate of interest on a notional principal amount of $50 million for a period of three years. These interest rate swaps expired on January 4, 2000. The average fixed rate obtained through these interest rate swaps was 6.20% including the Company’s current borrowing spread of .425%. The Company is also a party to three forward starting interest rate swaps to fix the rate of interest on a total notional principal amount of $75 million. The starting date on the interest rate swaps is August, 2000 and they mature in August, 2010. The average fixed rate of the three forward starting interest rate swaps, including the Company’s current borrowing spread of .425% is 7.2%. The effective interest rate on the Company’s revolving credit, demand notes and commercial paper program, including the interest rate swap expense incurred on existing and now expired interest rate swaps, was 6.2%, 6.4%, and 6.8% during 1999, 1998 and 1997, respectively. Additional interest expense recorded as a result of the Company’s hedging activity was $202,000, $75,000 and $ 0 in 1999, 1998 and 1997, respectively. The Company is exposed to credit loss in the event of non-performance by the counterparty to the interest rate swap agreements. All of the counterparties are creditworthy financial institutions rated AA or better by Moody’s Investor Service and the Company does not anticipate non-performance. The value of the interest rate swap obligations at December 31, 1999 was approximately $2.9 million.

    The Company expects to finance all capital expen-ditures and acquisitions with internally generated funds and borrowed funds. Additional borrowed funds may be obtained either through refinancing the existing revolving credit agreement, the commercial paper facility or the issuance of long-term securities.