UNIVERSAL HEALTH REALTY INCOME TRUST quarterly report, Q2 FY2023

Business Context and Reporting Period

Universal Health Realty Income Trust is a healthcare-focused REIT that owns or invests in acute-care and behavioral hospitals, free-standing emergency departments, medical and office buildings, childcare centers and specialty facilities. This unaudited Form 10-Q covers the three and six months ended June 30, 2023. As of August 1, 2023, the portfolio comprised 76 investments or commitments in 21 states.

UHS-related tenants generated approximately 41% of consolidated revenue, and UHS subsidiaries lease six hospital facilities and numerous medical or office properties. A UHS subsidiary also serves as the Trust’s Advisor, creating related-party and concentration considerations.

Financial Results and Key Metrics

Metric	Q2 2023	Q2 2022	Six months 2023	Six months 2022
Revenue	$23.8 million	$22.2 million	$47.0 million	$44.3 million
Net income	$3.5 million	$5.2 million	$7.9 million	$10.6 million
Basic EPS	$0.25	$0.38	$0.58	$0.77
Diluted EPS	$0.25	$0.38	$0.57	$0.77
FFO	$10.6 million	$12.2 million	$22.0 million	$24.6 million
FFO per diluted share	$0.77	$0.88	$1.59	$1.78
Cash flow from operations	Not separately provided	Not separately provided	$22.3 million	$24.9 million

Q2 revenue increased 7.4%; six-month revenue increased 6.1%.
Q2 net income declined 33.4%, and six-month net income declined 25.3%.
Net margin was approximately 14.6% in Q2 2023 versus 23.5% in Q2 2022; the six-month margin was approximately 16.9% versus 24.0%.
Revenue growth primarily reflected higher property-level revenue, including the newly constructed Sierra Medical Plaza I medical office building in Reno, Nevada.
Interest expense increased to $4.2 million in Q2 and $7.9 million for the first six months, versus $2.4 million and $4.6 million, respectively, in the comparable periods.
At June 30, 2023, total assets were $603.0 million, total liabilities were $386.3 million and equity was $216.6 million.
The Trust declared and paid dividends of $0.720 per share in Q2 and $1.435 per share for the first six months. Operating cash flow exceeded first-half dividends by approximately $2.5 million.

Debt, Liquidity and Capital Resources

Revolving credit borrowings were $311.4 million under a $375 million facility maturing July 2, 2025. After $3.1 million of letters of credit, available capacity was $60.5 million.
Non-recourse mortgage notes payable were $39.7 million net, with scheduled maturities of $6.2 million in November 2023 and $12.4 million in April 2024.
Total debt carrying value was approximately $351.4 million, compared with fair value of approximately $349.2 million.
Net cash used in investing activities was $8.9 million, including $8.8 million of real estate additions and $3.9 million of investments in unconsolidated LLCs, partially offset by a $3.5 million advance repayment.
Net cash used in financing activities was $11.6 million, including $19.8 million of dividends, $5.0 million of mortgage repayments and $13.3 million of net revolving-credit borrowings.
Management stated that operating cash flow, cash, available borrowing capacity and capital-market access should provide sufficient resources for operating, investing and financing needs for the next twelve months, including REIT distributions.
The Trust was in compliance with all credit agreement covenants. Total leverage was 43.9%, unencumbered leverage was 43.4% and fixed-charge coverage was 3.6x.

Material Changes Versus the Prior Comparable Period

Higher revenue was more than offset by substantially higher borrowing costs. The average revolving-credit rate increased to 6.59% in Q2 2023 from 2.28% in Q2 2022, while average borrowings increased to $303.8 million from $272.5 million.
Q2 and year-to-date results included $862,000 and $1.1 million, respectively, of demolition costs for the vacant Chicago specialty facility. Demolition was substantially completed during Q2.
Other operating expenses increased by $1.3 million in Q2 and $1.9 million for the first six months, primarily due to property-level changes, the Reno MOB and Chicago demolition costs.
The Sierra Medical Plaza I MOB was substantially completed in March 2023. Estimated total cost is approximately $35 million, of which approximately $24 million had been incurred by June 30, 2023. A UHS subsidiary leases approximately 68% of the space under a master flex lease with initial annual minimum rent of approximately $1.3 million, subject to reductions as third-party leases are executed.
The revolving credit agreement and three interest-rate swaps were amended in May 2023 to replace LIBOR with adjusted term SOFR. The swaps had a combined notional amount of $140 million and a net fair-value asset of $11.0 million at quarter-end.
No acquisitions or divestitures occurred during the first six months of 2023, compared with two medical office building acquisitions in the first quarter of 2022.

Outlook, Commentary, Risks and Unusual Items

Management expects to fund capital expenditures, acquisitions and dividends through internally generated cash and additional borrowings, mortgage refinancing, ATM equity issuance or other long-term debt. No shares were issued under the ATM program during the first six months of 2023.
Management expects approximately $5.5 million of 2023 income-statement interest income from the Aiken and Canyon Creek financing arrangements; related annual rental payments are approximately $5.8 million.
Three specialty properties remain vacant, including the Chicago property undergoing demolition. Management estimates approximately $1.3 million of additional 2023 operating expenses for the vacant properties, excluding Chicago demolition costs.
Healthcare labor shortages, elevated temporary labor costs, inflation, reimbursement changes, patient-volume and payer-mix pressure, and potential regulatory changes could weaken tenants’ operating results and ability to pay rent.
UHS concentration is material: approximately 41% of consolidated revenue came from UHS-related tenants. Lease nonrenewals, purchase-option exercises or deterioration in UHS’s financial condition could reduce revenue, cash flow and property values.
Interest-rate exposure remains significant. Management estimates that a 1% change in interest rates would affect net income by approximately $1.7 million after considering the interest-rate swaps.
Near-term refinancing or repayment requirements include the $6.2 million mortgage maturing in November 2023 and the $12.4 million mortgage maturing in April 2024. The Trust expects to refinance or use revolving-credit borrowings.
The filing reports no material change in previously disclosed risk factors and states that disclosure controls and procedures were effective as of June 30, 2023.

Important Facts for Investors to Verify

Whether higher interest rates and elevated revolving-credit borrowings continue to pressure net income, FFO and dividend coverage.
Availability and terms of refinancing for the November 2023 and April 2024 mortgage maturities.
UHS tenant credit quality, lease renewals, purchase-option activity and the continuing 41% revenue concentration.
Lease-up progress and final cost of Sierra Medical Plaza I, including the impact of third-party leasing on the UHS master flex lease.
Remaining costs and potential redevelopment, sale or leasing outcomes for the vacant specialty facilities.
Compliance with credit facility covenants and the $60.5 million of reported borrowing capacity.
The sustainability of dividends relative to operating cash flow, capital expenditures, debt repayments and required REIT distributions.