UNIVERSAL HEALTH REALTY INCOME TRUST quarterly report, Q2 FY2014

Universal Health Realty Income Trust — 2014 Q2 Form 10-Q

Business context and reporting period

Quarterly report for the three and six months ended June 30, 2014. The Trust is a healthcare real estate investment trust owning or investing in hospitals, medical office buildings, rehabilitation and behavioral healthcare facilities, sub-acute facilities, surgery centers, childcare centers and related properties. At quarter-end, it reported 58 real estate investments or commitments in 16 states.

UHS is the principal tenant and also provides the Trust’s advisory services through a wholly owned subsidiary. UHS hospital leases represented approximately 30% of consolidated second-quarter revenue and 29% of six-month revenue. The Trust had no salaried employees as of June 30, 2014.

Financial performance and key metrics

Metric	Three months ended June 30, 2014	Three months ended June 30, 2013	Six months ended June 30, 2014	Six months ended June 30, 2013
Revenue	$14.317 million	$13.502 million	$28.605 million	$27.387 million
Net income	$3.408 million	$2.941 million	$7.182 million	$6.368 million
Diluted earnings per share	$0.26	$0.23	$0.56	$0.50
Funds from operations	$8.820 million	$8.390 million	$17.703 million	$17.327 million
Adjusted funds from operations	$8.861 million	$8.439 million	$17.806 million	$17.458 million
Cash flow from operations	Not separately provided	Not separately provided	$15.295 million	$15.653 million

Reported net margin was approximately 23.8% for the quarter and 25.1% for the six-month period. These margins include significant depreciation and amortization and are therefore not directly comparable to property-level operating margins.

Quarterly revenue increased $815,000, or approximately 6.0%; six-month revenue increased $1.218 million, or approximately 4.4%.
Quarterly net income increased $467,000, or approximately 15.9%; six-month net income increased $814,000, or approximately 12.8%.
Quarterly FFO increased $430,000, or approximately 5.1%; six-month FFO increased $376,000, or approximately 2.2%.
Quarterly dividends were $0.63 per share; six-month dividends were $1.255 per share. Dividends paid totaled $16.195 million for the first six months, compared with $15.804 million in the prior-year period.

Balance sheet, debt and liquidity

Total assets were $383.712 million at June 30, 2014, compared with $373.145 million at December 31, 2013. Net real estate investments were $318.233 million.
Cash and cash equivalents were $3.860 million.
Revolving credit borrowings were $102.350 million. The $150 million facility had $8.1 million of outstanding letters of credit and $39.6 million of available capacity at quarter-end.
Fourteen consolidated non-recourse mortgages totaled $114.635 million, excluding a $604,000 debt premium. Total reported line-of-credit and mortgage borrowings were approximately $217.6 million.
The revolver expires July 24, 2015. The Trust was in compliance with all covenants, including debt-to-total-capital of 39.1%, debt-service coverage of 17.5 times and debt-to-cash-flow of 2.36 times.
On July 1, 2014, the Trust borrowed $9.1 million under the revolver to repay the $9.081 million Summerlin Hospital Medical Office Building I mortgage that matured that day.
The Trust entered into interest-rate caps covering $30 million of notional amounts, expiring January 13, 2017, with a 1.50% one-month LIBOR strike.

Material changes versus the prior comparable period

Revenue growth was driven primarily by medical office buildings acquired in the third quarter of 2013 and first quarter of 2014, higher UHS bonus rent and changes at existing properties.
Effective January 1, 2014, the Trust acquired the remaining minority interests in Palmdale Medical Properties and Sparks Medical Properties for $170,000 and began consolidating both entities. Fair-value recognition produced a $316,000 non-cash gain in the first six months.
In January 2014, the Trust acquired two Arkansas medical office buildings for approximately $7.2 million, including $7.050 million of net cash paid.
Operating cash flow declined $358,000 year over year despite higher net income, primarily because of timing-related changes in accrued expenses and other liabilities.
The Trust issued 57,410 shares under its at-the-market program during the first six months at an average price of $42.67, generating approximately $2.9 million of net proceeds, including settlement of late-2013 sales.
Effective August 1, 2014, the Trust agreed to acquire minority interests in six additional LLCs for approximately $6.8 million, partly through a note payable. The properties will be consolidated and a related aggregate gain is expected in the third quarter.

Outlook, risks and unusual items

Management did not provide formal earnings or revenue guidance. Management stated that operating cash flows, cash, available revolver capacity and access to capital markets were expected to provide sufficient resources for operating, investing and financing needs over the next twelve months, including required REIT distributions. Future dividend levels will depend on operating results, capital commitments, debt repayments and REIT distribution requirements.

The Bridgeway lease, generating approximately $1.1 million of annual revenue, was scheduled to expire in December 2014. Renewal at fair market rent was uncertain, and UHS could instead purchase the facility at appraised fair value.
UHS concentration creates tenant and related-party risk; UHS also controls the advisory relationship and employs the Trust’s officers.
Healthcare reimbursement changes, Medicare and Medicaid reductions, regulatory compliance, patient volumes and competition could affect facility operators and property values.
Credit-market conditions could increase borrowing costs or impair refinancing and growth financing. A non-recourse $12.4 million Grayson Properties loan had been extended through October 1, 2014 and was expected to be refinanced.
The Trust had approximately $8.1 million of standby letters of credit and additional equity and debt funding commitments to LLC investments, including $2.1 million for Texoma Medical Properties and $1.2 million for Arlington Medical Properties.
Two LLC properties in California were located in earthquake zones without earthquake insurance because management considered available coverage uneconomical.
The $316,000 fair-value gain and the forthcoming third-quarter gain from LLC consolidations are unusual items and should be distinguished from recurring property operations.

Investor verification checklist

Verify the renewal, purchase or replacement-tenant outcome for The Bridgeway lease.
Review UHS’s financial condition and the concentration of rent, bonus rent and advisory relationships with UHS.
Confirm completion and financing terms for the August 1, 2014 acquisition of six LLC minority interests and the expected fair-value gain.
Monitor the revolver maturity in July 2015, mortgage maturities, refinancing of the Grayson Properties loan and post-quarter-end borrowing.
Reconcile dividends of $16.2 million with property operating cash flow of approximately $16.0 million for the first six months.
Assess FFO and AFFO alongside GAAP net income and cash flow, recognizing that FFO and AFFO are non-GAAP measures and are not liquidity measures.
Review UHS filings, healthcare reimbursement developments, occupancy and rental-rate trends, and the earthquake exposure of California properties.