Business Context and Reporting Period
Universal Health Realty Income Trust filed its Form 10-K for the fiscal year ended December 31, 2012. The Maryland REIT invests in healthcare and human-service properties, including hospitals, medical office buildings, rehabilitation and sub-acute facilities, and childcare centers. As of February 28, 2013, the portfolio comprised 54 investments or commitments in 15 states: seven hospitals, 43 medical office buildings and four childcare centers.
UHS of Delaware, Inc., a subsidiary of Universal Health Services, Inc. (UHS), serves as the Advisor, and all officers are UHS employees. The Trust had no salaried employees at year-end. Twelve medical office buildings were owned through unconsolidated LLCs in which the Trust held non-controlling interests.
Financial Performance and Position
| Metric | 2012 | 2011 | Change or commentary |
|---|---|---|---|
| Revenue | $53.950 million | $29.494 million | Reported increase of $24.456 million; 2011 as-adjusted revenue was $46.455 million, implying a comparable increase of $7.495 million, or approximately 16%. |
| Net income | $19.477 million | $73.794 million | Decrease of $54.317 million; 2011 included significant transaction and divestiture gains. |
| Basic and diluted EPS | $1.54 | $5.84/$5.83 | 2012 results included an $8.520 million divestiture gain. |
| Funds from operations | $34.280 million | $32.468 million | Increase of $1.812 million, or approximately 6%. |
| Adjusted FFO | $34.960 million | $32.986 million | Increase of $1.974 million, or approximately 6%. |
| Cash flow from operations | $30.783 million | $21.372 million | Increase of $9.411 million. |
| Dividends paid | $31.195 million | $30.703 million | 2012 declared and paid dividend was $2.460 per share. |
| Net real estate investments | $314.386 million | $288.633 million | Increase primarily from acquisitions and property additions. |
| Total assets | $383.038 million | $370.929 million | Increase of approximately 3%. |
| Total indebtedness | $197.936 million | $174.836 million | Includes the revolving credit facility and non-recourse mortgage debt. |
Net income represented an approximately 36% margin in 2012, while reported 2011 net income was materially distorted by one-time gains. FFO represented approximately 64% of 2012 revenue; FFO is a non-GAAP measure and is not a substitute for GAAP net income or operating cash flow.
Revenue consisted primarily of base rent, bonus rent and tenant reimbursements. UHS facilities generated $19.580 million of 2012 revenue, including $4.142 million of bonus rent. UHS accounted for approximately 37% of consolidated revenue according to the risk-factor disclosure, while leases on UHS hospital facilities represented approximately 30% of consolidated revenue.
Hospital facility coverage improved: the weighted-average hospital Coverage Ratio was approximately 5.9x in 2012 versus 5.5x in 2011 and 5.1x in 2010. Medical office building renewal rents decreased approximately 1% versus expiring leases. The portfolio’s average effective annual rent per square foot increased to $23.87 from $23.73.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $3.048 million at December 31, 2012, compared with $11.649 million at December 31, 2011.
- The $150 million revolving credit facility had $81.8 million outstanding and $13.3 million of letters of credit, leaving $54.9 million of available capacity. The facility matures July 24, 2015.
- Thirteen non-recourse mortgages totaled $114.9 million, excluding the net debt premium. Consolidated total debt was approximately $197.9 million.
- Management reported compliance with all credit-facility covenants. Debt-to-total-capital was 32%, debt-service coverage was 20.30x and debt-to-cash-flow was 1.94x.
- Scheduled consolidated debt repayments totaled approximately $196.7 million, including $81.8 million of revolving borrowings scheduled for repayment or refinancing in 2015.
- 2012 investing cash outflows included $16.9 million for two medical office building acquisitions, $4.0 million of real estate additions, $3.0 million of LLC investments and an $8.0 million advance to an LLC that was repaid following a property sale.
- Contractual equity and debt financing commitments totaled $10.532 million, and standby letters of credit totaled $13.3 million.
Material Changes Versus the Prior Comparable Period
- Reported revenue increased substantially because eleven LLCs acquired in December 2011 were consolidated for a full year in 2012, and because of acquisitions completed in 2011 and 2012. On an as-adjusted basis, revenue increased approximately 16%.
- Net income declined sharply because 2011 included a $28.6 million gain from purchasing minority interests in eleven LLCs and a $35.8 million gain from property divestitures. In 2012, the Trust recorded an $8.5 million divestiture gain.
- Depreciation and amortization increased to $20.216 million from $7.306 million, primarily because of the higher fair-value basis from consolidating LLCs and acquisitions.
- Interest expense increased to $7.768 million from $2.402 million, reflecting higher average borrowings and higher effective borrowing costs. Average revolving borrowings increased to $75.4 million from $67.8 million, and the effective rate increased to 2.4% from 1.8%.
- Operating cash flow increased 44% to $30.8 million, exceeding the $31.2 million of dividends paid when considering the Trust’s reported property operating cash generation of approximately $34.0 million.
- The Trust acquired PeaceHealth Medical Clinic in Washington and Northwest Texas Professional Office Tower in Texas for an aggregate purchase price of approximately $40.0 million, funded with $16.9 million of cash and assumed debt.
- Two LLC-owned medical office properties were divested, producing $12.2 million of net cash proceeds and an $8.5 million gain.
- The Advisory Agreement was renewed for 2013, and the advisory fee increased effective January 1, 2013 from 0.65% to 0.70% of average invested real estate assets, an estimated annual increase of $163,000.
Outlook, Commentary, Risks and Unusual Items
Management stated that operating cash flow, cash, available revolver capacity, equity issuance capacity and capital-market access were expected to provide sufficient resources for the next twelve months, including required REIT distributions. The filing does not provide formal earnings or FFO guidance.
- UHS remains a significant tenant and related party. Its leases on four hospitals are guaranteed by UHS and cross-defaulted, but UHS has purchase options, rights of first refusal and renewal rights. UHS’s increased leverage following acquisitions of Ascend Corporation and Psychiatric Solutions, Inc. could affect its ability to meet lease obligations.
- The Bridgeway and HealthSouth Deaconess leases expire in 2014, while three UHS hospital leases expire in 2016. UHS has renewal and purchase rights that may limit the Trust’s ability to re-lease or sell these properties on favorable terms.
- The Palmdale Medical Plaza master lease commitment expires in June 2013, and the property was only approximately 75% covered by the UHS master lease threshold. The filing indicated that the Trust was pursuing additional tenants.
- Two consolidated mortgages mature in 2013. Management expected to refinance the Palmdale loan and subsequently disclosed that the Centennial Hills loan was refinanced into a new five-year loan after year-end.
- Medicare and Medicaid reimbursement reductions, healthcare reform, state budget deficits and potential Medicare sequestration cuts could reduce hospital operator revenues, bonus rent and lease coverage.
- Competition, labor shortages, higher healthcare operating costs, declining patient volumes and private-payor pricing pressure could weaken tenants and operators.
- Medical office building exposure includes lease rollover, occupancy risk and tenant improvement costs. Approximately 18% of other consolidated property rentable square footage was scheduled to expire in 2013, and 9% in 2014.
- Two California LLC properties with approximately $12.1 million of Trust investments or advances lacked economically available earthquake insurance.
- The filing reported no legal proceedings, no unresolved SEC staff comments, effective disclosure controls and an unqualified KPMG audit opinion on the financial statements and internal controls.
Investor Verification Checklist
- Reconcile reported 2012 revenue growth with the as-adjusted comparison, including the effects of LLC consolidation and acquisitions.
- Separate recurring operating performance from the $8.5 million 2012 divestiture gain and the unusually large 2011 gains.
- Review FFO and AFFO reconciliations and confirm that these non-GAAP measures are not being treated as liquidity or dividend-capacity measures.
- Assess UHS concentration, UHS credit quality, lease expirations, renewal options, purchase rights and related-party advisory arrangements.
- Verify refinancing of 2013 mortgage maturities and the 2015 revolving credit maturity, including interest-rate exposure.
- Evaluate coverage ratios, medical office building occupancy, lease rollover and expected tenant improvement and leasing commission requirements.
- Review the Palmdale master lease expiration, remaining LLC financing commitments and non-recourse debt maturities at unconsolidated LLCs.
- Confirm the Trust’s continuing REIT qualification and the tax characterization of dividends, including ordinary income, capital gains and return-of-capital components.