UNIVERSAL HEALTH REALTY INCOME TRUST quarterly report, Q2 FY2011

Universal Health Realty Income Trust: 2011 Q2 Form 10-Q Summary

Business Context and Reporting Period

Universal Health Realty Income Trust is a healthcare and human-services real estate investment trust. The filing covers the three and six months ended June 30, 2011, with unaudited results. As of June 30, 2011, the portfolio consisted of 53 real estate investments or commitments in 15 states: seven hospitals, 42 medical office buildings and four preschool or childcare centers. The Trust operated as a single reportable segment.

Financial Performance and Position

Metric	Three months ended June 30, 2011	Three months ended June 30, 2010	Six months ended June 30, 2011	Six months ended June 30, 2010
Revenue	$6.8 million	$7.5 million	$13.4 million	$15.1 million
Net income	$3.7 million	$4.3 million	$7.8 million	$8.8 million
Diluted earnings per share	$0.29	$0.35	$0.62	$0.73
FFO	$7.9 million	$8.3 million	$16.2 million	$16.8 million
Net cash from operating activities	Not separately provided	Not separately provided	$10.3 million	$12.3 million

Net income margin was approximately 54.6% for the second quarter and 58.2% for the first six months. FFO per diluted share was approximately $0.63 for the quarter and $1.28 for the six-month period; the filing does not present these per-share amounts directly.

Quarterly revenue declined approximately 9.5%, net income declined approximately 13.6%, diluted EPS declined approximately 17.1% and FFO declined approximately 4.6% versus the prior-year quarter.
Six-month revenue declined approximately 11.1%, net income declined approximately 11.1%, diluted EPS declined approximately 15.1% and FFO declined approximately 3.5% versus the prior-year period.
At June 30, 2011, total assets were $227.7 million, including $134.9 million of net real estate investments, $82.7 million of investments in and advances to LLCs and $0.7 million of cash.
Total liabilities were $89.5 million, including $71.7 million drawn on the revolving credit facility, $8.3 million of mortgage notes and $6.5 million of non-recourse debt at a consolidated LLC.
The Trust declared and paid a quarterly dividend of $0.605 per share, or approximately $7.7 million, on June 30, 2011.

Liquidity, Debt and Cash Flow

Operating cash flow for the first six months declined by $2.0 million from the prior-year period, primarily because of lower net income, higher rent receivables and changes in accrued liabilities. Investing activities used $14.3 million, including approximately $11.8 million for the Lake Pointe Medical Arts medical office building, $11.1 million of advances to LLCs and $3.1 million of LLC investments. Financing activities provided $3.8 million, principally from $19.1 million of net revolving borrowings, partially offset by $15.3 million of dividends.

On July 25, 2011, after quarter-end, the Trust replaced its $100 million revolving facility with a new $150 million facility maturing in four years. Based on June 30 borrowings and letters of credit, the Trust reported $68.9 million of available capacity under the new facility. The Trust was in compliance with its debt covenants, reporting debt to total capital of 34%, debt service coverage of 43.96x and debt to cash flow of 2.19x.

Consolidated non-recourse mortgages and term debt totaled $14.8 million at June 30, 2011, with maturities in 2013, 2017 and 2019. Equity-method LLCs had $269.4 million of additional non-recourse loans, including significant maturities in 2011 through 2015. Outstanding letters of credit totaled $15.5 million. The filing states that operating cash flow was expected to be sufficient to support required REIT distributions, but also notes that dividends exceeded property-level operating cash flow during the first six months and were funded using aggregate cash sources and financing activities.

Material Changes Versus the Prior Comparable Period

The June 2010 expiration of the Southern Crescent II master lease reduced annual revenue, net income and operating cash flow by approximately $1.1 million and was the principal recurring adverse comparison.
Equity income from unconsolidated LLCs decreased by $221,000 in the quarter and $295,000 for the six-month period, partly because of low occupancy at a Phoenix medical office building and reserves for certain tenant receivables.
Lake Pointe Medical Arts, a 50,974-square-foot medical office building in Rowlett, Texas, was acquired in June 2011 for approximately $12.2 million.
Borrowings increased to fund property acquisitions, LLC advances and investments. Interest expense increased on higher average borrowings and a higher rate on the Palmdale medical office building loan.
Summerlin Hospital Medical Office Building II was no longer consolidated beginning October 1, 2010 after expiration of its master lease; management reported no material impact on net income from the deconsolidation.
The advisory agreement with UHS was renewed for 2011 on unchanged terms. Advisory fees were $951,000 for the first six months, versus $903,000 in the prior-year period. No incentive fee was earned.

Outlook, Risks, Contingencies and Unusual Items

The filing does not provide formal earnings or dividend guidance. Management stated that future dividends will depend on REIT distribution requirements, property performance, capital commitments, debt repayments and anticipated operating conditions.

UHS-related leases generated approximately 61% of consolidated revenue in the second quarter and 54% for the first six months. UHS also serves as the Trust’s advisor and employs all of the Trust’s officers, creating related-party and concentration risks.
UHS had substantially increased leverage following its acquisition of Psychiatric Solutions, Inc. Financial difficulties at UHS could reduce rent payments, bonus rentals and the Trust’s ability to maintain dividends.
Southwest Healthcare System, an indirect UHS operator of the Inland Valley property, remained subject to CMS and California Department of Public Health compliance matters. A July 2011 CMS survey was pending at the filing date. Failure to achieve substantial compliance could adversely affect operations, bonus rent and property value, although the $2.6 million annual base rent on Inland Valley was guaranteed by UHS through December 2016.
Management entered into a non-binding letter of intent involving 30 LLCs. The proposed transactions included purchasing minority interests in 14 LLCs, divesting majority non-controlling interests in 10 LLCs and restructuring ownership interests in six LLCs. Completion was targeted for September 30, 2011, but was not assured.
Forney Medical Plaza was acquired in July 2011 for approximately $15.0 million. Two additional medical office building acquisitions were under negotiation, and completion was uncertain.
The planned transactions were intended to qualify as Section 1031 like-kind exchanges. Failure to redeploy proceeds could reduce FFO and cash available for distribution; failure to defer taxable gains could require additional borrowing, a special dividend or tax payments.
Other risks included healthcare reimbursement changes, possible Medicare reductions, economic and credit-market weakness, vacancies, refinancing needs, real estate value declines, limited earthquake insurance for three California LLC properties and the Trust’s non-controlling ownership interests in LLCs.

Important Facts for Investors to Verify

Verify the extent to which UHS continues to support rent payments and the financial condition of UHS following its increased leverage.
Monitor the outcome of the CMS certification survey and related licensing matters affecting Southwest Healthcare System and Inland Valley.
Confirm completion and financial effects of the proposed 30-LLC restructuring and related Section 1031 transactions.
Assess refinancing exposure for LLC debt, including the $12.8 million Banburry loan maturing December 31, 2011 and other substantial 2012-2015 maturities.
Reconcile dividends with operating cash flow, FFO, cash available for distribution and future acquisition or capital requirements.
Evaluate occupancy and tenant receivable trends at underperforming medical office buildings, particularly the Phoenix property and the former Southern Crescent II master-lease property.