UHT

Business Context and Reporting Period

Company: Universal Health Realty Income Trust (a Maryland REIT)

Reporting Period: Quarterly period ended March 31, 2004 (Form 10-Q)

Business Overview: The Trust invests in healthcare and human service facilities, including acute care hospitals, rehabilitation centers, and medical office buildings. As of March 31, 2004, the portfolio consisted of 44 real estate investments across 15 states. The Trust is advised by Universal Health Services, Inc. ("UHS"), a related party that also leases six hospital facilities from the Trust, accounting for approximately 62% of consolidated revenues.

Key Financial Metrics

Debt Profile: The Trust maintains an $80 million revolving credit facility (with a $20 million expansion option). As of March 31, 2004, borrowings under the line of credit were $33,005,000. Additionally, the Trust held $26,600,000 in non-recourse mortgage notes payable.

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased by $622,000 (11%) compared to Q1 2003. This was primarily driven by a $537,000 decrease in equity income from Limited Liability Companies (LLCs).
• LLC Income Drivers: The decline in LLC income was due to a $365,000 gain on the sale of real property recorded in Q1 2003 (non-recurring) and a $440,000 increase in depreciation and amortization expenses at certain LLCs due to revised purchase price allocations.
• FFO Growth: Despite the drop in net income, Funds from Operations (FFO) increased 5% to $7.8 million, reflecting the non-cash nature of the depreciation adjustments.
• Balance Sheet Expansion: Total assets increased by approximately $22.4 million from year-end 2003, largely due to the adoption of FIN 46R, which required the consolidation of three LLCs previously accounted for under the equity method. This added $39.5 million in assets and $22.5 million in non-recourse borrowings.
• Interest Expense: Increased by $29,000 (5%) due to higher average outstanding borrowings.

Outlook, Risks, and Management Commentary

• Lease Renewals and Expirations: Two significant leases with UHS subsidiaries (Virtue Street Pavilion and The Bridgeway) expire in December 2004. Management cannot predict if these will be renewed at current rates. The Virtue Street Pavilion lease renewal is estimated to reduce annual base rental by approximately $325,000 based on current Treasury rates.
• Accounting Changes: Effective March 31, 2004, the Trust adopted FIN 46R. While this increased reported assets and liabilities, management states there will be no impact on net income from the consolidation of these LLCs.
• Dividends: A dividend of $0.495 per share was declared and paid in March 2004. The Trust intends to maintain its REIT qualification, requiring the distribution of at least 90% of taxable income.
• Risk Factors: Key risks include heavy reliance on UHS for revenue (62% of consolidated revenue), potential changes in healthcare reimbursement rates (Medicare/Medicaid), and the ability to renew leases or find new operators for expiring facilities. Competition in markets like McAllen, Texas, may negatively impact bonus rentals.

Investor Verification Checklist

• UHS Lease Renewals: Verify the status of the Virtue Street Pavilion and The Bridgeway leases expiring in December 2004 and the potential impact of the estimated $325,000 annual rent reduction.
• LLC Depreciation Impact: Confirm the duration and magnitude of the increased depreciation expenses at LLCs resulting from purchase price allocation revisions.
• Debt Covenants: Review compliance with the revolving credit facility covenants, specifically the tangible net worth and financial ratio requirements.
• REIT Qualification: Monitor the Trust's ability to maintain REIT status to avoid corporate income tax liabilities.
• Like-Kind Exchanges: Track the $6.3 million in escrowed proceeds from 2003 property sales to ensure they are reinvested in like-kind exchanges during 2004 to defer capital gains taxes.