UNIVERSAL HEALTH REALTY INCOME TRUST quarterly report, Q3 FY2011

Universal Health Realty Income Trust — Q3 2011 Form 10-Q Summary

Business Context and Reporting Period

Universal Health Realty Income Trust is a healthcare-focused REIT investing in and leasing hospitals, medical office buildings, behavioral healthcare, rehabilitation, sub-acute, surgery, childcare and other human-service facilities. The filing covers the three and nine months ended September 30, 2011. At quarter-end, the portfolio included 54 real estate investments or commitments in 15 states: seven hospitals, 43 medical office buildings and four preschool or childcare centers.

UHS is the principal tenant and provides the Trust’s advisory and management services. UHS-related hospital leases represented approximately 55% of consolidated revenue in the third quarter and 59% for the first nine months of 2011. The Trust held investments or commitments in 32 LLCs, with 31 accounted for under the equity method and one consolidated as a variable-interest entity.

Financial Performance and Key Metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Revenue	$7.394 million	$7.171 million	$20.836 million	$22.288 million
Net income	$3.348 million	$3.387 million	$11.168 million	$12.188 million
Diluted EPS	$0.26	$0.27	$0.88	$1.00
FFO	$7.852 million	$7.466 million	$24.046 million	$24.256 million
Net cash from operating activities	Not provided	Not provided	$15.797 million	$17.641 million
Dividends paid	$7.7 million	$7.5 million	$22.977 million	$22.215 million

Q3 revenue increased 3.1%, while nine-month revenue declined 6.5%. Q3 net income decreased 1.2%; nine-month net income decreased 8.4%. Q3 FFO increased 5.2%, while nine-month FFO declined 0.9%. Reported operating margins were approximately 43.1% in Q3 and 49.2% for the first nine months, based on net income divided by revenue; these figures are not management-defined operating margins.

At September 30, 2011, total assets were $242.839 million, including $144.295 million of net real estate investments and $82.615 million invested in or advanced to LLCs. Cash and cash equivalents were $787,000. Total liabilities were $108.768 million and shareholders’ equity was $133.992 million.

Debt, Liquidity and Cash Flow

The Trust replaced its $100 million revolving facility with a new four-year $150 million revolving credit facility on July 25, 2011, with an option to increase capacity by up to $50 million subject to lender approval.
At September 30, 2011, revolving borrowings were $90.4 million, letters of credit were $14.9 million and available capacity, net of letters of credit, was $44.7 million.
The applicable rate was one-month LIBOR plus 1.75%, with a 0.30% unused commitment fee. The Trust was in compliance with all debt covenants.
Consolidated non-recourse mortgages and a term loan totaled $14.749 million, with maturities in 2013, 2017 and 2019.
Nine-month operating cash flow declined $1.844 million year over year to $15.797 million. Investing cash use increased to $29.686 million, primarily because of the Texas medical office building acquisitions and additional LLC funding.
Nine-month financing cash flow was positive $13.689 million, principally reflecting $37.8 million of net revolving-credit borrowings, partly offset by $22.977 million of dividends and $1.104 million of financing costs.

Material Changes Versus the Prior Comparable Period

Revenue benefited in Q3 from the Lake Pointe Medical Arts Building and Forney Medical Plaza acquisitions, but nine-month revenue was reduced by the June 2010 expiration of the Southern Crescent II master lease, which had generated approximately $1.1 million of annual revenue, net income and operating cash flow.
The two Texas medical office buildings were acquired in June and July 2011 for an aggregate purchase price of approximately $27.2 million. They generated $827,000 of revenue and approximately $200,000 of property net income during the nine months after acquisition, excluding transaction costs.
Transaction costs of $455,000 in Q3 and $590,000 for the first nine months reduced earnings; no comparable costs were recorded in 2010.
Interest expense increased because of higher average revolving borrowings, higher borrowing rates under the new facility and a higher rate on the Palmdale Medical Plaza loan.
Equity in income from unconsolidated LLCs increased to $875,000 in Q3 and $2.377 million for the first nine months, compared with $335,000 and $1.904 million, respectively, on a reported basis in 2010.
Depreciation and amortization increased due primarily to the Texas acquisitions, newly constructed properties and renovations.
On May 19, 2011, UHS exercised five-year renewal options for McAllen Medical Center, Wellington Regional Medical Center and Southwest Healthcare System’s Inland Valley Campus, extending those leases to December 2016.

Guidance, Outlook, Commentary and Risks

Management stated that operating cash flow had been sufficient to fund dividends and expected net operating cash flow to support distributions required to retain REIT status. Future dividend levels will depend on property operating results, capital commitments, debt repayments, vacancy levels and the performance of recently acquired properties. No formal earnings or FFO guidance was provided.

Ten LLCs entered into an agreement to sell their real estate, expected to generate approximately $50 million of cash proceeds to the Trust after closing costs and minority interests. The Trust also agreed to purchase minority interests in 11 LLCs for approximately $5 million, potentially resulting in 100% ownership. Both transactions were expected to close on or before December 1, 2011, subject to customary conditions, and were not assured of completion.

The Trust also had purchase agreements for two additional medical office buildings. Management expected that, if the contemplated transactions were completed, FFO and cash available for distribution might not differ materially from existing levels, but cautioned that failure to complete or redeploy proceeds could materially affect FFO, distributions and taxable gains. Failure to defer substantially all gains through Section 1031 transactions could require additional borrowing for a special dividend or result in federal income or excise tax liabilities.

Concentration in UHS: UHS is the major tenant, advisor and employer of the Trust’s officers. UHS’s increased leverage following its Psychiatric Solutions acquisition could impair its ability to meet lease obligations.
Healthcare and regulatory exposure: Medicare and Medicaid reimbursement reductions, healthcare reform, licensing issues and lower patient volumes could affect tenants, bonus rent and property values.
Financing and refinancing risk: Credit-market conditions could increase borrowing costs or limit access to capital. An LLC mortgage of approximately $12.7 million matured December 31, 2011 and was expected to be refinanced.
LLC governance and concentration: Approximately 69% of consolidated and unconsolidated revenues for the first nine months came from LLCs in which the Trust held majority but non-controlling interests.
Real estate risks include vacancies, lease expirations, market rents, interest rates, competition and property-value declines. Three California LLCs could not obtain earthquake insurance at economically attractive rates.
The Southwest Healthcare System received CMS notification in November 2011 that it had regained deemed status and complied with Medicare conditions after follow-up surveys.

Most Important Facts for Investors to Verify

Completion, proceeds and tax treatment of the planned sale of 10 LLC-owned property portfolios and the purchase of minority interests in 11 LLCs.
Whether the two additional medical office building acquisitions closed and the resulting effect on FFO, leverage and liquidity.
UHS’s financial condition, lease payments, hospital operating performance and ability to support bonus rents and renewals.
Refinancing of the LLC debt maturing in late 2011 and early 2012, including the approximately $12.7 million Banburry loan and other non-recourse maturities.
Sustainability of the $0.605-per-share quarterly dividend given nine-month dividends of $23.0 million versus $15.8 million of consolidated operating cash flow and reliance on other funding sources.
Actual occupancy, leasing progress and financial performance of Southern Crescent II and the recently acquired Texas medical office buildings.
Compliance with REIT distribution, Section 1031 and potential excise-tax requirements after the proposed asset sales.