UHT

Business Context and Reporting Period

Company: Universal Health Realty Income Trust (UHT)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2010
Business Overview: UHT is a Maryland real estate investment trust (REIT) investing in healthcare and human service facilities, including acute care hospitals, behavioral healthcare, rehabilitation hospitals, medical office buildings (MOBs), and childcare centers. As of year-end 2010, the portfolio consisted of 52 investments across 15 states. The Trust is heavily reliant on Universal Health Services, Inc. (UHS), which serves as the primary tenant for hospital facilities and the Trust's Advisor.

Key Financial Metrics

Note: Total indebtedness excludes $271.7 million of non-recourse third-party debt held by unconsolidated LLCs.

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased by approximately $3.0 million (9.5%) compared to 2009. On an "As Adjusted" basis (accounting for deconsolidations), revenue decreased by $1.2 million. Key drivers included the expiration of a master lease at Southern Crescent II MOB in Georgia ($700,000 impact) and decreased occupancy at certain MOBs.
• Net Income Decrease: Net income fell by $2.3 million (12.4%) to $16.3 million. This was primarily due to lower revenues, a decrease in equity income from unconsolidated LLCs, and increased advisory fees (rate increased from 0.60% to 0.65% of average invested real estate assets).
• Deconsolidations: Two medical office buildings (Summerlin Hospital MOB III and MOB II) were deconsolidated during 2010 as master lease thresholds were met or expired, shifting their accounting treatment to the equity method. This reduced consolidated assets and revenue but had no material impact on net income.
• Debt Reduction: Consolidated indebtedness decreased by $16.7 million compared to 2009, driven by mortgage pay-offs and refinancing activities.

Guidance, Outlook, Risks, and Contingencies

Management Commentary & Outlook: Management expects to fund capital expenditures and dividends through internally generated cash flows and additional equity/debt financing. The Trust maintains an At-The-Market (ATM) equity program, issuing 548,900 shares in 2010 for approximately $17.6 million in net proceeds. Dividends were maintained at $2.415 per share for 2010.

Key Risks and Contingencies:

• Concentration Risk: UHS accounted for approximately 60% of consolidated revenues in 2010. Four hospital facilities leased to UHS have lease terms expiring in 2011 or 2014. Failure of UHS to renew leases or meet obligations would materially impact UHT.
• Regulatory Issues (Southwest Healthcare System): UHS subsidiary Southwest Healthcare System (SWHCS) faced potential termination of its Medicare provider agreement and hospital license revocation by the California Department of Public Health (CDPH). While agreements were reached to abate termination and maintain the license pending a mid-2011 survey, failure to achieve compliance could materially adversely impact the Inland Valley Regional Medical Center (book value $19.0 million) and bonus rental revenue.
• UHS Leverage: UHS significantly increased indebtedness following its acquisition of Psychiatric Solutions, Inc. (PSI), raising concerns about its ability to meet lease obligations.
• Healthcare Reform: The Patient Protection and Affordable Care Act and the Reconciliation Act introduce changes to Medicare and Medicaid reimbursement that could affect tenant revenues and, consequently, UHT's bonus rents.
• Insurance: Three LLCs owning properties in California could not obtain earthquake insurance at economically beneficial rates.

Investor Verification Checklist

• UHS Lease Renewals: Verify the status of lease renewals for the four UHS hospital facilities expiring in December 2011 (McAllen, Wellington, Inland Valley) and December 2014 (The Bridgeway).
• SWHCS Compliance: Monitor the outcome of the CMS full certification survey for Southwest Healthcare System expected in mid-2011, as failure could impact the Inland Valley property value and bonus rents.
• UHS Financial Health: Review UHS's latest filings to assess the impact of the PSI acquisition on its liquidity and ability to pay guaranteed base and bonus rents.
• LLC Debt Maturities: Review the $271.7 million of non-recourse debt held by unconsolidated LLCs, noting significant maturities in 2011 ($47.8 million) and 2012 ($32.1 million), and the Trust's ability to refinance or fund these obligations.
• Occupancy Trends: Monitor occupancy rates at Medical Office Buildings (MOBs), particularly those in Nevada and Arizona, which contributed to the decrease in equity income from unconsolidated affiliates.