UHT

Business Context and Reporting Period

Company: Universal Health Realty Income Trust (Maryland)

Filing Type: Form 10-Q (Unaudited)

Reporting Period: Quarterly period ended June 30, 1998 (Six months ended June 30, 1998)

Business Overview: The Trust invests in healthcare and human service-related facilities, including acute care hospitals, behavioral healthcare facilities, and medical office buildings. Approximately 71% of revenues are derived from leases with subsidiaries of Universal Health Services, Inc. (UHS), which unconditionally guarantees these obligations.

Key Financial Metrics

Note: FFO is defined by the Trust as Net Income plus depreciation, amortization of unconsolidated investments, and amortization of interest rate cap expense.

Material Changes vs. Prior Period

• Revenue Growth: Six-month revenues increased by $181,000 (1.6%) primarily due to a $525,000 increase in base rentals from non-related parties (driven by the Cypresswood Professional Center) and a $55,000 increase in bonus rentals. This was partially offset by a $410,000 decrease in interest income following the full repayment of a mortgage loan receivable in June 1997.
• Expense Increases: Interest expense rose 14% ($204,000) for the six months due to increased borrowings for new investments. Other operating expenses increased 37% ($247,000), largely attributable to operating costs for the newly opened Cypresswood Professional Center and maintenance of Lake Shore Hospital.
• Net Income Decline: Net income decreased slightly by $111,000 (1.5%) for the six-month period, resulting in a $0.01 decrease in diluted EPS.
• Debt Expansion: Bank borrowings increased by $10.7 million during the period to finance new investments, including a 99% interest in Desert Springs Medical Plaza and a 95% interest in Edwards Medical Plaza.

Outlook, Risks, and Management Commentary

• Lease Renewals: In late July 1998, UHS subsidiaries exercised five-year renewal options on four hospitals representing 30% of the Trust's rental revenue. These renewals occurred at existing lease rates, reducing uncertainty regarding lease expirations between 1999 and 2001.
• Liquidity and Credit: The Trust replaced its revolving credit agreement in Q2 1998 with a new facility providing $80 million in capacity (expandable to $100 million), maturing in 2003. As of June 30, 1998, approximately $25 million of capacity remained unused.
• Dividends: A quarterly dividend of $0.435 per share ($3.9 million aggregate) was declared and paid on June 30, 1998.
• Year 2000 (Y2K) Risk: Management acknowledges Y2K risks but does not expect building-related modification costs to be material. However, the Trust relies heavily on UHS (71% of revenue); while UHS is addressing Y2K issues, the Trust cannot guarantee that UHS or its suppliers will successfully remediate systems, which could materially impact operations.
• Accounting Changes: The Trust has not yet quantified the impact of FASB Statement No. 133 (Derivatives), which may increase earnings volatility upon adoption.

Investor Verification Checklist

• Concentration Risk: Verify the financial stability of Universal Health Services, Inc. (UHS), given that 71% of revenues depend on its subsidiaries.
• Lease Expirations: Confirm the status of the remaining UHS facility lease expiring in 2000 (representing ~5% of revenue) which had an EBITDAR coverage ratio of only 1.0x.
• Debt Service: Review the terms of the new $80 million revolving credit facility and the Trust's ability to service the increased debt load ($51.9 million outstanding).
• Y2K Contingency: Assess the progress of UHS's Y2K remediation efforts, as failure could disrupt the primary revenue stream.
• FFO vs. Net Income: Analyze the divergence between Net Income and Funds From Operations (FFO) to understand the impact of depreciation on reported earnings.