UHT

Business Context and Reporting Period

Company: Universal Health Realty Income Trust (UHRT)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2002
Business Overview: UHRT is a Maryland real estate investment trust (REIT) investing in healthcare and human service facilities, including acute care hospitals, rehabilitation centers, and medical office buildings (MOBs). As of December 31, 2002, the Trust held investments in 42 facilities across 15 states. A significant portion of the portfolio consists of hospital facilities leased to subsidiaries of Universal Health Services, Inc. (UHS), which also serves as the Trust's Advisor.

Key Financial Metrics

Note: Total indebtedness excludes $128.7 million of non-recourse third-party debt held by unconsolidated LLCs in which the Trust has non-controlling interests.

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 3% ($0.9 million) in 2002 compared to 2001. This was driven by a $0.7 million increase in bonus rentals from UHS facilities and a $0.2 million increase in rentals from non-related parties due to higher occupancy and expense reimbursements.
• Net Income Increase: Net income rose 18% to $21.6 million. Key drivers included a $1.2 million gain on the sale of the Samaritan West Valley Medical Center (part of a like-kind exchange) and a 38% reduction in interest expense ($1.5 million decrease) following the repayment of revolving credit facility borrowings with proceeds from a 2001 equity offering.
• Debt Reduction: Total recourse indebtedness decreased significantly from $33.4 million in 2001 to $30.5 million in 2002, reflecting the continued paydown of the revolving credit facility.
• Derivative Loss: The Trust recorded a $0.2 million loss on derivatives in 2002 due to the ineffective portion of cash flow hedges, compared to a $17,000 gain in 2001.

Guidance, Outlook, Risks, and Contingencies

• Concentration Risk: The Trust is heavily dependent on UHS. In 2002, 60% of consolidated revenues were derived from leases with UHS subsidiaries. UHS leases are cross-defaulted and guaranteed by UHS.
• Lease Renewals: Several key leases with UHS subsidiaries are approaching expiration or renewal. The Chalmette Medical Center lease was renewed for five years, but the renewal rate is estimated to reduce annual base rental by approximately $300,000. The Trust cannot predict if other leases will be renewed at current rates.
• Healthcare Regulation: The Trust is exposed to changes in Medicare/Medicaid reimbursement rates and managed care trends. Legislative changes (e.g., Balanced Budget Act) and payment reductions could adversely affect lessee operations and their ability to pay rent.
• Accounting Changes: The Trust anticipates the impact of FASB Interpretation No. 46 (Consolidation of Variable Interest Entities) in the third quarter of 2003. This may require the consolidation of certain LLCs, potentially increasing reported assets and liabilities, though management expects no impact on net income.
• Related Party Transactions: UHS serves as the Advisor and receives an annual fee of 0.60% of average invested real estate assets. All Trust officers are employees of UHS.
• Insurance Risks: Four LLCs own properties in California earthquake zones that are not covered by earthquake insurance due to cost. Additionally, rising liability insurance costs have led some operators to self-insure, increasing their risk exposure.

Investor Verification Checklist

• UHS Financial Health: Verify the financial stability of Universal Health Services, Inc., given that 60% of the Trust's revenue depends on its subsidiaries.
• Lease Expiration Schedule: Review the specific expiration dates of the six hospital facilities leased to UHS and the terms of renewal options.
• Non-Recourse Debt: Assess the $128.7 million of non-recourse debt held by unconsolidated LLCs and the creditworthiness of the third-party lenders.
• FFO vs. Net Income: Analyze Funds from Operations (FFO) as the primary performance metric for REITs, noting the $1.2 million gain on property sale included in 2002 Net Income.
• Dividend Coverage: Confirm that cash available for distribution continues to support the declared dividend of $1.92 per share, particularly given the 95% distribution limit on the revolving credit facility.