Business Context and Reporting Period
Universal Health Realty Income Trust is a healthcare and human-services REIT investing in hospitals, medical/office buildings, free-standing emergency departments and childcare facilities. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018. As of October 31, 2018, the portfolio comprised 69 investments in 20 states.
UHS-related tenants generated approximately 30% of consolidated revenue, including three hospitals leased to UHS subsidiaries and 17 medical office buildings or emergency departments with UHS-related tenants. UHS also provides advisory and administrative services, and all Trust officers are UHS employees.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Revenue | $18.8 million | $18.2 million | $57.5 million | $54.1 million |
| Net income | $4.4 million | $4.0 million | $19.8 million | $39.6 million |
| Net margin | 23.2% | 21.8% | 34.4% | 73.1% |
| Diluted EPS | $0.32 | $0.29 | $1.44 | $2.91 |
| FFO | $10.7 million | $10.5 million | $34.2 million | $31.7 million |
| FFO per diluted share | $0.78 | $0.77 | $2.49 | $2.33 |
| Cash flow from operations | — | — | $33.2 million | $33.6 million |
At September 30, 2018, cash and cash equivalents were $5.1 million, compared with $3.4 million at December 31, 2017. Total assets were $487.6 million and total equity was $203.4 million.
Debt consisted of $195.0 million drawn under the $300 million revolving credit facility and $65.3 million of net non-recourse mortgage debt. Available revolver capacity was $105.0 million. The revolver matures in March 2022, with two optional six-month extensions. The applicable September 30, 2018 LIBOR margin was 1.15%.
The Trust declared and paid $0.67 per share in third-quarter 2018 dividends and $2.005 per share for the first nine months. Management stated that operating cash flows, cash, borrowing capacity and capital-market access should provide sufficient resources for the next 12 months, including required REIT distributions.
Material Changes Versus the Prior Comparable Period
- Third-quarter revenue increased 3.5%, while net income increased 10.5% and FFO increased 2.3%.
- Nine-month revenue increased 6.3%, but net income declined 50.0% and diluted EPS declined 50.5%, principally because 2017 included a $27.2 million gain from the Arlington/St. Mary’s transaction.
- Nine-month 2018 results included $4.5 million of hurricane insurance recoveries in excess of property damage write-downs and $1.2 million of business-interruption insurance proceeds.
- A second-quarter 2018 lease termination agreement increased income and FFO by approximately $1.7 million.
- Nine-month FFO increased 7.8%, or $0.16 per diluted share, to $2.49, reflecting the lease termination payment, insurance proceeds and improved property-level results.
- The Trust acquired the Beaumont Medical Sleep Center Building for approximately $4.0 million in June 2018 and completed no dispositions during the first nine months.
- Net cash used in investing activities was $6.5 million in 2018 versus $39.6 million of cash provided in 2017, when the Trust received substantial proceeds from the St. Mary’s disposition.
- Mortgage debt declined from $75.4 million at December 31, 2017 to $65.3 million at September 30, 2018, while revolver borrowings increased from $181.1 million to $195.0 million. Three maturing mortgages were repaid using revolver borrowings, and one property was refinanced with a new $13.0 million mortgage.
Outlook, Risks, Contingencies and Unusual Items
No specific earnings or revenue guidance was provided. Management expects to fund capital expenditures, acquisitions and dividends through internally generated cash and, as needed, revolver borrowings, mortgage financing, equity issuance or other long-term debt.
Hurricane Harvey damaged five Houston-area medical office buildings. Reconstruction of occupied space was complete and operations had resumed by June 30, 2018. Aggregate insurance recoveries reached approximately $12.5 million and covered substantially all remediation, reconstruction and business-interruption costs.
UHS concentration is a significant risk: UHS-related tenants represented approximately 30% of revenue, while the three hospital leases represented approximately 21%. Two hospital leases expire in December 2021 and one in December 2026, subject to renewal and purchase options. Nonrenewal, property purchases by UHS or deterioration in UHS operations could reduce revenue.
Other risks include healthcare reimbursement and regulatory changes, Medicare and Medicaid reductions, real-estate occupancy and rental-rate pressure, interest-rate and refinancing risk, access to capital, severe weather, litigation involving UHS, related-party conflicts and continued qualification as a REIT.
The Trust was in compliance with all credit-facility covenants at September 30, 2018. Reported covenant measures included total leverage of 41.3% versus a maximum of 60%, secured leverage of 9.9% versus 30%, fixed-charge coverage of 4.2x versus a minimum of 1.50x, and tangible net worth of $185.0 million versus a minimum of $125.0 million.
The Trust adopted new revenue and cash-flow classification standards in 2018 without a significant financial-statement impact. Lease accounting guidance becomes effective January 1, 2019; management was evaluating the impact, primarily on ground leases.
Investor Verification Priorities
- Verify the sustainability of earnings and FFO excluding the $1.7 million lease termination payment and hurricane-related insurance recoveries.
- Assess UHS tenant concentration, lease renewal and purchase options, and the financial condition and regulatory exposure of UHS.
- Review the $195.0 million revolver balance, $105.0 million availability, floating-rate exposure, covenant headroom and upcoming mortgage maturities, including the July 2019 maturity.
- Reconcile dividends of $27.6 million with operating cash flow and capital requirements, and evaluate future dividend coverage.
- Monitor occupancy, rental rates, property-level operating expenses and the continuing effects of healthcare reimbursement changes.
- Evaluate the implementation effects of the new lease standard and any future capital commitments to unconsolidated LLCs.