UHT

Business Context and Reporting Period

Company: Universal Health Realty Income Trust (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and nine months ended September 30, 2010
Business Overview: The Trust invests in healthcare and human service facilities, including acute care hospitals, behavioral healthcare facilities, and medical office buildings (MOBs). As of September 30, 2010, the portfolio consisted of 52 real estate investments or commitments across 15 states. A significant portion of revenue is derived from leases with subsidiaries of Universal Health Services, Inc. ("UHS"), which also serves as the Trust's Advisor.

Key Financial Metrics

Note: Debt figures include $56.6 million in line of credit borrowings and $23.5 million in consolidated mortgage/term loans. Unconsolidated LLC debt is non-recourse to the Trust.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased by approximately $0.40 million (3-month) and $0.68 million (9-month) compared to the prior year periods. This was primarily due to the expiration of a master lease agreement in June 2010 for an MOB in Georgia, decreased tenant reimbursements due to lower occupancy rates, and operating losses at a recently vacated single-tenant MOB in Las Vegas.
• Net Income Decrease: Net income fell by $1.18 million (3-month) and $1.83 million (9-month) year-over-year. Key drivers included the lease expiration mentioned above, a decrease in equity income from unconsolidated LLCs (due to reserves for tenant receivables and low occupancy), and dilution from new share issuances.
• Equity Income: Equity in income of unconsolidated LLCs dropped significantly, from $0.75 million to $0.34 million (3-month) and from $2.52 million to $1.90 million (9-month), reflecting operational challenges at specific joint ventures.
• Deconsolidation: The Summerlin Hospital Medical Office Building III was deconsolidated in Q1 2010 after meeting master lease thresholds, shifting its accounting treatment to the equity method. This had no material impact on net income.

Guidance, Outlook, Risks, and Contingencies

• Dividends: A dividend of $0.605 per share was declared and paid on September 30, 2010. Management believes operating cash flows are sufficient to fund dividends and maintain REIT status.
• Capital Resources: The Trust utilized an At-The-Market (ATM) equity program, issuing 390,000 shares in the first nine months of 2010 for net proceeds of approximately $12.0 million. The revolving credit facility has $22.9 million in available capacity.
• Key Risks:
  • UHS Dependency: Approximately 56% of consolidated revenue comes from UHS hospital facilities. UHS's acquisition of Psychiatric Solutions, Inc. increases its leverage, potentially impacting its ability to meet lease obligations.
  • Regulatory Issues: Southwest Healthcare System (a UHS subsidiary operating Inland Valley Regional Medical Center) faces potential termination of its Medicare provider agreement and hospital license revocation. While agreements with CMS and CDPH have temporarily abated these actions, failure to achieve compliance could materially impact bonus rentals and property value.
  • Market Conditions: Deteriorating economic conditions and credit markets may affect occupancy rates, bonus rentals, and the ability to refinance debt.
• Unusual Items: The Trust recorded a $4.6 million asset impairment charge in 2008 for properties in Georgia; the associated master lease expired in June 2010, resulting in an estimated annual revenue reduction of up to $1 million.

Investor Verification Checklist

• UHS Financial Health: Verify the financial stability of Universal Health Services, Inc., given its status as the primary tenant and the impact of its recent acquisition of Psychiatric Solutions, Inc.
• Southwest Healthcare System Status: Monitor the outcome of the CMS full certification survey for Southwest Healthcare System (expected mid-2011) to assess the risk to the Inland Valley Regional Medical Center lease.
• Occupancy Trends: Review occupancy rates and lease renewal terms for the Georgia MOB (post-lease expiration) and the Las Vegas MOB to gauge revenue recovery.
• Debt Maturities: Assess the refinancing risk for the Summerlin Hospital MOB II mortgage maturing in December 2010 and other near-term LLC debt maturities.
• FFO vs. Net Income: Analyze the reconciliation between Net Income and Funds From Operations (FFO) to understand the impact of depreciation and amortization on cash generation capabilities.