FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(MARK ONE)
|X|ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
| |TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For
the transition period from ___________ to
_____________
Commission File No. 1-9321
UNIVERSAL HEALTH
REALTY INCOME TRUST
(Exact name of registrant as specified in its charter)
Maryland 23-6858580
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Universal Corporate Center
367 South Gulph Road
P.O. Box 61558 19406-0958
King of Prussia, Pennsylvania (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (610) 265-0688
Securities registered pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange on which registered
Shares of beneficial interest,
$.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports to be
filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. | |
Aggregate market value of voting shares held by non-affiliates as of January 31,
1999: $168,231,750.
Number of shares of beneficial interest outstanding of registrant as of January
31, 1999: 8,955,465.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for its 1999 Annual
Meeting of Shareholders, which will be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998 (incorporated by reference
under Part III).
PART I
Item 1. BUSINESS
General
The Trust commenced operations on December 24, 1986. As of December 31,
1998, the Trust had investments in thirty-one facilities located in
fourteen states consisting of the following:
Facility Name Location Type of Facility Guarantor
- --------------------------------------------- ----- --------------------- ------------------------ --------------------------------
Chalmette Medical Center (A) Chalmette, LA Acute Care Universal Health Services, Inc.
Virtue Street Pavilion (A) Chalmette, LA Rehabilitation Universal Health Services, Inc.
Inland Valley Regional Medical Ctr. (A) Wildomar, CA Acute Care Universal Health Services, Inc.
McAllen Medical Center (A) McAllen, TX Acute Care Universal Health Services, Inc.
Meridell Achievement Center (A) Austin, TX Behavioral Health Universal Health Services, Inc.
The Bridgeway (A) N.Little Rock, AR Behavioral Health Universal Health Services, Inc.
Wellington Regional Medical Center (A) W.Palm Beach, FL Acute Care Universal Health Services, Inc.
Vencor Hospital - Chicago (B) Chicago, IL Sub-Acute Care Vencor, Inc.
Tri-State Rehabilitation Hospital (B) Evansville, IN Rehabilitation HEALTHSOUTH Corporation
Fresno Herndon Medical Plaza (B) Fresno, CA Medical Office Bldg. ---
Family Doctor's Medical Office Bldg. (B) Shreveport, LA Medical Office Bldg. Columbia/HCA Healthcare Corp.
Kelsey-Seybold Clinic at Kings Crossing (B) Kingwood, TX Medical Office Bldg. Caremark International, Inc.
Professional Bldgs. at Kings Crossing (B) Kingwood, TX Medical Office Bldg. ---
Chesterbrook Academy (B) Audubon, PA Preschool & Childcare Nobel Education Dynamics & Subs.
Carefree Learning Center (B) New Britain, PA Preschool & Childcare Nobel Education Dynamics & Subs.
Carefree Learning Center (B) Newtown, PA Preschool & Childcare Nobel Education Dynamics & Subs.
Carefree Learning Center (B) Uwchlan, PA Preschool & Childcare Nobel Education Dynamics & Subs.
Southern Crescent Center (B) Riverdale, GA Medical Office Bldg. ---
Desert Samaritan Hospital MOBs (C) Phoenix, AZ Medical Office Bldg. ---
Suburban Medical Center MOBs (D) Louisville, KY Medical Office Bldg. ---
Maryvale Samaritan Hospital MOBs (E) Phoenix, AZ Medical Office Bldg. ---
Desert Valley Medical Center MOB (F) Phoenix, AZ Medical Office Bldg. ---
Thunderbird Paseo Medical Plaza (G) Glendale, AZ Medical Office Bldg. ---
Cypresswood Professional Center (H) Houston, TX Medical Office Bldg. ---
Samaritan West Valley Medical Ctr. (I) Goodyear, AZ MOB, Imaging Ctr. ---
Edwards Medical Plaza (F) Phoenix, AZ Medical Office Bldg. ---
Desert Springs Medical Plaza (J) Las Vegas, NV Medical Office Bldg. Quorum Health Group, Inc.
Pacifica Palms Medical Plaza (F) Torrance, CA Medical Office Bldg. ---
St. Jude Heritage Health Complex (K) Fullerton, CA Medical Office Bldg. ---
Rio Rancho Medical Center (L) Rio Rancho, NM Medical Office Bldg. ---
Lake Shore Hospital (M) Manchester, NH Unoccupied ---
(A) Leased to subsidiaries of Universal Health Services, Inc.
(B) Real estate assets owned by the Trust and leased to an unaffiliated
third-party or parties.
(C) The Trust has a 61% equity interest in a limited liability company
("LLC") which owns the real estate assets of this facility.
(D) The Trust has a 33% equity interest in a LLC which owns the real
estate assets of this facility on which construction was completed
during the third quarter of 1996. In connection with this property,
the Trust posted a $3.5 million standby letter of credit for the
benefit of the third-party lending institution that provided financing
which matures in May, 1999.
(E) The Trust has a 60% interest in a LLC which owns the real estate
assets of this facility.
(F) The Trust has a 95% equity interest in a LLC which owns the real
estate assets of this facility.
(G) The Trust has a 75% equity interest in a LLC which owns the real
estate assets of this facility.
(H) The Trust has provided financing, which matures in August, 2002, to a
limited partnership in which the Trust owns a 77% controlling
interest. Construction on this facility was completed on a substantial
portion of the building and the facility was opened during the third
quarter of 1997. In connection with this investment, the Trust made a
capital contribution of $343,000 to the limited partnership.
(I) The Trust has a 89% equity interest in a LLC which owns the real
estate assets of this facility. Construction was completed and the
facility opened during the fourth quarter of 1997.
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(J) The Trust has a 99% equity interest in a LLC which owns the real
estate assets of this facility.
(K) The Trust has a 48% equity interest in a LLC which owns the real
estate assets of this facility.
(L) The Trust has a 80% equity interest in a LLC which owns the real
estate assets of this facility.
(M) The Trust received free and clear title to the real estate assets of
Lake Shore Hospital during 1995. The Trust continues to market this
facility to third parties interested in purchasing or leasing the real
estate assets.
In this Annual Report on Form 10-K, the term "revenues" does not
include the revenues of the unconsolidated limited liability companies
in which the Trust has various non-controlling equity interests ranging
from 33% to 99%. The Trust accounts for its share of the income/loss
from these investments by the equity method.
As of December 31, 1998, the Trust has invested an aggregate of $202
million in various real estate assets, mortgage loans, construction
loans and limited liability companies and limited partnerships which
own real estate assets. Included in the Trust's portfolio is ownership
of nine hospital facilities (aggregate investment of $136 million)
which contain an aggregate of 1,279 licensed beds. The leases with
respect to such facilities comprised 81% of the Trust's 1998 revenues,
have fixed terms with an average of 5.2 years remaining and provide for
renewal options for up to six five-year terms. During 1998,
wholly-owned subsidiaries of Universal Health Services, Inc. ("UHS")
exercised five-year renewal options on four hospitals owned by the
Trust which were scheduled to expire in 1999 through 2001. The leases
on these facilities were renewed at the same lease rates and terms as
the initial leases. Minimum rents are payable based on the initial
acquisition costs of the facilities and, with respect to all facilities
other than the one leased to Vencor Hospital - Chicago, additional
rents are payable based upon a percentage of each facility's revenue in
excess of base year amounts or CPI increases in excess of base year
amounts. The lessees have rights of first refusal to purchase the
facilities exercisable during and in most cases for 180 days after the
expiration of the lease terms and also have purchase options
exercisable upon three to six months notice at the end of each lease
term at the facility's fair market value. Subsequent to December 31,
1998, the lease on Tri-State Rehabilitation Hospital was amended and
renewed for a five-year term commencing June 1, 1999 and ending May 31,
2004. Pursuant to the terms of the lease, as amended, the minimum rent
has been increased and the additional rent provision has been
eliminated.
For the hospital facilities owned by the Trust, the combined ratio of
earnings before interest, taxes, depreciation, amortization and lease
and rental expense (EBITDAR) (excluding a favorable prior year net
revenue adjustment recorded during 1996 at one of the Trust's
facilities) to minimum rent plus additional rent payable to the Trust
was approximately 5.1, 4.7 and 5.0 for the years ended December 31,
1998, 1997 and 1996, respectively. The coverage ratio for individual
facilities varies (see "Relationship to Universal Health Services,
Inc.").
Pursuant to the terms of the leases with subsidiaries of UHS, UHS is
responsible for building operations, maintenance and renovations
required at the seven hospital facilities leased from the Trust. For
the Trust's multi-tenant medical office buildings, cash reserves have
been established to fund required building maintenance and renovations.
Lessees are required to maintain all risk, replacement cost and
commercial property insurance policies on the leased properties. The
Trust is one of the named insured and believes the leased properties
are adequately insured.
Relationship to Universal Health Services, Inc.
Leases. As of December 31, 1998, subsidiaries of UHS leased seven of
the nine hospital facilities owned by the Trust with terms expiring in
2000 through 2006. The leases to the subsidiaries of UHS are guaranteed
by UHS and are cross-defaulted with one another. Each of the leases
contains
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renewal options of up to six five-year periods. These leases accounted
for 75% of the total revenue of the Trust for the five years ended
December 31, 1998 (72% for the three years ended December 31, 1998).
During the third quarter of 1998, wholly-owned subsidiaries of UHS
exercised five-year renewal options on four hospitals owned by the
Trust which were scheduled to expire in 1999 through 2001 (Virtue
Street Pavilion, The Bridgeway, Inland Valley Regional Medical Center
and Wellington Regional Medical Center). The leases on these facilities
were renewed at the same lease rates and terms as the initial leases
and these renewals remove the majority of the previously disclosed
uncertainty regarding the lease renewals with subsidiaries of UHS. As
part of the renewal agreement, the Trust also agreed to grant
additional fixed rate renewal options to a wholly-owned subsidiary of
UHS commencing in 2022 on the real property of McAllen Medical Center.
The leases on the four renewed facilities represented 30% of the
Trust's rental revenue for the twelve month period ended December 31,
1998. On a combined basis, these four facilities had earnings before
interest, taxes, depreciation, amortization and lease and rental
expense (EBITDAR) for the twelve month period ended December 31, 1998
of 1.8 times the annual rent payable to the Trust (ranging from 1.2 to
3.0). The remaining UHS facilities, including McAllen Medical Center,
had a combined EBITDAR for the twelve month period ended December 31,
1998 of 7.7 times the annual rent payable to the Trust (ranging from
1.1 to 8.6). The lease on one UHS facility, which had EBITDAR for the
twelve month period ended December 31, 1998 of 1.1 times the rent
payable to the Trust, expires in 2000 and represented approximately 5%
of the Trust's rental revenue for the twelve month period ended
December 31, 1998. Management of the Trust can not predict whether the
leases with subsidiaries of UHS, which have renewal options at existing
lease rates, or any of the Trust's other leases, will be renewed at the
end of their initial term or first five-year renewal term.
In recent years, an increasing number of legislative initiatives have
been introduced or proposed in Congress and in state legislatures that
would effect major changes in the healthcare system, either nationally
or at the state level (see "Regulation"). In addition, the healthcare
industry has been characterized in recent years by increased
competition and consolidation. Management of the Trust is unable to
predict the effect, if any, these industry factors will have on the
operating results of its lessees, including the facilities leased to
subsidiaries of UHS, or on their ability to meet their obligations
under the terms of their leases with the Trust.
Pursuant to the terms of the leases with UHS, the lessees have rights
of first refusal to: (i) purchase the respective leased facilities
during and for 180 days after the lease terms at the same price, terms
and conditions of any third-party offer, or; (ii) renew the lease on
the respective leased facility at the end of, and for 180 days after,
the lease term at the same terms and conditions pursuant to any
third-party offer. The leases also grant the lessees options,
exercisable on at least six months notice, to purchase the respective
leased facilities at the end of the lease term or any renewal term at
the facility's then fair market value. The terms of the leases also
provide that in the event UHS discontinues operations at the leased
facility for more than one year, or elects to terminate its lease prior
to the expiration of its term for prudent business reasons, UHS is
obligated to offer a substitution property. If the Trust does not
accept the substitution property offered, UHS is obligated to purchase
the leased facility back from the Trust at a price equal to the greater
of its then fair market value or the original purchase price paid by
the Trust. As noted below, transactions with UHS must be approved by a
majority of the Trustees who are unaffiliated with UHS (the
"Independent Trustees"). The purchase options and rights of first
refusal granted to the respective lessees to purchase or lease the
respective leased facilities, after the expiration of the lease term,
may adversely affect the Trust's ability to sell or lease a facility,
and may present a
3
potential conflict of interest between the Trust and UHS since the
price and terms offered by a third-party are likely to be dependent, in
part, upon the financial performance of the facility during the final
years of the lease term.
Advisory Agreement. UHS of Delaware, Inc. (the "Advisor"), a
wholly-owned subsidiary of UHS, serves as Advisor to the Trust under an
Advisory Agreement dated December 24, 1986 between the Advisor and the
Trust (the "Advisory Agreement"). Under the Advisory Agreement, the
Advisor is obligated to present an investment program to the Trust, to
use its best efforts to obtain investments suitable for such program
(although it is not obligated to present any particular investment
opportunity to the Trust), to provide administrative services to the
Trust and to conduct the Trust's day-to-day affairs. In performing its
services under the Advisory Agreement, the Advisor may utilize
independent professional services, including accounting, legal and
other services, for which the Advisor is reimbursed directly by the
Trust. The Advisory Agreement expires on December 31 of each year;
however, it is renewable by the Trust, subject to a determination by
the Independent Trustees that the Advisor's performance has been
satisfactory. The Advisory Agreement may be terminated for any reason
upon sixty days written notice by the Trust or the Advisor. The
Advisory Agreement has been renewed for 1999. All transactions with UHS
must be approved by the Independent Trustees. The Advisory Agreement
provides that the Advisor is entitled to receive an annual advisory fee
equal to .60% of the average invested real estate assets of the Trust,
as derived from its consolidated balance sheet from time to time. In
addition, the Advisor is entitled to an annual incentive fee equal to
20% of the amount by which cash available for distribution to
shareholders for each year, as defined in the Advisory Agreement,
exceeds 15% of the Trust's equity as shown on its balance sheet,
determined in accordance with generally accepted accounting principles
without reduction for return of capital dividends. No incentive fees
were paid during 1998, 1997 and 1996. The advisory fee is payable
quarterly, subject to adjustment at year end based upon audited
financial statements of the Trust.
Share Purchase Option. UHS has the option to purchase shares of
beneficial interest in the Trust at fair market value to maintain a 5%
interest in the Trust. As of December 31, 1998, UHS owned 8% of the
outstanding shares of beneficial interest.
Competition
The Trust believes that it is one of twelve publicly traded real estate
investment trusts (REITs) currently investing primarily in
income-producing real estate with an emphasis on healthcare related
facilities. The REITs compete with one another in that each is
continually seeking attractive investment opportunities in healthcare
related facilities.
The Trust may also compete with banks and other companies, including
UHS, in the acquisition, leasing and financing of healthcare related
facilities. In most geographical areas in which the Trust's facilities
operate, there are other facilities which provide services comparable
to those offered by the Trust's facilities, some of which are owned by
governmental agencies and supported by tax revenues, and others of
which are owned by nonprofit corporations and may be supported to a
large extent by endowments and charitable contributions. Such support
is not available to the Trust's facilities. In addition, certain
hospitals which are located in the areas served by the Trust's
facilities are special service hospitals providing medical, surgical
and behavioral health services that are not available at the Trust's
hospitals or other general hospitals. The competitive position of a
hospital is to a large degree dependent upon the number and quality of
staff physicians. Although a physician may at any time terminate his or
her affiliation with a hospital, the Trust's hospitals seek to retain
doctors of varied specializations on its hospital staffs and to attract
other
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qualified doctors by improving facilities and maintaining high ethical
and professional standards.
The Trust's hospital facilities continue to experience a shift in payor
mix resulting in an increase in revenues attributable to managed care
payors and unfavorable general industry trends which include pressures
to control healthcare costs. Providers participating in managed care
programs agree to provide services to patients for a discount from
established rates which generally results in pricing concessions by the
providers and lower margins. Additionally, managed care companies
generally encourage alternatives to inpatient treatment settings and
reduce utilization of inpatient services. In response to increased
pressure on revenues, the Trust's hospital facilities continue to
implement cost control programs including more efficient staffing
standards and re-engineering of services. Pressure on operating margins
is expected to continue due to, among other things, the changes in
Medicare payments mandated by the Balanced Budget Act of 1997 which
became effective October 1, 1997 and the industry-wide trend towards
managed care which limits the ability of the Trust's hospital
facilities to increase their prices.
Outpatient treatment and diagnostic facilities, outpatient surgical
centers, and freestanding ambulatory surgical centers also impact the
healthcare marketplace. Many of the Trust's facilities continue to
experience an increase in outpatient revenues which is primarily the
result of advances in medical technologies and pharmaceutical
improvements, which allow more services to be provided on an outpatient
basis, and increased pressure from Medicare, Medicaid, health
maintenance organizations ("HMOs"), preferred provider organizations
("PPOs"), and insurers to reduce hospital stays and provide services,
where possible, on a less expensive outpatient basis. The hospital
industry in the United States, as well as the Trust's hospital
facilities, continue to have significant unused capacity which has
created substantial competition for patients. Inpatient utilization
continues to be negatively affected by payor-required, pre-admission
authorization and by payor pressure to maximize outpatient and
alternative healthcare delivery services for less acutely ill patients.
The Trust expects its hospital facilities to continue to experience
increased competition, admission constraints and payor pressures.
The Trust anticipates investing in additional healthcare related
facilities and leasing the facilities to qualified operators, perhaps
including UHS and subsidiaries of UHS.
Regulation
The Medicare program reimburses the operators of the Trust's hospitals
primarily based on established rates by a diagnosis related group for
acute care hospitals and by cost based formula for behavioral health
facilities. Historically, rates paid under Medicare's prospective
payment system ("PPS") for inpatient services have increased, however,
these increases have been less than cost increases. The Balanced Budget
Act calls for the government to trim the growth of federal spending on
Medicare by $115 billion and on Medicaid by $13 billion over the next
five years. The act also calls for the reductions in the future rate of
increases to payments made to hospitals and reduces the amount of
reimbursement for outpatient services, bad debt expense and capital
costs. It is likely that future budgets will contain further reductions
in the rate of increase of Medicare and Medicaid spending, as evidence
by the Clinton Administration's proposed fiscal year 2000 budget which
includes a proposal to freeze Medicare hospital payment rates.
Outpatient reimbursement for Medicare patients is scheduled to convert
to a PPS during the second quarter of 2000. Since final provisions of
the outpatient Medicare PPS are not yet available, operators of the
Trust's hospitals can not completely estimate the resulting impact on
their future results of operations. While the Trust is unable to
predict whether this most recent proposal, or any other future health
reform legislation, will ultimately be enacted at the federal
5
or state level, the Trust expects continuing pressure to limit
expenditures by governmental healthcare programs. Further changes in
the Medicare or Medicaid programs and other proposals to limit
healthcare spending could have a material adverse impact on the
operating results of the Trust's facilities and the healthcare
industry.
In addition to the Medicare and Medicaid programs, other payors
continue to actively negotiate the amounts they will pay for services
performed. In general, the operators of the Trust's facilities expect
to continue to experience an increase in business from managed care
programs, including HMOs and PPOs. The consequent growth in managed
care networks and the resulting impact of these networks on the
operating results of the Trust's facilities vary among the markets in
which the Trust's facilities operate.
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Executive Officers of the Registrant
The executive officers of the Trust are as follows:
Name Age Position
Alan B. Miller 61 Chairman of the Board and
Chief Executive Officer
Kirk E. Gorman 48 President, Chief Financial
Officer, Secretary and Trustee
Charles F. Boyle 39 Vice President
and Controller
Cheryl K. Ramagano 36 Vice President and
Treasurer
Timothy J. Fowler 43 Vice President, Acquisition
and Development
Mr. Alan B. Miller has been Chairman of the Board and Chief Executive
Officer of the Trust since its inception in 1986. He served as
President of the Trust until March, 1990. Mr. Miller has been Chairman
of the Board, President and Chief Executive Officer of UHS since its
inception in 1978. Mr. Miller also serves as a director of CDI Corp.,
Genesis Health Ventures and Penn Mutual Life Insurance Company.
Mr. Kirk E. Gorman has been President and Chief Financial Officer of
the Trust since March, 1990 and was elected to the Board of Trustees
and Secretary in December, 1994. Mr. Gorman had previously served as
Vice President and Chief Financial Officer of the Trust since April,
1987. Mr. Gorman was elected Senior Vice President, Treasurer and Chief
Financial Officer of UHS in 1992 and served as its Senior Vice
President and Treasurer since 1989.
Mr. Charles F. Boyle was elected Vice President and Controller of the
Trust in June, 1991. Mr. Boyle was promoted to Assistant Vice President
- Corporate Accounting of UHS in 1994 and served as its Director of
Corporate Accounting since 1989.
Ms. Cheryl K. Ramagano was elected Vice President and Treasurer of the
Trust in September, 1992. Ms. Ramagano was promoted to Assistant
Treasurer of UHS in 1994 and served as its Director of Finance since
1990.
Mr. Timothy J. Fowler was elected Vice President, Acquisition and
Development of the Trust upon the commencement of his employment with
UHS in October, 1993. Prior thereto, he served as a Vice President of
The Chase Manhattan Bank, N.A. since 1986.
The Trust's officers are all employees of UHS and as of December 31,
1998, the Trust had no salaried employees and paid no cash
compensation. In 1999, the Trustees awarded a $50,000 bonus to Mr. Kirk
E. Gorman, President, Chief Financial Officer, Secretary and Trustee of
the Trust. UHS agreed to a $50,000 reduction in the 1999 advisory fee
paid by the Trust.
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Item 2. Properties
The following table shows the Trust's investments in hospital facilities leased
to Universal Health Services, Inc. and other non-related parties. The table on
the next page provides information related to various properties in which the
Trust has significant investments, some of which are accounted for by the equity
method. The capacity in terms of beds (for the hospital facilities) and the
five-year occupancy levels are based on information provided by the lessees.
Number of Lease Term
available -----------------------------
beds @ Average Occupancy (1) Minimum End of
Type of ------------------------------------------ initial Renewal
Hospital Facility Name and Location facility 12/31/98 1998 1997 1996 1995 1994 rent or renewed term
term (years)
- -----------------------------------------------------------------------------------------------------------------------------------
Chalmette Medical Centers
Virtue Street Pavilion (3) Rehabilitation 45 63% 64% 61% 57% 92% $1,261,000 2004 25
Chalmette Medical Center Acute Care 118 61% 64% 66% 67% 66% 921,000 2003 15
Chalmette, Louisiana (2)
Inland Valley Regional Medical Center Acute Care 80 60% 52% 49% 49% 45% 1,857,000 2006 30
Wildomar, California (3)
McAllen Medical Center Acute Care 472 69% 76% 88% 87% 89% 5,485,000 2001 30
McAllen, Texas (3)
Wellington Regional Medical Center Acute Care 120 37% 36% 36% 30% 32% 2,495,000 2006 30
West Palm Beach, Florida (3)
The BridgeWay Behavioral Health 70 79% 68% 62% 65% 61% 683,000 2004 25
North Little Rock, Arkansas (3)
Meridell Achievement Center Behavioral Health 114 53% 47% 45% 65% 47% 1,071,000 2000 20
Austin, Texas
Tri-State Regional Rehabilitation Hospital Rehabilitation 80 82% 74% 59% 59% 61% 1,167,000 2004 20
Evansville, Indiana (4)
Vencor Hospital Sub-Acute Care 75 42% 50% 45% 38% 38% 1,065,000 2001 25
Chicago, Illinois (5)
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Item 2. Properties (continued)
Lease Term
-----------------------------------
Type of Average Occupancy (1) Minimum End of initial Renewal
------------------------------- term
Facility Name and Location facility 1998 1997 1996 1995 1994 rent or renewed term (years)
- -----------------------------------------------------------------------------------------------------------------------------------
Fresno - Herndon Medical Plaza Medical 100% 100% 100% 100% - $740,000 1999 -2003 various
Fresno, California (6) Office Building
Kelsey-Seybold Clinic at King's Crossing Medical 100% 100% 100% 100% - 264,000 2005 10
Professional Center at King's Crossing Office Buildings 100% 100% 93% 100% - 299,000 2000 -2005 various
Kingwood, Texas (7)
The Southern Crescent Center Medical 100% 100% 89% - - 795,000 1999 -2006 various
Riverdale, Georgia (8) Office Building
The Cypresswood Professional Center Medical 100% 96% - - - 524,000 2002 -2007 various
Spring, Texas (9) Office Building
Desert Samaritan Medical Buildings Medical 99% 97% 97% - - 4,147,000 1998-2008 various
Phoenix, Arizona (10) Office Buildings
Desert Springs Medical Plaza Medical 100% - - - - 1,633,000 1999-2002 various
Las Vegas, Nevada (11) Office Building
Edwards Medical Plaza Medical 87% - - - - 2,212,000 1999-2005 various
Phoenix, Arizona (12) Office Building
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(1) Average occupancy rate for the hospital facilities is based on the
average number of available beds occupied during the five years ended
December 31, 1998. Average occupancy rate for the multi-tenant medical
office buildings is based on the occupied square footage of each
building. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for effects of various occupancy
levels at the Trust's hospital facilities. Average available beds is
the number of beds which are actually in service at any given time for
immediate patient use with the necessary equipment and staff available
for patient care. A hospital may have appropriate licenses for more
beds than are in service for a number of reasons, including lack of
demand, incomplete construction, and anticipation of future needs.
(2) The operations of The Virtue Street Pavilion and Chalmette Medical
Center, two facilities which are separated by approximately one mile,
were combined at the end of 1989. Each facility is leased pursuant to a
separate lease. The Chalmette Medical Center facility is a 118-bed
medical/surgical facility. The Virtue Street Pavilion is a 73-bed
facility made up of a physical rehabilitation unit, skilled nursing and
inpatient behavioral health services. In December of 1994, the operator
of the Virtue Street Pavilion entered into a three year sub-lease
agreement with Lifecare Hospitals of New Orleans, LLC, for a portion of
the facility. Annual rental is $1.1 million under the provisions of
this agreement. The sub-lease, which expires in December, 2000,
contains one three year extension at the lessee's option. No assurance
can be given as to the effect, if any, the consolidation of the two
facilities as mentioned above, had on the underlying value of the
Virtue Street Pavilion and Chalmette Medical Center. Rental commitments
and the guarantee by UHS under the existing leases continue for the
remainder of the respective terms of the leases.
(3) During 1998, wholly-owned subsidiaries of UHS exercised five-year
renewal options on four hospitals owned by the Trust which were
scheduled to expire in 1999 through 2001 (Virtue Street Pavilion, The
Bridgeway, Inland Valley Regional Medical Center and Wellington Medical
Center ). The leases on these facilities were renewed at the same lease
rates and terms as the initial leases. As part of the renewal
agreement, the Trust also agreed to grant additional fixed rate renewal
options to a wholly-owned subsidiary of UHS commencing in 2022 on the
real property of McAllen Medical Center.
(4) The Trust purchased this hospital during 1989 for approximately
$7.5 million. During 1993, the Trust purchased for approximately $1.1
million, a 20 bed addition which was added to the facility. The Trust
entered into an agreement with the operator, an unaffiliated
third-party, to lease the facility for an initial fixed term of 10
years, with the operator having the option to extend the lease for five
5-year renewal terms. Subsequent to December 31, 1998, the lease on
this facility was amended and renewed for a five-year term commencing
on June 1, 1999 and ending on May 31, 2004. Pursuant to the terms of
the lease as amended, the minimum rent has been increased and the
additional rent provision has been eliminated
(5) During December of 1993, UHS, the former lessee and operator of
Belmont Community Hospital, sold the operations of the facility to
THC-Chicago, Inc., an indirect wholly-owned subsidiary of Community
Psychiatric Centers ("CPC"). Concurrently, the Trust purchased certain
related real property from UHS for $1 million in cash and a note
payable with a carrying value of $1.2 million at December 31, 1998. The
note payable has a face value of $1 million and is due on December 31,
2001. The amount of interest payable on this note is contingent upon
the financial performance of this leased facility and its estimated
fair value at the end of the initial lease term. The Trust has
estimated the total amount payable under the terms of this note and has
discounted the payments to their net present value using a 6% rate.
10
Included in the Trust's 1998 financial results is approximately $69,000
of interest expense related to this note. In connection with this
transaction, UHS's lease with the Trust was terminated and the Trust
entered into an eight year lease agreement with THC-Chicago. In 1997,
CPC was acquired by Vencor, Inc. who assumed their obligations under
the lease and renamed the facility Vencor Hospital-Chicago. The lease
is guaranteed by Vencor, Inc.
(6) In November of 1994, the Trust purchased the Fresno-Herndon Medical
Plaza located in Fresno, California for $6.3 million. The 37,800 square
foot medical office building is leased to several tenants, including an
outpatient surgery center operated by Columbia/HCA Healthcare
Corporation, under the terms of leases with expiration dates ranging
from November, 1999 to March, 2003. The Trust has granted the seller
the option to repurchase the property in November, 2001 for $7,250,000.
(7) In December of 1994, the Trust agreed to provide construction
financing for the Professional Center at Kings Crossing, of which $1.1
million was advanced during 1994 and $3.2 million was advanced during
1995. During the fourth quarter of 1995, upon completion and occupancy
of the properties, the Trust purchased the single tenant and two
multi-tenant medical office buildings for the total construction cost
of $4.3 million. The single tenant building consists of 20,000 net
square feet and is leased to Kelsey-Seybold, a subsidiary of Caremark
International, Inc., for an initial term of 10 years. The two
multi-tenant buildings total 27,535 net square feet and are occupied by
tenants consisting primarily of medical professionals. The lease is
guaranteed by Caremark International, Inc., a subsidiary of
Medpartners, Inc.
(8) During the second quarter of 1996, the Trust purchased The Southern
Crescent Center, a multi-tenant medical office building, for
approximately $6 million. The Southern Crescent Center is a 41,400
square foot, multi-tenant medical office building located adjacent to
the Southern Regional Medical Center in Riverdale, Georgia.
(9) Construction on the Cypresswood Professional Center, located in
Houston, Texas, was completed during 1997 for a total cost of $4.4
million. In connection with this investment, the Trust provided
five-year financing (which matures in August, 2002) to a limited
partnership which owns the real estate assets of this facility. The
Trust owns a 77% controlling interest in the partnership.
(10) In January 1996, the Trust invested $5 million to acquire a 61%
non-controlling interest in a limited liability company that owns three
medical office buildings located in Phoenix, Arizona. The three
buildings total approximately 194,000 gross square feet and are leased
to several tenants. In connection with this investment the limited
liability company obtained non-recourse, third-party financing, which
has outstanding balance at December 31, 1998 of $17.1 million.
(11) Since April 1998, the Trust invested a total of $10.1 million to
acquire a 99% non-controlling interest in a limited liability company
that owns the Desert Springs Medical Plaza located in Las Vegas,
Nevada. The 89,000 square foot medical office building, which is
located on the campus of Desert Springs Hospital, is master leased and
guaranteed by Quorum Health Group, Inc. In connection with this
investment the limited liability company obtained non-recourse,
third-party financing, which has an outstanding balance at December 31,
1998 of $5.9 million.
(12) In April 1998, the Trust invested $3.8 million to acquire a 95%
non-controlling interest in a limited liability company that owns the
Edwards Medical Plaza located in Phoenix, Arizona.
11
The 85,000 square foot medical office building, which is leased to
multiple tenants, is located on the campus of the Good Samaritan
Regional Medical Center. In connection with this investment the limited
liability company obtained non-recourse, third-party financing which
has an outstanding balance at December 31, 1998 of $7.5 million
Item 3. LEGAL PROCEEDINGS
Not Applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable. No matter was submitted during the fourth quarter of
the year ended December 31, 1998 to a vote of security holders.
12
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The Trust's shares of beneficial interest are listed on the New York
Stock Exchange. The high and low closing sales prices for the Trust
shares of beneficial interest for each quarter in the two years ended
December 31, 1998 and 1997 are summarized below:
1998 1997
------------------------------------ ---------------------------------------
High Price Low Price High Price Low Price
----------------- ------------------ -------------------- ------------------
First Quarter $22 1/2 $21 $22 3/8 $19 3/4
Second Quarter $21 3/8 $18 13/16 $20 $18 1/2
Third Quarter $20 1/4 $18 1/16 $21 1/2 $18 15/16
Fourth Quarter $20 1/4 $18 3/8 $21 7/8 $20 1/16
As of January 31, 1999, there were approximately 982 shareholders of
record of the Trust's shares of beneficial interest. It is the Trust's
intention to declare quarterly dividends to the holders of its shares
of beneficial interest so as to comply with applicable sections of the
Internal Revenue Code governing real estate investment trusts.
Covenants relating to the revolving credit facility limit the Trust's
ability to increase dividends in excess of 95% of cash available for
distribution unless additional distributions are required to be made so
as to comply with applicable sections of the Internal Revenue Code and
related regulations governing real estate investment trusts. In each of
the past five years, dividends per share were declared as follows:
1998 1997 1996 1995 1994
---------- ---------- ---------- --------- ----------
First Quarter $ .435 $ .425 $ .420 $ .42 $ .415
Second Quarter .435 .425 .425 .42 .415
Third Quarter .440 .425 .425 .42 .415
Fourth Quarter .445 .430 .425 .42 .420
---------- ---------- ---------- --------- ----------
$ 1.755 $ 1.705 $ 1.695 $ 1.68 $ 1.665
========== ========== ========== ========= ==========
12
Item 6. SELECTED FINANCIAL DATA
Financial highlights for the Trust for the five years ended December
31, 1998 were as follows:
1998 (1) 1997 (1) 1996 (1) 1995 1994
----------------------------- ----------------- ----------------- ----------------- ----------------- -----------------
Revenues $23,234,000 $22,764,000 $21,923,000 $20,417,000 $18,826,000
Net income $14,337,000 $13,967,000 $14,158,000 $13,584,000 $14,312,000
Funds from
Operations (2) $19,857,000 $18,809,000 $18,174,000 $17,024,000 $17,501,000
Per Share Data:
Net income-Basic $1.60 $1.56 $1.58 $1.52 $1.60
Net income-Diluted $1.60 $1.56 $1.58 $1.52 $1.60
Dividends $1.755 $1.705 $1.695 $1.680 $1.665
(1) See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
(2) Funds from operations ("FFO") may not be calculated in the same
manner for all companies, and accordingly, FFO as presented above
may not be comparable to similarly titled measures by other
companies. FFO does not represent cash flows from operations as
defined by generally accepted accounting principles and should
not be considered as an alternative to net income as an indicator
of the Trust's operating performance or to cash flows as a
measure of liquidity. FFO shown above is calculated as follows:
1998 1997 1996 1995 1994
Net income $14,337,000 $13,967,000 $14,158,000 $13,584,000 $14,312,000
Depreciation expense:
Consolidated investments 3,809,000 3,740,000 3,554,000 3,315,000 3,127,000
Unconsolidated affiliates 1,587,000 978,000 337,000 -- --
Amortization of interest
rate cap 124,000 124,000 125,000 125,000 62,000
----------- ----------- ----------- ----------- -----------
Total $19,857,000 $18,809,000 $18,174,000 $17,024,000 $17,501,000
=========== =========== =========== =========== ===========
At End of Period 1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------------------------
Total Assets $169,406,000 $146,755,000 $148,566,000 $132,770,000 $128,907,000
Debt $ 66,016,000 $ 42,347,000 $ 43,082,000 $ 26,396,000 $ 21,283,000
14
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Forward Looking Statements
The matters discussed in this report, as well as the news releases
issued from time to time by the Trust, include certain statements
containing the words "believes", "anticipates", "intends", "expects",
and words of similar import, which constitute "forward-looking
statements" within the meaning of Private Securities Litigation Reform
Act of 1995. Such forward-looking statements involve known and unknown
risks, uncertainties and other factors that may cause the actual
results, performance or achievements of the Trust's or industry results
to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements.
Such factors include, among other things, the following: a substantial
portion of the Trust's revenues are dependent on one operator,
Universal Health Services, Inc., ("UHS"); a substantial portion of the
Trust's leases are involved in the healthcare industry which is
undergoing substantial changes and is subject to possible changes in
the levels and terms of reimbursement from third-party payors and
government reimbursement programs, including Medicare and Medicaid; the
Trust's ability to finance its growth on favorable terms; the impact of
Year 2000 issues; liability and other claims asserted against the Trust
or operators of the Trust's facilities, and other factors referenced
herein. Additionally, the operators of the Trust's facilities,
including UHS, are confronted with other issues such as: industry
capacity; demographic changes; existing laws and government regulations
and changes in or failure to comply with laws and governmental
regulations; the ability to enter into managed care provider agreements
on acceptable terms; competition; the loss of significant customers;
technological and pharmaceutical improvements that increase the cost of
providing, or reduce the demand for healthcare; and the ability to
attract and retain qualified personnel, including physicians.
Management of the Trust is unable to predict the effect, if any, these
factors will have on the operating results of its lessees, including
the facilities leased to subsidiaries of UHS. Given these
uncertainties, prospective investors are cautioned not to place undue
reliance on such forward-looking statements. The Trust disclaims any
obligation to update any such factors or to publicly announce the
result of any revisions to any of the forward-looking statements
contained herein to reflect future events or developments.
Liquidity and Capital Resources
General
The Trust commenced operations on December 24, 1986. As of December 31,
1998, the Trust had investments in thirty-one facilities located in
fourteen states.
It is the Trust's intention to declare quarterly dividends to the
holders of its shares of beneficial interest so as to comply with
applicable sections of the Internal Revenue Code governing real estate
investment trusts. Convenants relating to the revolving credit facility
limit the Trust's ability to increase dividends in excess of 95% of
cash available for distribution unless additional distributions are
required to be made to comply with applicable sections of the Internal
Revenue Code and related regulations governing real estate investment
trusts. During 1998, dividends of $1.755 per share, or $15,716,000 in
the aggregate, were declared and paid.
15
Net cash generated by operating activities was $18.7 million in 1998,
$17.7 million in 1997 and $18.0 million in 1996. The $1 million net
increase in 1998 as compared to 1997 was due primarily to: (i) a
$500,000 increase in net income plus the addback of the non-cash
charges (depreciation, amortization, and amortization of interest rate
cap expense); (ii) a $100,00 favorable change in rent receivable, and;
(iii) a $400,000 favorable change in tenant escrows, deposits and
prepaid rents. The $300,000 net decrease in 1997 as compared to 1996
was due primarily to a $100,000 decrease in net income plus the addback
of the non-cash charges (as defined above) and $200,000 of unfavorable
changes in other net working capital accounts.
During 1998, the $18.7 million of cash flows generated from operations,
the $23.6 million of additional borrowings, the $900,000 of cash
distributions received in excess of income from the Trust's investments
in LLCs and the $600,000 reduction in cash were used primarily to: (i)
pay dividends ($15.7 million); (ii) investments in and advances to five
limited liability companies ($27.9 million, see Note 3), and; (iii)
purchase real property and additions to land and buildings ($200,000).
Included in the $27.9 million invested in/advanced to limited liability
companies was $10.0 million of short-term loans advanced to three
separate LLCs in which the Trust has ownership interests ranging from
48% to 95%. These loans, which are earning interest at variable rates
depending upon the length of time the loan is outstanding, earned
interest at an annual average rate of 9% for 1998. The loans are
expected to be fully repaid to the Trust during 1999 once the LLCs
secure long-term, third-party financing.
During 1997, the $17.7 million of cash flows generated from operations,
the $6.8 million of cash received for repayments under a mortgage and a
construction note receivable (net of $3.4 million of advances in 1997)
and the $600,000 of cash distributions received in excess of income
from the Trust's investments in LLCs were used primarily to: (i) pay
dividends ($15.3 million); (ii) purchase real property and additions to
land and buildings ($4.2 million); (iii) purchase equity interests in
two limited liability companies ($3.7 million, see Note 3), and; (iv)
repay debt ($800,000). As of December 31, 1997, the Trust had a $1
million short-term cash investment which was used to repay debt in the
beginning of January, 1998.
During 1996, the $18.0 million of cash flows generated from operations
and the $16.6 million of additional borrowings were used primarily to:
(i) pay dividends ($15.2 million); (ii) purchase additional real
property ($10.2 million, see Note 3); (iii) purchase equity interest in
various limited liability companies ($7.6 million, see Note 3), and;
(iv) begin construction on two new medical office buildings which will
be owned by limited liability companies and limited partnerships in
which the Trust will own equity interests ($1.6 million, see Note 3).
During 1998, the Trust replaced its $70 million revolving credit
agreement with a new $80 million unsecured, non-amortizing revolving
credit agreement (the "Agreement"), which is scheduled to expire in
June, 2003. During the term of the Agreement, the Trust has the option
to request an increase in the borrowing capacity to $100 million. The
Agreement provides for interest at the Trust's option, at the
certificate of deposit rate plus 5/8% to 1 1/8%, Eurodollar rate plus
1/2% to 1 1/8% or the prime rate. A fee of .175% to .375% is required
on the unused portion of this commitment. The margins over the
certificate of deposit rate, Eurodollar rate and the commitment fee are
based upon the Trust's debt to total capital ratio as defined by the
Agreement. At December 31, 1998, the applicable margin over the
certificate of deposit and Eurodollar rates were 7/8% and 5/8%,
respectively, and the commitment fee was .20%. There are no
compensating balance requirements. The Agreement contains a provision
whereby the commitments will be reduced by 50% of the proceeds
generated from any new equity offering. At December 31, 1998, the Trust
had approximately $12 million of available borrowing capacity.
16
Covenants relating to the revolving credit facility require the
maintenance of a minimum tangible net worth and specified financial
ratios, limit the Trust's ability to incur additional debt, limit the
aggregate amount of mortgage receivables and limit the Trust's ability
to increase dividends in excess of 95% of cash available for
distribution, unless additional distributions are required to comply
with the applicable section of the Internal Revenue Code and related
regulations governing real estate investment trusts.
The Trust has entered into interest rate swap agreements and an
interest rate cap agreement which are designed to reduce the impact of
changes in interest rates on its floating rate revolving credit notes.
The Trust has three outstanding swap agreements for notional principal
amounts of $5 million, $4 million and $1,580,000 which mature in May,
1999, July, 2002 and May, 2001, respectively. These swap agreements
effectively fix the interest rate on $10,580,000 of variable rate debt
at 7.56% including the revolver spread of .625%. The interest rate cap,
for which the Trust paid $622,750, (unamortized premium of $62,000 at
December 31, 1998) matures in June, 1999 and fixes the maximum rate on
$15 million of variable rate revolving credit notes at 7.625% including
the revolver spread of .625%. The interest rate swap and cap agreements
were entered into in anticipation of certain borrowing transactions
made by the Trust during 1995, 1996 and 1997. The effective rate on the
Trust's revolving credit notes including commitment fees and interest
rate swap expense was 6.7%, 6.9% and 6.8% during 1998, 1997 and 1996,
respectively. Additional interest expense recorded as a result of the
Trust's hedging activity, which is included in the effective interest
rates shown above, was $136,000, $118,000 and $130,000 in 1998, 1997
and 1996, respectively. The Trust is exposed to credit loss in the
event of non-performance by the counterparties to the interest rate
swap and cap agreements. These counterparties are major financial
institutions and the Trust does not anticipate non-performance by the
counterparties which are rated A or better by Moody's Investors
Service. Termination of the interest rate swaps at December 31, 1998
would have resulted in payments to the counterparties of approximately
$322,000 and termination of the interest rate cap would have had no
impact on the Trust. The fair value of the interest rate swap and cap
agreements at December 31, 1998 reflects the estimated amounts that the
Trust would pay or receive to terminate the contracts and are based on
quotes from the counterparties.
Results of Operations
Total revenues increased 2% or $470,000 to $23.2 million in 1998 as
compared to 1997 and 4% or $841,000 to $22.8 million in 1997 as
compared to 1996. The $470,000 increase during 1998 over 1997 was due
primarily to a $788,000 increase in base rentals from non-related
parties (due primarily to the completion of The Cypresswood
Professional Center during the third quarter of 1997), and a $122,000
increase in bonus rental income from UHS facilities. These favorable
changes were partially offset by a $473,000 decrease in interest income
due to a mortgage loan receivable which was fully repaid in June, 1997
and a construction loan receivable which was repaid in December, 1997.
The $841,000 increase during 1997 over 1996 was primarily attributable
to an increase in base rentals from non-related parties due to the
various acquisitions made by the Trust during the second quarter of
1996 and the third quarter of 1997 (see Note 3).
The average occupancy rate of a hospital is affected by a number of
factors, including the number of physicians using the hospital, changes
in the number of beds, the composition and size of the population of
the community in which the hospital is located, general and local
economic conditions, variations in local medical and surgical practices
and the degree of outpatient use of the hospital services. Current
industry trends in utilization and occupancy have been significantly
affected by changes in reimbursement policies of third-party payors. A
continuation of such
17
industry trends could have a material adverse impact upon the future
operating performance of the Trust's hospital facilities. The Trust's
hospital facilities have experienced growth in outpatient utilization
over the past several years. The increase in outpatient services is
primarily the result of advances in medical technologies and
pharmaceutical improvements, which allow more services to be provided
on an outpatient basis, and increased pressure from Medicare, Medicaid,
managed care companies and other insurers to reduce hospital stays and
provide services where possible, on a less expensive outpatient basis.
The hospital industry in the United States as well as the Trust's
hospital facilities continue to have significant unused capacity which
has created substantial competition for patients. Inpatient utilization
continues to be negatively affected by payor-required, pre-admission
authorization and by payor pressure to maximize outpatient and
alternative healthcare delivery services for less acutely ill patients.
The Trust expects the increased competition, admission constraints and
payor pressures to continue. The ability of the Trust's hospital
facilities to maintain their historical rate of net revenue growth and
operating margins is dependent upon their ability to successfully
respond to these trends as well as reductions in spending on
governmental healthcare programs.
A significant portion of the revenues generated at the Trust's hospital
facilities are derived from fixed payment services, including Medicare
and Medicaid. The Medicare program reimburses the Trust's hospital
facilities primarily based on established rates by a diagnosis related
group for acute care hospitals and by a cost based formula for
behavioral health facilities. Historically, rates paid under Medicare's
prospective payment system ("PPS") for inpatient services have
increased, however, these increases have been less than cost increases.
The Balanced Budget Act calls for the government to trim the growth of
federal spending on Medicare by $115 billion and on Medicaid by $13
billion over the next five years. The act also calls for the reductions
in the future rate of increases to payments made to hospitals and
reduces the amount of reimbursement for outpatient services, bad debt
expense and capital costs. It is likely that future budgets will
contain further reductions in the rate of increase of Medicare and
Medicaid spending, as evidence by the Clinton Administration's proposed
fiscal year 2000 budget which includes a proposal to freeze Medicare
hospital payment rates. Outpatient reimbursement for Medicare patients
is scheduled to convert to a PPS during the second quarter of 2000.
Since final provisions of the outpatient Medicare PPS are not yet
available, operators of the Trust's hospitals can not completely
estimate the resulting impact on their future results of operations.
While the Trust is unable to predict whether this most recent proposal,
or any other future health reform legislation, will ultimately be
enacted at the federal or state level, the Trust expects continuing
pressure to limit expenditures by governmental healthcare programs.
Further changes in the Medicare or Medicaid programs and other
proposals to limit healthcare spending could have a material adverse
impact on the operating results of the Trust's facilities and the
healthcare industry.
In general, the operators of the Trust's hospital facilities expect to
continue to experience an increase in business from managed care
programs, including HMOs and PPOs. The consequent growth in managed
care networks and the resulting impact of these networks on the
operating results of the Trust's facilities vary among the markets in
which the Trust's facilities operate. Management of the Trust is unable
to predict the rate of growth of the net revenues of its facilities and
the resulting impact on bonus revenues, which are computed as a
percentage of each facility's net revenues in excess of base year
amounts or CPI increases in excess of base year amounts. Net revenues
of the Trust's facilities are dependent upon developments in medical
technologies and physician practice patterns, both of which are beyond
the control of management of the facilities.
Interest expense increased $547,000 or 19% in 1998 as compared to 1997
and $378,000 or 15% in 1997 as compared to 1996 due primarily to the
additional borrowings used to finance the 1998,
18
1997 and 1996 investments described in Note 3.
Depreciation and amortization expense increased $104,000 or 3% in 1998
as compared to 1997 and $139,000 or 4% in 1997 as compared to 1996 due
primarily to the depreciation expense related to the 1997 and 1996
acquisitions described in Note 3.
Other operating expenses increased $479,000 or 34% in 1998 as compared
to 1997 due to the operating expenses on the Cypresswood Professional
Center on which construction was completed during the third quarter of
1997 and an increase in various other operating expenses. Other
operating expenses increased $276,000 or 24% in 1997 as compared to
1996 due primarily to the expenses related to the medical office
buildings acquired by the Trust during the second quarter of 1996 and
the third quarter of 1997 and an increase in various other operating
expenses. The expenses related to the medical office buildings, in
which the Trust has a controlling ownership interest, totaled $1.0
million in 1998, $770,000 in 1997 and $551,000 in 1996. The majority of
these expenses are passed on directly to the tenants and are included
as revenues in the Trust's statements of income.
Net income for 1998 was $14.3 million or $1.60 per basic and diluted
share compared to $14.0 million or $1.56 per basic and diluted share in
1997 and $14.2 million or $1.58 per basic and diluted share in 1996.
Funds from operations ("FFO"), which is the sum of net income plus
depreciation expense for consolidated investments and unconsolidated
investments and amortization of interest rate cap expense, totaled
$19.9 million in 1998, $18.8 million in 1997 and $18.2 million in 1996.
FFO may not be calculated in the same manner for all companies, and
accordingly, may not be comparable to similarly titled measures by
other companies. FFO does not represent cash flows from operations as
defined by generally accepted accounting principles and should not be
considered as an alternative to net income as an indicator of the
Trust's operating performance or to cash flows as a measure of
liquidity.
General
During the third quarter of 1998, wholly-owned subsidiaries of UHS
exercised five-year renewal options on four hospitals owned by the
Trust which were scheduled to expire in 1999 through 2001 (Virtue
Street Pavilion, The Bridgeway, Inland Valley Regional Medical Center
and Wellington Regional Medical Center). The leases on these facilities
were renewed at the same lease rates and terms as the initial leases
and these renewals remove the majority of the previously disclosed
uncertainty regarding the lease renewals with subsidiaries of UHS. As
part of the renewal agreement, the Trust also agreed to grant
additional fixed rate renewal options to a wholly-owned subsidiary of
UHS commencing in 2022 on the real property of McAllen Medical Center.
Management of the Trust can not predict whether the leases with
subsidiaries of UHS, which have renewal options at existing lease
rates, or any of the Trust's other leases, will be renewed at the end
of their initial term or first five-year renewal term.
19
Year 2000 Issue
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year.
Computer programs, certain building infrastructure components
(including elevators, alarm systems and certain HVAC systems) and
certain computer aided medical equipment that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than
the year 2000. This could result in system failures or miscalculations
causing disruption of operations or medical equipment malfunctions that
could affect patient diagnosis and treatment.
Management of the Trust recognizes the need to evaluate the impact on
its operations of the change to calendar year 2000 and does not expect
the total cost of required building related modifications to have a
material impact on its results of operations. Approximately 72% of the
Trust's total revenues for the three year period ended December 31,
1998, were earned under the terms of the leases with wholly-owned
subsidiaries of UHS.
UHS has undertaken steps to inventory and assess applications and
equipment at risk to be affected by Year 2000 issues and to convert,
remediate or replace such applications and equipment. UHS has completed
its assessment of its major financial and clinical software and
believes that such software is substantially Year 2000 compliant. As to
certain peripheral software, UHS has scheduled upgrades to be completed
by June, 1999. For its biomedical equipment, UHS expects to complete
the assessment phase of its Year 2000 analysis by early in the second
quarter of 1999. UHS believes that Year 2000 related remediation costs
incurred through December 31, 1998 have not had a material impact on
its results of operations. However, UHS is not able to reasonably
estimate the total capital costs to be incurred for equipment
replacement since the equipment analysis phase has not yet been
completed. Some replacement or upgrade of systems and equipment would
take place in the normal course of business. Several systems, key to
UHS's operations, have been scheduled to be replaced through vendor
supplied systems before Year 2000. The costs of repairing existing
systems is expensed as incurred. UHS has allocated a portion of its
1999 capital budget as Year 2000 contingency funds and expects that all
of the capital costs can be accommodated within that budget. UHS
presently believes that with modifications to existing software and
conversions to new software, the Year 2000 issue will not pose material
operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed
timely, the Year 2000 issue could have a material impact on the
operations of UHS and UHS's ability to meet its obligations under the
terms of its leases with the Trust.
The majority of the software used by UHS is purchased from third
parties. UHS is relying on software (including UHS's major outsourcing
vendor which provides the financial and clinical applications for the
majority of UHS's acute care facilities), hardware and other equipment
vendors to verify Year 2000 compliance of their products. UHS also
depends on: fiscal intermediaries which process claims and make
payments for the Medicare program; health maintenance organizations,
insurance companies and other private payors; vendors of medical
supplies and pharmaceuticals used in patient care; and, providers of
utilities such as electricity, water, natural gas and telephone
services. As part of its Year 2000 strategy, UHS intends to seek
assurances from these parties that their services and products will not
be interrupted or malfunction due to the Year 2000 problem. Failure of
third parties to resolve their Year 2000 issues could have a material
adverse effect on UHS's results of operations and its ability to
provide health care services.
20
Each of UHS's hospitals has a disaster plan which will be reviewed as
part of UHS's Year 2000 contingency planning process. However, no
assurance can be given that UHS will be able to develop contingency
plans which will enable each of its facilities to continue to operate
in all circumstances.
This Year 2000 assessment is based on information currently available
to UHS and the Trust and UHS and the Trust will revise its assessment
at it implements its Year 2000 strategy. UHS can provide no assurance
that applications and equipment UHS believes to be Year 2000 compliant
will not experience difficulties or that UHS will not experience
difficulties obtaining resources needed to make modifications to or
replace its affected systems and equipment. Failure by UHS or third
parties on which it relies to resolve Year 2000 issues could have a
material adverse effect on its results of operations, its ability to
provide health care services and on UHS's ability to meet its
obligations under the terms of its leases with the Trust. Consequently,
the Trust can give no assurances that issues related to Year 2000 will
not have a material adverse effect on it's financial condition or
results of operations.
With respect to the Trust's non-related properties, an assessment was
conducted by the Trust which covered the compliance efforts of the
tenants and based upon the responses received, these tenants do not
expect Year 2000 related issues to have a material impact on their
operations. Management of the Trust will continue to monitor the Year
2000 compliance efforts of its non-related tenants as well as the
effects of potential non-compliance.
The Trust will develop contingency plans if, and to the extent, deemed
necessary. However, based upon current information and barring
developments, the Trust does not anticipate developing any substantive
contingency plans with respect to Year 2000 issues. In addition, the
Trust has no plans to seek independent verification or review of its
assessments. The Trust believes that its expenditures for assessing and
correcting Year 2000 issues have not been material. In addition, the
Trust is not aware of any issues that will require material
expenditures by the Trust or tenants of the Trust's facilities in the
future.
Based upon current information, the Trust believes that the risk posed
by the foreseeable Year 2000 related problems with its internal
systems, (including both information and non-information systems) is
minimal. Year 2000 related problems at certain third-party payors,
service providers and non-related tenants is greater, however, based
upon current information, the Trust does not believe such problems will
have a material effect on its operations. While the Trust believes that
it will be Year 2000 compliant by December 31, 1999, there can be no
assurance that the Trust or tenants of the Trust's properties will be
successful in identifying and assessing all compliance issues, or that
the efforts of the Trust or tenants of the Trust' properties to remedy
all Year 2000 compliance issues will be effective such that they will
not have a material adverse effect on the Trust's business or results
of operations.
Market Risks Associated with Financial Instruments
The Trust's interest expense is sensitive to changes in the general
level of domestic interest rates. To mitigate the impact of
fluctuations in domestic interest rates, a portion of the Trust's debt
is fixed rate accomplished by entering into interest rate swap
agreements. The interest rate swap agreements are contracts that
require the Trust to pay a fixed and receive a floating interest rate
over the life of the agreements. The floating-rates are based on LIBOR
and the fixed-rates are determined upon consummation of the swap
agreements. The interest rate swap agreements do not constitute
positions independent of the underlying exposures. The Trust does not
hold or
21
issue derivative instruments for trading purposes and is not a party to
any instruments with leverage features. The Trust is exposed to credit
losses in the event of non-performance by the counterparties to its
financial instruments. The counterparties are creditworthy financial
institutions, rated A or better by Moody's Investor Services and the
Trust anticipates that the counterparties will be able to fully satisfy
their obligations under the contracts. For the years ended December 31,
1998, 1997 and 1996, the Trust received a weighted average rate of
5.24%, 5.79% and 5.60%, respectively, and paid a weighted average rate
on its interest rate swap agreements of 6.94%, 6.94% and 6.80%,
respectively.
The table below presents information about the Trust's derivative
financial instruments and other financial instruments that are
sensitive to changes in interest rates, including interest rate swaps
as of December 31, 1998. For debt obligations, the table presents
principal cash flows and related weighted-average interest rates by
contractual maturity dates. For interest rate swap agreements, the
table presents notional amounts by expected maturity date and weighted
average interest rates based on rates in effect at December 31, 1998.
Maturity Date, Fiscal Year Ending December 31
There-
(Dollars in thousands) 1999 2000 2001 2002 2003 after Total
---- ---- ---- ---- ---- ----- -----
Long-term debt:
Fixed rate $1,216 $1,216
Average interest rates 6.0%
Variable rate long-term debt 64,800 64,800
Interest rate swaps:
Pay fixed/receive
variable notional amounts 5,000 1,580 4,000 10,580
Average pay rate 7.245% 6.80% 6.6025%
Average receive rate 3 month 3 month 6 month
LIBOR LIBOR LIBOR
Interest rate caps 15,000 15,000
Cap rate 7.0%
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Trust's Balance Sheets and its Statements of Income, Changes in
Shareholders' Equity and Cash Flows, together with the report of Arthur
Andersen LLP, independent public accountants, are included elsewhere
herein. Reference is made to the "Index to Financial Statements and
Schedules."
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
22
PART III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There is hereby incorporated by reference the information to appear
under the caption "Election of Trustees" in the Trust's definitive
Proxy Statement to be filed with the Securities and Exchange Commission
within 120 days after December 31, 1998. See also "Executive Officers
of the Registrant" appearing in Part I hereof.
Item 11. EXECUTIVE COMPENSATION
There is hereby incorporated by reference the information under the
caption "Executive Compensation" and "Compensation Pursuant to Plans"
in the Trust's definitive Proxy Statement to be filed with the
Securities and Exchange Commission within 120 days after December 31,
1998.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
There is hereby incorporated by reference the information under the
caption "Security Ownership of Certain Beneficial Owners and
Management" in the Trust's definitive Proxy Statement to be filed with
the Securities and Exchange Commission within 120 days after December
31, 1998.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is hereby incorporated by reference the information under the
caption "Transactions With Management and Others" in the Trust's
definitive Proxy Statement to be filed with the Securities and Exchange
Commission within 120 days after December 31, 1998.
23
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) Financial Statements and Financial Statement Schedules:
1) Report of Independent Public Accountants
2) Financial Statements
Consolidated Balance Sheets - December 31, 1998 and
December 31, 1997
Consolidated Statements of Income - Years Ended
December 31, 1998, 1997 and 1996
Consolidated Statements of Shareholders' Equity -
Years Ended December 31, 1998, 1997 and 1996
Consolidated Statements of Cash Flows - Years Ended
December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements -
December 31, 1998
(3) Schedules
Schedule II - Valuation and Qualifying Accounts -
Years Ended December 31, 1998, 1997 and 1996
Schedule III - Real Estate and Accumulated
Depreciation - December 31, 1998
Notes to Schedule III - December 31, 1998
(b) Reports on Form 8-K:
No reports on Form 8-K were filed during the last quarter
of the year ended December 31, 1998
(c) Exhibits:
3.1 Declaration of Trust, dated as of August 1986, previously
filed as Exhibit 3.1 Amendment No. 3 of the Registration Statement on
Form S-11 and Form S-2 of Universal Health Services, Inc. and the Trust
(Registration No. 33-7872), is incorporated herein by reference.
3.2 Amendment to Declaration of Trust, dated as of June 23,
1993, previously filed as Exhibit 3.2 to the Trust's Annual Report on
Form 10-K for the year ended December 31, 1993, is incorporated herein
by reference.
3.3 Amended and restated bylaws, filed as Exhibit 10.1 to the
Trust's Form 10-Q for the quarter ended March 31, 1998, is incorporated
herein by reference.
10.1 Advisory Agreement, dated as of December 24, 1986,
between UHS of Delaware, Inc. and The Trust, previously filed as
Exhibit 10.2 to the Trust's Current Report on Form 8-K dated December
24, 1986, is incorporated herein by reference.
10.2 Agreement effective January 1, 1999, to renew Advisory
Agreement dated as of December 24, 1986 between Universal Health Realty
Income Trust and UHS of Delaware, Inc.
24
10.3 Contract of Acquisition, dated as of August 1986,
between the Trust and certain subsidiaries of Universal Health
Services, Inc., previously filed as Exhibit 10.2 to Amendment No. 3 of
the Registration Statement on Form S-11 and S-2 of Universal Health
Services, Inc. and the Trust (Registration No. 33-7872), is
incorporated herein by reference.
10.4 Form of Leases, including Form of Master Lease Document
Leases, between certain subsidiaries of Universal Health Services, Inc.
and the Trust, previously filed as Exhibit 10.3 to Amendment No. 3 of
the Registration Statement on Form S-11 and Form S-2 of Universal
Health Services, Inc. and the Trust (Registration No. 33-7872), is
incorporated herein by reference.
10.5 Share Option Agreement, dated as of December 24, 1986,
between the Trust and Universal Health Services, Inc., previously filed
as Exhibit 10.4 to the Trust's Current Report on Form 8-K dated
December 24, 1986, is incorporated herein by reference.
10.6 Corporate Guaranty of Obligations of Subsidiaries
Pursuant to Leases and Contract of Acquisition, dated December 1986,
issued by Universal Health Services, Inc. in favor of the Trust,
previously filed as Exhibit 10.5 to the Trust's Current Report on Form
8-K dated December 24, 1986, is incorporated herein by reference.
10.7 Contract of Acquisition dated August 31, 1988 between
the Trust, Rehab Systems Company, Inc. and Tri-State Regional
Rehabilitation Hospital, Inc., previously filed as Exhibit 10.2 to the
Trust's September 30, 1988 Form 10-Q, is incorporated herein by
reference.
10.8 Key Employees' Restricted Share Purchase Plan approved
by the Trustees on December 1, 1988 which authorized the issuance of up
to 50,000 common shares, previously filed as Exhibit 10.11 to the
Trust's Annual Report on form 10-K for the year ended December 31,
1988, is incorporated herein by reference.
10.9 Share Compensation Plan for Outside Trustees, previously
filed as Exhibit 10.12 to the Trust's Annual Report on Form 10-K for
the year ended December 31, 1991, is incorporated herein by reference.
10.10 1988 Non-Statutory Stock Option Plan, as amended,
previously filed as Exhibit 10.13 to the Trust's Annual Report on Form
10-K for the year ended December 31, 1991, is incorporated herein by
reference.
10.11 Lease dated December 22, 1993, between Universal Health
Realty Income Trust and THC-Chicago, Inc. as lessee, previously filed
as Exhibit 10.14 to the Trust's Annual Report on Form 10-K for the year
ended December 31, 1993, is incorporated herein by reference.
10.12 Mortgage Modification, Consolidation and Extension
Agreement and Consolidated Note dated December 28, 1993 in the amount
of $6,500,000 from Crouse Irving Memorial Properties, Inc. to Universal
Health Realty Income Trust, previously filed as Exhibit 10.15 to the
Trust's Annual Report on Form 10-K for the year ended December 31,
1993, is incorporated herein by reference.
10.13 Agreement for Purchase and Sale and Repurchase
Agreement dated as of November 4, 1994 between Fresno-Herndon Partners,
Limited and Universal Health Realty Income Trust, previously filed as
Exhibit 10.16 to the Trust's Annual Report on Form 10-K for the year
ended December 31, 1994, is incorporated herein by reference.
25
10.14 Agreement of Purchase and Sale, and Construction Loan
Agreement dated as of December 20, 1994 between Turner Adreac, L.C. and
Universal Health Realty Income Trust, previously filed as Exhibit 10.17
to the Trust's Annual Report on Form 10-K for the year ended December
31, 1994, is incorporated herein by reference.
10.15 Sale Agreement, dated as of September 1, 1995, by and
among Universal Health Realty Income Trust and Desert Commercial
Properties Limited Partnership, previously filed as Exhibit 10.18 to
the Trust's Annual Report on Form 10-K for the year ended December 31,
1996, is incorporated herein by reference.
10.16 Operating Agreement of DSMB Properties, L.L.C., dated
as of September 1, 1995, by and among Universal Health Realty Income
Trust and Desert Commercial Properties Limited Partnership, previously
filed as Exhibit 10.19 to the Trust's Annual Report on Form 10-K for
the year ended December 31, 1996, is incorporated herein by reference.
10.17 Agreement and Escrow Instructions, dated as of August
15, 1995, by and between Phase III Desert Samaritan Medical Building
Partners and Desert Commercial Properties Limited Partnership,
previously filed as Exhibit 10.20 to the Trust's Annual Report on 10-K
for the year ended December 31, 1996, is incorporated herein by
reference.
10.18 Amendment to Credit Agreement dated as of September 27,
1996 by and among Universal Health Realty Income Trust, Corestates
Bank, N.A. as agent, NationsBank, N.A., and First Union National Bank,
previously filed as Exhibit 10.1 to the Trust's Form 10-Q for the
quarter ended September 30, 1996, is incorporated herein by reference.
10.19 Universal Health Realty Income Trust 1997 Incentive
Plan, previously filed as Exhibit 10.1 to the Trust's Form 10-Q for the
quarter ended September 30, 1997, is incorporated herein by reference.
10.20 Revolving Credit Agreement as of June 24, 1998 among (i)
Universal Health Realty Income Trust, a real estate investment trust
organized under the laws of the State of Maryland and having its
principal place of business at 366 South Gulph Road, King of Prussia,
Pennsylvania 19406 (the "Company"), (ii) The Financial Institutions
Listed on Schedule 1 Hereto (individually a "Bank" and collectively the
"Banks") and (iii) First Union National Bank, as successor by merger to
CoreStates Bank, N.A., as administrative agent for the Banks (the
"Agent"), previously filed as Exhibit 10.1 to the Trust's Form 10-Q for
the quarter ended June 30, 1998, is incorporated herein by reference.
10.21 Amendment No. 1 to Lease, made as of July 31, 1998,
between Universal Health Realty Income Trust, a Maryland real estate
investment trust ("Lessor"), and Inland Valley Regional Medical Center,
Inc., a California Corporation ("Lessee"), previously filed as Exhibit
10.1 to the Trust's Form 10-Q for the quarter ended September 30, 1998,
is incorporated herein by reference.
26
10.22 Amendment No. 1 to Lease, made as of July 31, 1998,
between Universal Health Realty Income Trust, a Maryland real estate
investment trust ("Lessor"), and McAllen Medical Center, L.P. (f/k/a
Universal Health Services of McAllen, Inc.), a Texas Limited
Partnership ("Lessee"), amends the lease, made as of December 24, 1986,
between Lessor and Lessee, previously filed as Exhibit 10.2 to the
Trust's Form 10-Q for the quarter ended September 30, 1998, is
incorporated herein by reference.
27 Financial Data Schedule
28.1 Dividend Reinvestment Plan for Stockholders, previously
filed as Exhibit 28.1 to the Trust's Form 10-Q for the quarter ended
March 31, 1987, is incorporated herein by reference.
27
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
Date: March 8, 1999
UNIVERSAL HEALTH REALTY INCOME TRUST
(Registrant)
By: /s/ Alan B. Miller
Alan B. Miller, Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Date Signature and Title
/s/ Alan B. Miller
March 8, 1999 Alan B. Miller, Chairman of the Board
and Chief Executive Officer
/s/ Kirk E. Gorman
March 8, 1999 Kirk E. Gorman, President, Chief
Financial Officer, Secretary and Trustee
/s/ James E. Dalton
March 8, 1999 James E. Dalton, Jr., Trustee
/s/ Myles H. Tanenbaum
March 8, 1999 Myles H. Tanenbaum, Trustee
/s/ Daniel M. Cain
March 8, 1999 Daniel M. Cain, Trustee
/s/ Miles L. Berger
March 8, 1999 Miles L. Berger, Trustee
28
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
Page
Report of Independent Public Accountants F-2
Consolidated Balance Sheets - December 31, 1998 and December 31, 1997 F-3
Consolidated Statements of Income - Years Ended December 31, 1998,
1997 and 1996 F-4
Consolidated Statements of Shareholders' Equity - Years Ended
December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows - Years Ended December 31,
1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements - December 31, 1998 F-7
Schedule II - Valuation and Qualifying Accounts -
Years Ended December 31, 1998, 1997 and 1996 F-19
Schedule III - Real Estate and Accumulated Depreciation -
December 31, 1998 F-20
Notes to Schedule III - December 31, 1998 F-21
F-1
Report of Independent Public Accountants
To The Shareholders and Board of Trustees of
Universal Health Realty Income Trust:
We have audited the accompanying consolidated balance sheets of Universal Health
Realty Income Trust and Subsidiaries (a Maryland real estate investment trust)
as of December 31, 1998 and 1997 and the related consolidated statements of
income, changes in shareholders' equity and cash flows for each of the three
years in the period ended December 31, 1998. These financial statements and the
schedules referred to below are the responsibility of the Trust's management.
Our responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Universal Health Realty Income Trust and Subsidiaries, as of December 31, 1998
and 1997 and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the Index to
Financial Statements and Schedules on Page F-1 are presented for the purpose of
complying with the Securities and Exchange Commission's rules and are not a
required part of the basic financial statements. These schedules have been
subjected to the auditing procedures applied in our audit of the basic financial
statements and, in our opinion, fairly state in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
Philadelphia, Pennsylvania Arthur Andersen LLP
January 19, 1999
F-2
Universal Health Realty Income Trust
Consolidated Balance Sheets
December 31, December 31,
Assets: 1998 1997
- ------- ------------- -------------
Real Estate Investments:
Buildings & improvements $ 142,871,000 $ 143,600,000
Accumulated depreciation (34,006,000) (30,280,000)
------------- -------------
108,865,000 113,320,000
Land 21,061,000 20,255,000
Construction in progress 28,000 --
Reserve for investment losses (116,000) (89,000)
------------- -------------
Net Real Estate Investments 129,838,000 133,486,000
------------- -------------
Investments in and advances to limited liability companies 38,165,000 11,075,000
Other Assets:
Cash 572,000 1,238,000
Bonus rent receivable from UHS 681,000 653,000
Rent receivable from non-related parties 24,000 80,000
Deferred charges and other assets, net 126,000 223,000
------------- -------------
$ 169,406,000 $ 146,755,000
============= =============
Liabilities and Shareholders' Equity:
Liabilities:
Bank borrowings $ 64,800,000 $ 41,200,000
Note payable to UHS 1,216,000 1,147,000
Accrued interest 281,000 217,000
Accrued expenses & other liabilities 1,300,000 1,130,000
Tenant reserves, escrows, deposits and prepaid rents 374,000 268,000
Minority interest 87,000 101,000
Shareholders' Equity:
Preferred shares of beneficial interest,
$.01 par value; 5,000,000 shares authorized;
none outstanding -- --
Common shares, $.01 par value;
95,000,000 shares authorized; issued
and outstanding: 1998 - 8,955,465
1997 - 8,954,840 90,000 90,000
Capital in excess of par value 128,685,000 128,650,000
Cumulative net income 126,458,000 112,121,000
Cumulative dividends (153,885,000) (138,169,000)
------------- -------------
Total Shareholders' Equity 101,348,000 102,692,000
------------- -------------
$ 169,406,000 $ 146,755,000
============= =============
The accompanying notes are an integral part of these financial statements.
F-3
Universal Health Realty Income Trust
Consolidated Statements of Income
Year ended December 31,
--------------------------------------------
1998 1997 1996
----------- ----------- ------------
Revenues (Note 2):
Base rental - UHS facilities $13,764,000 $13,731,000 $13,731,000
Base rental - Non-related parties 6,393,000 5,605,000 4,706,000
Bonus rental 2,966,000 2,844,000 2,735,000
Interest 111,000 584,000 751,000
----------- ----------- -----------
23,234,000 22,764,000 21,923,000
----------- ----------- -----------
Expenses:
Depreciation & amortization 3,879,000 3,775,000 3,636,000
Interest expense 3,490,000 2,943,000 2,565,000
Advisory fees to UHS (Note 2) 1,161,000 1,099,000 1,044,000
Other operating expenses 1,904,000 1,425,000 1,149,000
----------- ----------- -----------
10,434,000 9,242,000 8,394,000
----------- ----------- -----------
Income before equity in limited liability companies 12,800,000 13,522,000 13,529,000
Equity in income of limited liability companies 1,537,000 445,000 629,000
----------- ----------- -----------
Net Income $14,337,000 $13,967,000 $14,158,000
=========== =========== ===========
Net Income Per Share - Basic $ 1.60 $ 1.56 $ 1.58
=========== =========== ===========
Net Income Per Share - Diluted $ 1.60 $ 1.56 $ 1.58
=========== =========== ===========
Weighted average number of shares outstanding - Basic 8,952,000 8,952,000 8,952,000
Weighted average number of share equivalents 22,000 15,000 6,000
----------- ----------- -----------
Weighted average number of shares and equivalents
outstanding - Diluted 8,974,000 8,967,000 8,958,000
=========== =========== ===========
The accompanying notes are an integral part of these financial statements.
F-4
Universal Health Realty Income Trust
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 1998, 1997 and 1996
Common Shares Capital in
Number excess of Cumulative Cumulative
of Shares Amount par value net income dividends
- -----------------------------------------------------------------------------------------------------------------------
January 1, 1996 8,947,192 $ 89,000 $ 128,643,000 $ 83,996,000 ($107,731,000)
Net Income -- -- -- 14,158,000 --
Issuance of shares of
beneficial interest 5,148 1,000 -- -- --
Dividends ($1.695/share) -- -- -- -- (15,174,000)
- -----------------------------------------------------------------------------------------------------------------------
January 1, 1997 8,952,340 90,000 128,643,000 98,154,000 (122,905,000)
Net Income -- -- -- 13,967,000 --
Issuance of shares of
beneficial interest 2,500 -- 7,000 -- --
Dividends ($1.705/share) -- -- -- -- (15,264,000)
- -----------------------------------------------------------------------------------------------------------------------
January 1, 1998 8,954,840 90,000 128,650,000 112,121,000 (138,169,000)
Net Income -- -- -- 14,337,000 --
Issuance of shares of
beneficial interest 625 -- 35,000 -- --
Dividends ($1.755/share) -- -- -- -- (15,716,000)
=======================================================================================================================
December 31, 1998 8,955,465 $ 90,000 $ 128,685,000 $ 126,458,000 ($153,885,000)
=======================================================================================================================
The accompanying notes are an integral part of these financial statements.
F-5
Universal Health Realty Income Trust
Consolidated Statements of Cash Flows
Year ended December 31,
----------------------------------------------------
1998 1997 1996
------------ ------------ ------------
Cash flows from operating activities:
Net income $ 14,337,000 $ 13,967,000 $ 14,158,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation & amortization 3,879,000 3,775,000 3,636,000
Amortization of interest rate cap 124,000 124,000 125,000
Changes in assets and liabilities:
Rent receivable 28,000 (67,000) (47,000)
Accrued expenses & other liabilities 170,000 197,000 77,000
Tenant escrows, deposits & prepaid rents 106,000 (247,000) (29,000)
Accrued interest 64,000 (17,000) 77,000
Deferred charges & other (53,000) (26,000) 6,000
------------ ------------ ------------
Net cash provided by operating activities 18,655,000 17,706,000 18,003,000
------------ ------------ ------------
Cash flows from investing activities:
Investments in and advances to limited liability companies (27,892,000) (3,741,000) (7,624,000)
Acquisitions and additions to land, buildings and CIP (158,000) (4,246,000) (10,195,000)
Payments made for construction in progress (28,000) -- (1,246,000)
Cash distributions in excess of income from LLCs 863,000 598,000 --
Advances under construction notes receivable -- (3,414,000) (391,000)
Repayments under mortgage and construction notes receivable -- 10,262,000 --
------------ ------------ ------------
Net cash used in investing activities (27,215,000) (541,000) (19,456,000)
------------ ------------ ------------
Cash flows from financing activities:
Additional borrowings, net of financing costs 23,600,000 -- 16,625,000
Repayment of debt -- (800,000) --
Issuance of shares of beneficial interest 10,000 -- --
Dividends paid (15,716,000) (15,264,000) (15,174,000)
------------ ------------ ------------
Net cash provided by (used in) financing activities 7,894,000 (16,064,000) 1,451,000
------------ ------------ ------------
(Decrease) increase in cash (666,000) 1,101,000 (2,000)
Cash, beginning of period 1,238,000 137,000 139,000
------------ ------------ ------------
Cash, end of period $ 572,000 $ 1,238,000 $ 137,000
============ ============ ============
Supplemental disclosures of cash flow information:
Interest paid $ 3,232,000 $ 2,770,000 $ 2,302,000
============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-6
Universal Health Realty Income Trust
Notes to the Consolidated Financial Statements
December 31, 1998
(1) Summary of Significant Accounting Policies
Nature of Operations
Universal Health Realty Income Trust and Subsidiaries (the "Trust") is organized
as a Maryland real estate investment trust. As of December 31, 1998 the Trust
had investments in thirty-one facilities located in fourteen states consisting
of investments in healthcare and human service related facilities including
acute care hospitals, behavioral healthcare facilities, rehabilitation
hospitals, sub-acute care facilities, surgery centers, childcare centers and
medical office buildings, seven of which are leased to subsidiaries of Universal
Health Services, Inc., ("UHS").
Federal Income Taxes
No provision has been made for federal income tax purposes since the Trust
qualifies as a real estate investment trust under Sections 856 to 860 of the
Internal Revenue Code of 1986, and intends to continue to remain so qualified.
As such, it is required to distribute at least 95 percent of its real estate
investment taxable income to its shareholders.
The Trust is subject to a federal excise tax computed on a calendar year basis.
The excise tax equals 4% of the excess, if any, of 85% of the Trust's ordinary
income plus 95% of any capital gain income for the calendar year over cash
distributions during the calendar year, as defined. No provision for excise tax
has been reflected in the financial statements as no tax was due.
Earnings and profits, which will determine the taxability of dividends to
shareholders, will differ from net income reported for financial reporting
purposes due to the differences for federal tax purposes in the cost basis of
assets and in the estimated useful lives used to compute depreciation and the
recording of provision for investment losses.
Real Estate Properties
The Trust records acquired real estate at cost and uses the straight-line method
of depreciation for buildings and improvements over estimated useful lives of 25
to 45 years.
It is the Trust's policy to review the carrying value of long-lived assets for
impairment whenever events or changes in circumstances indicate that the
carrying value of such assets may not be recoverable. Measurement of the
impairment loss is based on the fair value of the asset. Generally, fair value
will be determined using valuation techniques such as the present value of
expected future cash flow.
The Trust invests primarily in healthcare-related facilities and, therefore, is
subject to certain industry risk factors, which directly impact the operating
results of its lessees. In recent years, an increasing number of legislative
initiatives have been introduced or proposed in Congress and in state
legislatures that would effect major changes in the healthcare system, either
nationally or at the state level. In addition, the healthcare industry has been
characterized in recent years by
F-7
increased competition and consolidation.
In assessing the carrying value of the Trust's real estate investments for
possible impairment, management reviews estimates of future cash flows expected
from each of its facilities and evaluates the creditworthiness of its lessees
based on their current operating performance and on current industry conditions.
Management of the Trust is unable to predict the effect, if any, that the
industry factors discussed above will have on the operating results of its
lessees or on their ability to meet their obligations under the terms of their
leases with the Trust. In addition, management of the Trust cannot predict
whether any of the leases will be renewed on their current terms or at all. As a
result, management's estimate of future cash flows from its leased properties
could be materially affected in the near term, if certain of the leases are not
renewed at the end of their lease terms.
Investments in Limited Liability Companies
The consolidated financial statements of the Trust include the accounts of its
controlled investments. In accordance with the American Institute of Certified
Public Accountants' Statement of Position 78-9 "Accounting for Investments in
Real Estate Ventures" and Emerging Issues Task Force Issue 96-16, "Investor's
Accounting for an Investee When the Investor Has a Majority of the Voting
Interest but the Minority Shareholder or Shareholders Have Certain Approval or
Veto Rights", the Trust accounts for its investment in limited liability
companies which it does not control using the equity method of accounting. These
investments, which represent 33% to 99% non-controlling ownership interests, are
recorded initially at the Trust's cost and subsequently adjusted for the Trust's
net equity in income and cash contributions and distributions.
Earnings Per Share
Basic earnings per share are based on the weighted average number of common
shares outstanding during the year. Diluted earnings per share are based on the
weighted average number of common shares during the year adjusted to give effect
to common stock equivalents.
Stock-Based Compensation
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation" encourages a fair value based method of accounting for
employee stock options and similar equity instruments, which generally would
result in the recording of additional compensation expense in the Trust's
financial statements. The Statement also allows the Trust to continue to account
for stock-based employee compensation using the intrinsic value-based method of
accounting as prescribed by Accounting Principals Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees." The Trust has adopted the
disclosure-only provisions of SFAS No. 123. Accordingly, no compensation cost
has been recognized for the stock option plans in the accompanying financial
statements.
Statements of Cash Flows
For purposes of the Consolidated Statements of Cash Flows, the Trust considers
all highly liquid investment instruments with original maturities of three
months or less to be cash equivalents.
F-8
Interest Rate Protection Agreements
In managing interest rate exposure, the Trust at times enters into interest rate
swap agreements and interest rate cap agreements. When interest rates change,
the differential to be paid or received under the Trust's interest rate swap
agreements is accrued as interest expense. Premiums paid for purchased interest
rate cap agreements are amortized to interest expense over the terms of the
caps. Unamortized premiums are included in deferred charges in the accompanying
balance sheet. Amounts receivable under the cap agreements are accrued as a
reduction of interest expense.
Fair Value of Financial Instruments
The fair value of the Trust's interest rate swap agreements and investments are
based on quoted market prices. The carrying amounts reported in the balance
sheet for cash, accrued liabilities, and short-term borrowings approximate their
fair values due to the short-term nature of these instruments. Accordingly,
these items have been excluded from the fair value disclosures included
elsewhere in these notes to consolidated financial statements.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income". The standard establishes additional
disclosure for the elements of comprehensive income and a total comprehensive
income calculation. Net income as reported by the Trust reflects total
comprehensive income for the years ended December 31, 1998, 1997 and 1996.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Accounting Pronouncement Not Yet Adopted
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Statement establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
Statement requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the income statement, and requires
that a company must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting.
F-9
SFAS No. 133 is effective as of the beginning of fiscal years beginning after
June 15, 1999. A company may also implement the SFAS No. 133 as of the beginning
of any fiscal quarter after issuance. SFAS No. 133 cannot be applied
retroactively. SFAS No. 133 must be applied to: (a) derivative instruments, and;
(b) certain derivative instruments embedded in hybrid contracts that were
issued, acquired, or substantially modified after December 31, 1997 (and at the
Trust's election, before January 1, 1998).
The Trust has not yet quantified the impact of adopting SFAS No. 133 on its
financial statements and has not determined the timing of or method of adoption
of SFAS No. 133. However, SFAS No. 133 could increase the volatility in earnings
and other comprehensive income.
Reclassifications
Certain prior year amounts have been reclassified to conform with current year
financial statement presentation.
(2) Related Party Transactions
UHS of Delaware, Inc. (the "Advisor"), a wholly-owned subsidiary of UHS, serves
as Advisor to the Trust under an Advisory Agreement dated December 24, 1986
between the Advisor and the Trust (the "Advisory Agreement"). Under the Advisory
Agreement, the Advisor is obligated to present an investment program to the
Trust, to use its best efforts to obtain investments suitable for such program
(although it is not obligated to present any particular investment opportunity
to the Trust), to provide administrative services to the Trust and to conduct
the Trust's day-to-day affairs. In performing its services under the Advisory
Agreement, the Advisor may utilize independent professional services, including
accounting, legal and other services, for which the Advisor is reimbursed
directly by the Trust. The Advisory Agreement expires on December 31 of each
year; however, it is renewable by the Trust, subject to a determination by the
Independent Trustees that the Advisor's performance has been satisfactory. The
Advisory Agreement may be terminated for any reason upon sixty days written
notice by the Trust or the Advisor. The Advisory Agreement has been renewed for
1999. All transactions with UHS must be approved by the Independent Trustees.
The Advisory Agreement provides that the Advisor is entitled to receive an
annual advisory fee equal to .60% of the average invested real estate assets of
the Trust, as derived from its consolidated balance sheet from time to time. In
addition, the Advisor is entitled to an annual incentive fee equal to 20% of the
amount by which cash available for distribution to shareholders, as defined in
the Advisory Agreement, for each year exceeds 15% of the Trust's equity as shown
on its balance sheet, determined in accordance with generally accepted
accounting principles without reduction for return of capital dividends. No
incentive fees were paid during 1998, 1997 and 1996. The advisory fee is payable
quarterly, subject to adjustment at year end based upon audited financial
statements of the Trust.
For the years ended December 31, 1998, 1997 and 1996, 71%, 72% and 74%,
respectively, of the Trust's revenues were earned under the terms of the leases
with wholly-owned subsidiaries of UHS. The leases to subsidiaries of UHS are
guaranteed by UHS and cross-defaulted with one another.
F-10
During the third quarter of 1998, wholly-owned subsidiaries of UHS exercised
five-year renewal options on four hospitals owned by the Trust which were
scheduled to expire in 1999 through 2001 (Virtue Street Pavilion, The Bridgeway,
Inland Valley Regional Medical Center and Wellington Regional Medical Center).
The leases on these facilities were renewed at the same lease rates and terms as
the initial leases and these renewals remove the majority of the previously
disclosed uncertainty regarding the lease renewals with subsidiaries of UHS. As
part of the renewal agreement, the Trust also agreed to grant additional fixed
rate renewal options to a wholly-owned subsidiary of UHS commencing in 2022 on
the real property of McAllen Medical Center. The leases on the four renewed
facilities represented 30% of the Trust's rental revenue for the twelve month
period ended December 31, 1998. On a combined basis, these four facilities had
earnings before interest, taxes, depreciation, amortization and lease and rental
expense (EBITDAR) for the twelve month period ended December 31, 1998 of 1.8
times the total annual rent payable to the Trust in 1998 (ranging from 1.2 to
3.0). The remaining UHS facilities, including McAllen Medical Center, had a
combined EBITDAR for the twelve month period ended December 31, 1998 of 7.7
times the total annual rent payable to the Trust in 1998 (ranging from 1.1 to
8.6). The lease on one UHS facility, which had EBITDAR for the twelve month
period ended December 31, 1998 of 1.1 times the rent payable to the Trust,
expires in 2000 and represented approximately 5% of the Trust's rental revenue
for the twelve month period ended December 31, 1998. Management of the Trust can
not predict whether the leases with subsidiaries of UHS, which have renewal
options at existing lease rates, or any of the Trust's other leases, will be
renewed at the end of their initial term or first five-year renewal term.
In recent years, an increasing number of legislative initiatives have been
introduced or proposed in Congress and in state legislatures that would effect
major changes in the healthcare system, either nationally or at the state level.
In addition, the healthcare industry had been characterized in recent years by
increased competition and consolidation. Management of the Trust is unable to
predict the effect, if any, these industry factors will have on the operating
results of its lessees, including the facilities leased to subsidiaries of UHS,
or on their ability to meet their obligations under the terms of their leases
with the Trust.
Revenues received from UHS and from other non-related parties were as follows:
Year Ended December 31,
1998 1997 1996
-----------------------------------------------
Base rental - UHS facilities $13,764,000 $13,731,000 $13,731,000
Base rental - Non-related parties 6,393,000 5,605,000 4,706,000
----------- ----------- -----------
Total base rental 20,157,000 19,336,000 18,437,000
----------- ----------- -----------
Bonus rental - UHS facilities 2,737,000 2,615,000 2,506,000
Bonus rental - Non-related parties 229,000 229,000 229,000
----------- ----------- -----------
Total bonus rental 2,966,000 2,844,000 2,735,000
----------- ----------- -----------
Interest - Non-related parties 111,000 584,000 751,000
----------- ----------- -----------
Total revenues $23,234,000 $22,764,000 $21,923,000
=========== =========== ===========
At December 31, 1998, approximately 8% of the Trust's outstanding shares of
beneficial interest were held by UHS. The Trust has granted UHS the option to
purchase Trust shares in the future at fair market value to enable UHS to
maintain a 5% interest in the Trust.
F-11
The Trust's officers are all employees of UHS and as of December 31, 1998, the
Trust had no salaried employees and paid no cash compensation. In 1999, the
Trustees awarded a $50,000 bonus to Mr. Kirk E. Gorman, President, Chief
Financial Officer, Secretary and Trustee of the Trust. UHS agreed to a $50,000
reduction in the 1999 advisory fee paid by the Trust.
(3) Acquisitions and Dispositions
1998 - During 1998, the Trust added five new investments to its portfolio
consisting of the following: (i) the purchase of a 99% equity interest in a
limited liability company ("LLC"), that owns Desert Springs Medical Plaza
located in Las Vegas, Nevada ($10.1 million); (ii) the purchase of a 95% equity
interest in a LLC that owns the Edwards Medical Plaza located in Phoenix,
Arizona ($3.8 million); (iii) the purchase of a 95% equity interest in a LLC
that owns the Pacifica Palms Medical Plaza located in Torrance, California ($1.7
million); (iv) the purchase of a 48% equity interest in a LLC that owns the St.
Jude Heritage Health Complex located in Fullerton, California ($1.4 million),
and; (v) the purchase of an 80% equity interest in a LLC that owns the Rio
Rancho Medical Center, a medical office building located in Rio Rancho, New
Mexico ($900,000). In connection with the purchase of equity interest in LLCs
that own the Pacifica Palms Medical Plaza, the St. Jude Heritage Health Complex
and the Rio Rancho Medical Center, the Trust advanced a total of $10.0 million
of short term loans to three separate LLCs. The loans, which earned interest at
a combined average annual rate of 9% during 1998, are expected to be fully
repaid to the Trust during 1999.
1997 - During 1997, the Trust added new investments to its portfolio consisting
of the following: (i) the purchase of a capital addition to one of its medical
office buildings and two additional properties located in Louisiana and Georgia
($1.4 million); (ii) the purchase of a 75% equity interest in a LLC that
purchased the Thunderbird Paseo Medical Plaza ($1.9 million); (iii) the
completion of construction of The Cypresswood Professional Center, located in
Houston, Texas in which the Trust has a 77% controlling equity interest ($4.4
million including $1.2 million of construction in progress capitalized during
1996), and; (iv) the completion of construction of Samaritan West Valley Medical
Center located in Goodyear, Arizona in which the Trust owns a 89% equity
interest in a LLC which owns the real estate assets of the facility ($1.8
million).
1996 - During 1996, the Trust added eleven new investments to its portfolio
consisting of the following: (i) the purchase of a 50% equity interest in a LLC
which owns three medical office buildings located on the campus of Desert
Samaritan Hospital in Phoenix, Arizona ($5.0 million); (ii) the purchase of four
preschool and child-care centers located in southeastern Pennsylvania ($3.9
million); (iii) the acquisition of a 33% equity interest in a LLC which owns a
medical office building located on the campus of Columbia/HCA Healthcare
Corporation's 260-bed Suburban Medical Center in Louisville, Kentucky; (iv) the
purchase of multi-tenant medical office building adjacent to the Southern
Regional Medical Center in Riverdale, Georgia ($6.2 million); (v) the purchase
of a 50% equity interest in a LLC which owns two medical office buildings on the
campus of Maryvale Samaritan Hospital located in Phoenix, Arizona ($1.4
million); (vi) the purchase of a 95% equity interest in a LLC which purchased
the Desert Valley Medical Center, a medical office building located on the
campus of the Columbia Paradise Valley Hospital in Phoenix, Arizona ($4.3
million including $2.7 million of long-term, non-recourse debt); (vii)
construction financing provided to a limited partnership, of which the Trust
owns a 77% controlling equity interest, for the construction of The Cypresswood
Professional Center located in Houston, Texas ($1.2 million advanced as of
December 31, 1996 including a $343,000 capital contribution), and; (viii)
construction financing provided to a LLC (excluding
F-12
$525,000 of capital to be contributed by the Trust upon completion of the center
in the fourth quarter of 1997), of which the Trust owns a 50% initial equity
interest, for the construction of Samaritan West Valley Medical Center located
in Goodyear, Arizona ($391,000 advanced as of December 31, 1996). In connection
with the Trust's acquisition of a 33% equity interest in the LLC which owns the
medical office building on the campus of Suburban Medical Center, the Trust
posted a $3.5 million standby letter of credit for the benefit of the lender
providing the financing. Construction on The Cypresswood Professional Center and
the Samaritan West Valley Medical Center was completed in the third and fourth
quarters of 1997, respectively.
(4) Leases
All of the Trust's leases are classified as operating leases with initial terms
ranging from 5 to 15 years with up to six five-year renewal options. Under the
terms of the leases, the Trust earns fixed monthly base rents and may earn
periodic additional rents (see Note 2). The additional rent payments are
generally computed as a percentage of the facility's net patient revenue or CPI
increase in excess of a base amount. The base year amount is typically net
patient revenue for the first full year of the lease. The Trust records these
additional rents on a pro rata basis over the annual lease period if the
achievement of the specific net patient revenue target amounts is probable.
Minimum future base rents on non-cancelable leases are as follows:
1999 $ 19,373,000
2000 19,180,000
2001 18,116,000
2002 11,442,000
2003 10,616,000
Later Years 24,360,000
-------------
Total Minimum Base Rents $103,087,000
============
Under the terms of the hospital leases, the lessees are required to pay all
operating costs of the properties including property insurance and real estate
taxes. Tenants of the medical office buildings generally are required to pay
their pro-rata share of the property's operating costs above a stipulated
amount.
(5) Debt
The Trust has a $80 million unsecured non-amortizing revolving credit agreement
(the "Agreement"), which expires on June 24, 2003. The Agreement provides for
interest at the Trust's option, at the certificate of deposit rate plus 5/8% to
1 1/8%, Eurodollar rate plus 1/2% to 1 1/8% or the prime rate. A fee of .175% to
.375% is required on the unused portion of this commitment. The margins over the
certificate of deposit rate, Eurodollar rate and the commitment fee are based
upon the Trust's debt to total capital ratio as defined by the Agreement. At
December 31, 1998 the applicable margin over the certificate of deposit and
Eurodollar rates were 7/8% and 5/8%, respectively, and the commitment fee was
.20%. There are no compensating balance requirements. The Agreement contains a
provision whereby the commitments will be reduced by 50% of the proceeds
generated from any new equity offering.
F-13
At December 31, 1998, the Trust had approximately $12 million of available
borrowing capacity.
The average amounts outstanding under the revolving credit agreement during
1998, 1997 and 1996 were $49,195,000, $40,774,000 and $34,410,000, respectively,
with corresponding effective interest rates, including commitment fees but not
including the effect of interest rate swaps of 6.3%, 6.4% and 6.3%. The maximum
amounts outstanding at any month end were $64,800,000, $44,300,00 and
$42,200,000 during 1998, 1997 and 1996, respectively.
Covenants relating to the revolving credit facility require the maintenance of a
minimum tangible net worth and specified financial ratios, limit the Trust's
ability to incur additional debt, limit the aggregate amount of mortgage
receivables and limit the Trust's ability to increase dividends in excess of 95%
of cash available for distribution, unless additional distributions are required
to comply with the applicable section of the Internal Revenue Code and related
regulations governing real estate investment trusts.
The Trust has entered into interest rate swap agreements and an interest rate
cap agreement which are designed to reduce the impact of changes in interest
rates on its floating rate revolving credit notes. The Trust has three
outstanding swap agreements for notional principal amounts of $5 million, $4
million and $1,580,000 which mature in May, 1999, July, 2002 and May, 2001,
respectively. These swap agreements effectively fix the interest rate on
$10,580,000 of variable rate debt at 7.56% including the revolver spread of
.625%. The interest rate cap, for which the Trust paid $622,750, (unamortized
premium of $62,000 at December 31, 1998) matures in June, 1999 and fixes the
maximum rate on $15 million of variable rate revolving credit notes at 7.625%
including the revolver spread of .625%. The interest rate swap and cap
agreements were entered into in anticipation of certain borrowing transactions
made by the Trust during 1995, 1996 and 1997. The effective rate on the Trust's
revolving credit notes including commitment fees and interest rate swap expense
was 6.7%, 6.9% and 6.8% during 1998, 1997 and 1996, respectively. Additional
interest expense recorded as a result of the Trust's hedging activity, which is
included in the effective interest rates shown above, was $136,000, $118,000 and
$130,000 in 1998, 1997 and 1996, respectively. The Trust is exposed to credit
loss in the event of nonperformance by the counterparties to the interest rate
swap and cap agreements. These counterparties are major financial institutions
and the Trust does not anticipate nonperformance by the counterparties which are
rated A or better by Moody's Investors Service. Termination of the interest rate
swaps at December 31, 1998 would have resulted in payments to the counterparties
of approximately $322,000 and termination of the interest rate cap would have
had no impact on the Trust. The fair value of the interest rate swap and cap
agreements at December 31, 1998 reflects the estimated amounts that the Trust
would pay or receive to terminate the contracts and are based on quotes from the
counterparties.
(6) Dividends
Dividends of $1.755 per share were declared and paid in 1998, of which $1.682
per share was ordinary income and $.073 per share was a return of capital
distribution. Dividends of $1.705 per share were declared and paid in 1997, of
which $1.624 per share was ordinary income and $.081 per share was a return of
capital distribution. Dividends of $1.695 per share were declared and paid in
1996, of which $1.622 per share was ordinary income and $.073 per share was a
return of capital distribution.
F-14
(7) Incentive Plans
In 1991, the Trustees adopted a share compensation plan for Trustees who are
neither employees nor officers of the Trust ("Outside Trustees"). Pursuant to
the plan, each Outside Trustee may elect to receive, in lieu of all or a portion
of the quarterly cash compensation for services as a Trustee, shares of the
Trust based on the closing price of the shares on the date of issuance. As of
December 31, 1998 no shares have been issued under the terms of this plan.
During 1992 and 1993, the Trust granted options pursuant to the 1988
Non-Statutory Stock Option Plan. Pursuant to the terms of this plan, which
expired in December of 1998, the granted options vested ratably 25% per year
beginning one year after the date of grant and expired ten years from the grant
date. As of December 31, 1998, 58,024 options were outstanding and exercisable
at an aggregate purchase price of $973,137 or $16.77 per share.
During 1997, the Trust's Board of Trustees approved the Universal Health Realty
Income Trust 1997 Incentive Plan ("The Plan"), which is a newly created stock
option and dividend equivalents rights plan for employees of the Trust,
including officers and directors. There are 400,000 shares reserved for issuance
under The Plan. All stock options were granted with an exercise price equal to
the fair market value on the date of the grant. The options granted vest ratably
at 25% per year beginning one year after the date of grant, and expire in ten
years. Dividend equivalent rights reduce the exercise price of the 1997
Incentive Plan options by an amount equal to the cash or stock dividends
distributed subsequent to the date of grant. On June 23, 1997, there were 70,000
stock options with dividend equivalent rights granted to officers and trustees
of the Trust. The Trust recorded expenses relating to the dividend equivalent
rights of $123,000 in 1998 and $60,000 in 1997. As of December 31, 1998, there
were 16,250 options exercisable under The Plan with an average exercise price,
adjusted to give effect to the dividend equivalent rights, of $16.02 per share.
SFAS No. 123 requires the Trust to disclose pro-forma net income and pro-forma
earnings per share as if compensation expense were recognized for options
granted beginning in 1995. Because the SFAS No. 123 method of accounting has not
been applied to options granted prior to January 1, 1995 and since there were no
stock options granted by the Trust during 1995 or 1996, no pro forma disclosures
are required. Using this approach, the Trust's net earnings and earnings per
share would have been the pro forma amounts indicated below:
Year Ended December 31 1998 1997
- --------------------------------------------------------------------------------
Net Income:
As Reported $14,337,000 $13,967,000
Pro Forma $14,201,000 $13,898,000
Earnings Per Share:
As Reported:
Basic $ 1.60 $ 1.56
Diluted $ 1.60 $ 1.56
Pro Forma:
Basic $ 1.59 $ 1.55
Diluted $ 1.58 $ 1.55
F-15
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following range of assumptions used
for the three option grants that occurred during 1998 and 1997:
Year Ended December 31 1998 1997
- ----------------------------------------------------------------------------
Volatility 15% 15%
Interest rate 5% - 6% 6.5%
Expected life (years) 7.9 7.9
Forfeiture rate 2% 2%
- ----------------------------------------------------------------------------
Stock-based compensation costs on a pro forma basis would have reduced net
income by $136,000 in 1998 and $69,000 in 1997. Because the SFAS No. 123 method
of accounting has not been applied to options granted prior to January 1, 1995,
the resulting pro forma disclosures may not be representative of that to be
expected in future years.
Stock options to purchase shares of beneficial interest have been granted to
officers and directors of the Trust under various plans. Information with
respect to these options is summarized as follows:
Number of Average Option Range
Outstanding Options Shares Price (High-Low)
- --------------------------------------------------------------------------------------------
Balance, January 1, 1996 95,000 $16.80 $16.875/$16.125
Granted 0 N/A N/A
Exercised (36,976) $16.84 $16.875/$16.125
Cancelled 0 N/A N/A
- --------------------------------------------------------------------------------------------
Balance, January 1, 1997 58,024 $16.77 $16.875/$16.125
Granted 70,000 $18.625 $18.625/$18.625
Exercised 0 N/A N/A
Cancelled 0 N/A N/A
- --------------------------------------------------------------------------------------------
Balance, January 1, 1998 128,024 $17.79 $18.625/$16.125
Granted 7,500 $19.40 $21.4375/$18.375
Exercised (625) $18.625 $18.625/$18.625
Cancelled (4,375) $18.625 $18.625/$18.625
- --------------------------------------------------------------------------------------------
130,524 $17.85 $21.4375/$16.125
- --------------------------------------------------------------------------------------------
F-16
(8) Summarized Financial Information of Equity Affiliates
The following table represents summarized unaudited financial information of the
limited liability companies ("LLCs") accounted for by the equity method. Amounts
presented include investments in the following LLCs:
Name of LLC Property Owned by LLC
---------------------- ------------------------------------
DSMB Properties Desert Samaritan Hospital MOBs
DVMC Properties Desert Valley Medical Center MOBs
Parkvale Properties Maryvale Samaritan Hospital MOBs
Suburban Properties Suburban Medical Center MOBs
Litchvan Investments Samaritan West Valley Medical Center
Paseo Medical Properties II Thunderbird Paseo Medical Plaza
Willetta Medical Properties Edwards Medical Plaza
DesMed Desert Springs Medical Plaza
PacPal Investments Pacifica Palms Medical Plaza
RioMed Investments Rio Rancho Medical Center
West Highland Holdings St. Jude Heritage Health Complex
December 31,
-----------------------------------
1998 1997
-----------------------------------
(amounts in thousands)
Net property $95,732 $54,536
Other assets 5,430 4,164
Liabilities and third-party debt 58,118 44,261
Loans payable to the Trust 9,980 -----
Equity 33,063 14,439
UHT's share of equity 28,185 11,075
For the Year Ended December 31,
-----------------------------------
1998 1997
-----------------------------------
(amounts in thousands)
Revenues $12,942 $8,135
Operating expenses 4,677 2,727
Depreciation & amortization 2,450 1,846
Interest, net 4,133 3,093
Net income 1,682 469
UHT's share of net income 1,537 445
As of December 31, 1998, these LLCs had $56.1 million of non-recourse debt
payable to third-party lending institutions. The loans payable to the Trust
earned interest at a combined average annual rate of 9% during 1998 and are
expected to be fully repaid to the Trust during 1999 once the LLCs secure
long-term, third-party financing.
F-17
Aggregate maturities of non-recourse debt payable to third-parties is as
follows:
1999 $10,241
2000 914
2001 4,674
2002 934
2003 1,006
Later 38,312
-------
Total $56,081
=======
(9) Quarterly Results (unaudited)
1998
- ------------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------
Revenues $5,857,000 $5,793,000 $5,694,000 $5,890,000 $23,234,000
Net Income $3,569,000 $3,528,000 $3,471,000 $3,769,000 $14,337,000
Earnings Per Share-Basic $0.40 $0.39 $0.39 $0.42 $1.60
Earnings Per Share-Diluted $0.40 $0.39 $0.39 $0.42 $1.60
1997
- ------------------------------------------------------------------------------------------------------------------------
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------
Revenues $5,700,000 $5,769,000 $5,560,000 $5,735,000 $22,764,000
Net Income $3,658,000 $3,550,000 $3,342,000 $3,417,000 $13,967,000
Earnings Per Share-Basic $0.41 $0.40 $0.37 $0.38 $1.56
Earnings Per Share-Diluted $0.41 $0.40 $0.37 $0.38 $1.56
F-18
Universal Health Realty Income Trust
Schedule II - Valuation and Qualifying Accounts
Balance at Charged to Balance
beginning costs and at end
Description of period expenses Other (a) of period
Reserve for Investment Losses:
Year ended December 31, 1998 $ 89,000 $ 300,000 ($273,000) $ 116,000
========= ========= ========= =========
Year ended December 31, 1997 $ 151,000 $ 227,000 ($289,000) $ 89,000
========= ========= ========= =========
Year ended December 31, 1996 $ 158,000 $ 220,000 ($227,000) $ 151,000
========= ========= ========= =========
(a) Amounts charged against the reserve.
F-19
Schedule III
Universal Health Realty Income Trust
Real Estate and Accumulated Depreciation - December 31, 1998
(amounts in thousands)
Initial
Cost to
Universal Cost Gross amount
Health capitalized at which
Realty Subsequent carried Date of
Income to acquis- at close Accumu- const-
Trust ition of period lated ruction
Deprec- or most
iation recent Average
Building Land & Building & as of significant Date Depreciable
Description Land & Improv. Improv. Land Improvements Total Dec. 31, expansion Acquired Life
1998 or reno-
vation
- -----------------------------------------------------------------------------------------------------------------------------------
Virtue Street Pavilion $1,825 $9,445 - $1,770 $9,445 $11,215 $3,244 1975 1986 35 Years
Chalmette Medical Center 2,000 7,473 - 2,000 7,473 9,473 2,365 1981 1988 34 Years
Chalmette, Louisiana
Inland Valley Regional Medical Center
Wildomar, California 2,050 10,701 2,868 2,050 13,569 15,619 3,145 1986 1986 43 Years
McAllen Medical Center
McAllen, Texas 4,720 31,442 10,188 6,281 40,069 46,350 9,262 1994 1986 42 Years
Wellington Regional Medical Center
West Palm Beach, Florida 1,190 14,652 4,822 1,663 19,001 20,664 4,349 1986 1986 42 Years
The Bridgeway
North Little Rock, Arkansas 150 5,395 499 150 5,894 6,044 2,004 1983 1986 35 Years
Meridell Achievement Center
Austin, Texas 1,350 3,782 4,139 1,350 7,921 9,271 2,743 1991 1986 28 Years
Tri-State Rehabilitation Hospital
Evansville, Indiana 500 6,945 1,062 500 8,007 8,507 1,819 1993 1989 40 Years
Vencor Hospital - Chicago
Chicago, Illinois 158 6,404 1,907 158 8,311 8,469 3,559 1993 1986 25 Years
Fresno-Herndon Medical Plaza
Fresno, California 1,073 5,266 24 1,073 5,290 6,363 481 1992 1994 45 Years
Family Doctor's Medical Office Building
Shreveport, Louisiana 54 1,526 494 54 2,020 2,074 141 1991 1995 45 Years
Kelsey-Seybold Clinic at King's Crossing 439 1,618 - 439 1,618 2,057 117 1995 1995 45 Years
Professional Center at King's Crossing 439 1,837 43 439 1,880 2,319 127 1995 1995 45 Years
Kingwood, Texas
Chesterbrook Academy
Audubon, Pennsylvania - 996 - - 996 996 59 1996 1996 45 Years
Carefree Learning Center
New Britain, Pennsylvania 250 744 - 250 744 994 43 1991 1996 45 Years
Carefree Learning Center
Uwchlan, Pennsylvania 180 815 - 180 815 995 48 1992 1996 45 Years
Carefree Learning Center
Newtown, Pennsylvania 195 749 - 195 749 944 44 1992 1996 45 Years
The Southern Crescent Center 1,130 5,092 14 1,130 5,106 6,236 285 1994 1996 45 Years
The Southern Crescent Center II 806 806 0 806 0 1998 1998 35 Years
Riverdale, Georgia
The Cypresswood Professional Center
Spring, Texas 573 3,842 121 573 3,963 4,536 171 1997 1997 35 Years
------- -------- ------- ------- -------- -------- -------
TOTALS $18,276 $118,724 $26,987 $21,061 $142,871 $163,932 $34,006
======= ======== ======= ======= ======== ======== =======
F-20
Universal Health Realty Income Trust
Notes to Schedule III
December 31, 1998
(1) Reconciliation of Real Estate Properties
The following table reconciles the Real Estate Properties from January 1, 1996
to December 31, 1998:
1998 1997 1996
------------- ------------- -------------
Balance at January 1 $ 163,855,000 $ 158,083,000 $ 147,888,000
Additions and acquisitions 158,000 4,526,000 10,195,000
Reclasses from construction in progress -- 1,246,000 --
Dispositions (a) (81,000) -- --
------------- ------------- -------------
Balance at December 31 $ 163,932,000 $ 163,855,000 $ 158,083,000
============= ============= =============
(2) Reconciliation of Accumulated Depreciation
The following table reconciles the Accumulated Depreciation from January 1, 1996
to December 31, 1998:
1998 1997 1996
------------ ------------ ------------
Balance at January 1 $ 30,280,000 $ 26,540,000 $ 22,986,000
Current year depreciation expense 3,807,000 3,740,000 3,554,000
Dispositions (a) (81,000) -- --
------------ ------------ ------------
Balance at December 31 $ 34,006,000 $ 30,280,000 $ 26,540,000
============ ============ ============
(a) Consists of accumulated depreciation on demolished houses located on
land cleared for construction of The Southern Crescent Center II, a new
medical office building which is scheduled to open in the first quarter
of 2000.
The aggregate cost basis and net book value of the properties for Federal income
tax purposes at December 31, 1998 are approximately $153,000,000 and
$122,000,000, respectively.
F-21