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| UHT > SEC Filings for UHT > Form 10-K on 12-Mar-2009 | All Recent SEC Filings |
12-Mar-2009
Annual Report
Overview
We are a real estate investment trust ("REIT") that commenced operations in 1986. We invest in healthcare and human service related facilities including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers and medical office buildings. As of December 31, 2008, we have forty-nine real estate investments or commitments in fifteen states consisting of:
• seven hospital facilities including three acute care, one behavioral healthcare, one rehabilitation and two sub-acute;
• thirty-eight medical office buildings (including three under construction), and;
• four preschool and childcare centers.
Forward Looking Statements
This Annual Report contains "forward-looking statements" that reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results of operations, business and growth strategies, financing plans, expectations that regulatory developments or other matters will not have a material adverse effect on our business or financial condition, our competitive position and the effects of competition, the projected growth of the industry in which we operate, and the benefits and synergies to be obtained from our completed and any future acquisitions, and statements of our goals and objectives, and other similar expressions concerning matters that are not historical facts. Words such as "may," "will," "should," "could," "would," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," "appears," "projects" and similar expressions, as well as statements in future tense, identify forward-looking statements.
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or our good faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Such factors include, among other things, the following:
• a substantial portion of our revenues are dependent upon one operator, Universal Health Services, Inc., ("UHS");
• a subsidiary of UHS is our Advisor and our officers are all employees of UHS, which may create the potential for conflicts of interest;
• lost revenues from purchase option exercises and lease expirations and renewals, loan repayments and other restructuring;
• the availability and terms of capital to fund the growth of our business;
• the outcome of known and unknown litigation, government investigations, and liabilities and other claims asserted against us or the operators of our facilities, including the government's ongoing investigation of UHS's South Texas Health Systems affiliates, which includes McAllen Medical Center, as described herein;
• the potential unfavorable impact on our business of continued deterioration in national, regional and local economic and business conditions, including a continuation or worsening of unfavorable credit market conditions;
• a worsening of the economic and employment conditions in the United States could materially affect the business of our operators, including UHS;
• the deterioration of credit and capital markets may adversely affect our access to sources of funding and we cannot be certain of the availability and terms of capital to fund the growth of our business when needed;
• real estate market factors, including without limitation, the supply and demand of office space and market rental rates, changes in interest rates as well as an increase in the development of medical office condominiums in certain markets;
• government regulations, including changes in the reimbursement levels under the Medicare and Medicaid program;
• the issues facing the health care industry that affect the operators of our facilities, including UHS, such as: changes in, or the ability to comply with, existing laws and government regulations; unfavorable changes in the levels and terms of reimbursement for our charges by third party payors or government programs, including Medicare or Medicaid; demographic changes; the ability to enter into managed care provider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of patient accounts; decreasing in-patient admission trends; technological and pharmaceutical improvements that may increase the cost of providing, or reduce the demand for, health care, and; the ability to attract and retain qualified medical personnel, including physicians;
• three LLCs that own properties in California, in which we have various non-controlling equity interests, could not obtain earthquake insurance at rates which are economically beneficial in relation to the risks covered;
• competition for our operators from other REITs;
• competition from other health care providers, including physician owned facilities and other facilities owned by UHS, including, but not limited to, McAllen, Texas, the site of our largest acute care facility;
• changes in, or inadvertent violations of, tax laws and regulations and other factors than can affect REITs and our status as a REIT;
• fluctuations in the value of our common stock, and;
• other factors referenced herein or in our other filings with the Securities and Exchange Commission.
Given these uncertainties, risks and assumptions, you are cautioned not to place undue reliance on such forward-looking statements. Our actual results and financial condition, including the operating results of our lessees and the facilities leased to subsidiaries of UHS, could differ materially from those expressed in, or implied by, the forward-looking statements.
Forward-looking statements speak only as of the date the statements are made. We assume no obligation to publicly update any forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except as may be required by law. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes.
A summary of our critical accounting policies is outlined in Note 1 to the consolidated financial statements. We consider our critical accounting policies to be those that require us to make significant judgments and estimates when we prepare our financial statements, including the following:
Revenue Recognition: Our revenues consist primarily of rentals received from tenants, which are comprised of minimum rent (base rentals), bonus rentals and reimbursements from tenants for their pro-rata share of expenses such as common area maintenance costs, real estate taxes and utilities.
The minimum rent for all hospital facilities is fixed over the initial term or renewal term of the respective leases. Rental income recorded by our consolidated and unconsolidated medical office buildings ("MOBs") relating to leases in excess of one year in length, is recognized using the straight-line method under which contractual rents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting from straight-line rent adjustments is dependent on many factors including the nature and amount of any rental concessions granted to new tenants, scheduled rent increases under existing leases, as well as the acquisitions and sales of properties that have existing in-place leases with terms in excess of one year. As a result, the straight-line adjustments to rental revenue may vary from period-to-period. Bonus rents are recognized when earned based upon increases in each facility's net revenue in excess of stipulated amounts. Bonus rentals are determined and paid each quarter based upon a computation that compares the respective facility's current quarter's net revenue to the corresponding quarter in the base year. Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred.
Real Estate Investments: We account for our property acquisitions under the provisions of Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"). Under SFAS No. 141, the purchase price of a property is allocated to the property's land, buildings and intangible assets based upon our estimates of their fair values. Depreciation is computed using the straight-line method over the useful lives of the buildings and capital improvements. The value of intangible assets is amortized as real estate amortization over the remaining lease term.
Asset Impairment: Real estate investments and related intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the property might not be recoverable. A property to be held and used is considered impaired only if management's estimate of the aggregate future cash flows, less estimated capital expenditures, to be generated by the property, undiscounted and without interest charges, are less than the carrying value of the property. This estimate takes into consideration factors such as expected future operating income, trends and prospects, as well as the effects of demand, competition, local market conditions and other factors.
The determination of undiscounted cash flows requires significant estimates by management, including the expected course of action at the balance sheet date that would lead to such cash flows. Subsequent changes in estimated undiscounted cash flows arising from changes in anticipated action to be taken with respect to the property could impact the determination of whether an impairment exists and whether the effects could materially impact our net income. To the extent estimated undiscounted cash flows are less than the carrying value of the property, the loss will be measured as the excess of the carrying amount of the property over the fair value of the property.
Assessment of the recoverability by us of certain lease related costs must be made when we have reason to believe that a tenant might not be able to perform under the terms of the lease as originally expected. This requires us to make estimates as to the recoverability of such costs.
An other than temporary impairment of an investment in an unconsolidated joint venture is recognized when the carrying value of the investment is not considered recoverable based on evaluation of the severity and duration of the decline in value, including projected declines in cash flows. To the extent impairment has occurred, the excess carrying value of the asset over its estimated fair value is charged to income.
Intangible Assets: We account for our property acquisitions under the provisions of Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"). Under SFAS No. 141, the purchase price of a property is allocated to the property's land, buildings and intangible assets based upon our estimates of their fair values. Depreciation is computed using the straight-line method over the useful lives of the buildings and capital improvements. The value of intangible assets is amortized as real estate amortization over the remaining lease term.
Investments in Limited Liability Companies ("LLCs"): Our consolidated financial statements include the consolidated accounts of our controlled investments and those investments that meet the criteria of a variable interest entity where we are the primary beneficiary. In accordance with the American Institute of Certified Public Accountants' Statement of Position 78-9 "Accounting for Investments in Real Estate Ventures" as amended by FASB Staff Position SOP 78-9-1 "Interaction of AICPA Statement of Position 78-9 and EITF Issue No. 04-5", Emerging Issues Task Force Issue (EITF) 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" and EITF 04-5 "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" we account for our unconsolidated investments in LLCs which we do not control using the equity method of accounting. The third-party members in these investments have equal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and; (iii) financing commitments. These investments, which represent 33% to 99% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements, allocations of profits and losses of some of the LLC investments may be allocated disproportionately as compared to ownership interests after specified preferred return rate thresholds have been satisfied.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. This Interpretation, as revised ("FIN 46R"), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. As a result of our related party relationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and various properties owned by three LLCs in which we own non-controlling ownership interests ranging from 95% to 99%, these three LLCs were considered to be variable interest entities. In addition, we were the primary beneficiary of these three LLC investments. Upon the adoption of FIN 46R on March 31, 2004, we began consolidating the results of operations of these three LLC investments in our consolidated financial statements.
As a result of the expiration of the master lease arrangements between subsidiaries of UHS and two of these three LLCs, during the fourth quarter of 2006, we began recording the financial results of two LLCs on an unconsolidated basis in our consolidated financial statements. Beginning with the fourth quarter of 2006, the revenues and expenses of these two LLCs are no longer included in our consolidated revenues and expenses; instead, our share of the net income generated from each of these two LLCs is included in our consolidated statements of income as "Equity in income of unconsolidated LLCs". The revenues and expenses for these two LLCs related to the periods prior to the fourth quarter of 2006 are included in our revenues and expenses in our consolidated statements of income. There was no impact on our net income as a result of the change in accounting for these LLCs. Also, as a result of a master lease arrangement between a subsidiary of UHS and a LLC that owns a medical office building that opened during the third quarter of 2008, this LLC is included in our consolidated financial statements on a consolidated basis. Additionally, as a result of a master lease arrangement between a subsidiary of UHS and a LLC that owns a medical office building that was under construction, as of December 31, 2008, this LLC is also included in our consolidated financial statements on a consolidated basis. Therefore, as of December 31, 2008, our consolidated balance sheet includes the assets, liabilities and third-party debt (that is non-recourse to us) incurred by the LLC in connection with this newly constructed building which was completed and opened during the first quarter of 2009.
The other LLCs in which we hold various non-controlling ownership interests are not variable interest entities and therefore are not subject to the consolidation requirements of FIN 46R.
Federal Income Taxes: No provision has been made for federal income tax purposes since we qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, and intend to continue to remain so qualified. As such, we are exempt from federal income taxes and we are required to distribute at least 90% of our real estate investment taxable income to our shareholders.
We are subject to a federal excise tax computed on a calendar year basis. The excise tax equals 4% of the amount by which 85% of our ordinary income plus 95% of any capital gain income for the calendar year exceeds 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 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.
Relationship with UHS and Related Party Transactions
UHS is our principal tenant and through UHS of Delaware, Inc., a wholly owned subsidiary of UHS, serves as our advisor (the "Advisor") under an Advisory Agreement dated December 24, 1986 between the Advisor and us (the "Advisory Agreement"). Our officers are all employees of UHS and although as of December 31, 2008 we had no salaried employees, our officers do receive stock-based compensation from time-to-time.
Under the Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and to conduct our day-to-day affairs. In performing its services under the Advisory Agreement, the Advisor may utilize independent professional services, including accounting, legal, tax and other services, for which the Advisor is reimbursed directly by us. The Advisory Agreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Independent Trustees who are unaffiliated with UHS, that the Advisor's performance has been satisfactory. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreement has been renewed for 2009. All transactions between us and UHS must be approved by the Independent Trustees. The Advisor is entitled to certain advisory fees for its services. See "Relationship with Universal Health Services, Inc." in Item 1 and Note 2 to the consolidated financial statements for additional information on the Advisory Agreement and related fees.
The combined revenues generated from the leases on the UHS hospital facilities comprised approximately 55%, 57% and 51% of our revenues for the years ended December 31, 2008, 2007 and 2006, respectively. Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controlling equity interests ranging from 33% to 99%, the leases with wholly-owned UHS hospital facilities accounted for 21% of the combined consolidated and unconsolidated revenues for the year ended December 31, 2008 and 24% for each of the years ended December 31, 2007 and 2006. The leases to the hospital facilities of UHS are guaranteed by UHS and cross-defaulted with one another.
Recent Accounting Pronouncements: For a summary of recent accounting pronouncements, please see Note 1 to the Consolidated Financial Statements as included in this Annual Report on Form 10-K for the year ended December 31, 2008.
Results of Operations
Year ended December 31, 2008 as compared to the year ended December 31, 2007:
For the year ended December 31, 2008, net income was $11.7 million, or $0.98 per diluted share, as compared to $22.2 million, or $1.87 per diluted share for the year ended December 31, 2007. The decrease in net income of $10.5 million, or $.89 per diluted share, during 2008 as compared to 2007, was primarily attributable to:
• an unfavorable change of $4.6 million, or $.39 per diluted share, resulting from the provision for asset impairment recorded during 2008 on a certain medical office building complex, as discussed below;
• an unfavorable change of $1.7 million, or $0.15 per diluted share, resulting from the gain recognized during 2007 in connection with the Chalmette asset exchange and substitution transaction, as discussed herein;
• an unfavorable change of $264,000, or $0.02 per diluted share, resulting from the gain recorded during 2007 in connection with the sale of real property by a LLC in which we had an 80% non-controlling equity interest;
• an unfavorable change of $2.2 million, or $0.18 per diluted share,
resulting from increased depreciation and amortization expense at our
properties recorded on a consolidated basis ($700,000) and an
unconsolidated basis ($1.5 million) primarily resulting from:
(i) increased depreciation expense incurred during 2008 on various newly
constructed medical office buildings that were completed and opened during
2008 and 2007 including Palmdale Medical Plaza (2008), Canyon Springs
Medical Plaza (2007), Centennial Hills Medical Office Building I (2007),
Phoenix Children's East Valley Care Center (2007) and Spring Valley
Medical Office Building II (2007), and; (ii) depreciation and amortization
expense recorded on Kindred Hospital, Corpus Christi which was acquired
during 2008, and;
• other combined net favorable changes of $600,000, or $0.04 per diluted share.
Total revenue increased $1.2 million to $29.2 million during 2008, as compared to $28.0 million during 2007. The increase was primarily attributable to the revenues generated at Kindred Hospital-Corpus Christi which was acquired in February of 2008 and Palmdale Medical Plaza, a newly constructed medical office building that was completed and opened during the third quarter of 2008.
Depreciation and amortization expense increased $700,000 to $5.9 million during 2008, as compared to $5.2 million during 2007. The increase was primarily attributable to the depreciation and amortization expense recorded during 2008 on Kindred Hospital-Corpus Christi and Palmdale Medical Plaza as well as increased depreciation expense incurred on the replacement assets received from UHS (applicable to Southwest Healthcare System, Inland Valley) in connection with the Chalmette asset exchange and substitution transaction.
Included in our other operating expenses are expenses related to the consolidated medical office buildings, which totaled $4.0 million and $3.2 million for 2008 and 2007, respectively. A portion of the expenses associated with our consolidated medical office buildings is passed on directly to the tenants. Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred and are included as tenant reimbursement revenue in our condensed consolidated statements of income. During 2008, $2.5 million, or 62% of the expenses related to consolidated medical office buildings were passed on directly to the tenants. During 2007, $2.4 million, or 74% of the expenses related to consolidated medical office buildings were passed on directly to the tenants. The decrease in the percentage of operating expenses passed on directly to tenants during 2008, as compared to 2007, was primarily due to higher than anticipated repairs and maintenance expenses incurred at a certain MOB which were not allocated to the tenants of that property.
During 2008, we recorded an asset impairment charge of $4.6 million in
connection with two medical office buildings (Southern Crescent Centers I and
II) located on a medical campus in Clayton County (Riverdale), Georgia. This
asset impairment charge was recorded after evaluation of property and
location-specific factors including: (i) the future expiration of a master lease
which is scheduled to occur in June, 2010; (ii) the current and projected
occupancy of the buildings, and; (iii) the anticipated unfavorable impact on the
region and the properties resulting from the loss of the school district's
accreditation during 2008. Given the local market conditions, we believe it is
probable that the master lease (which has been in effect since 2000 on one of
these properties) will not be renewed upon its expiration in June, 2010. In the
likely event that the master lease is not
renewed, we will be required to find other operators for this property and/or enter into leases on terms potentially less favorable to us than the current master lease. During each of 2008, 2007 and 2006, our revenues, net income and net cash provided by operating activities included approximately $1.1 million annually in connection with the terms of this master lease. The combined fair value of these properties was determined based upon the present value of their expected future cash flows.
Interest expense, net of interest income, increased $642,000 during 2008, as compared to 2007, due primarily to: (i) an increase in our average borrowings outstanding under our revolving credit agreement, partially offset by a decrease in our average borrowing rate, and; (ii) the interest incurred on the term loan related to the newly constructed Palmdale Medical Plaza which was completed and opened during 2008. The increased borrowings under our revolving credit agreement were used primarily to fund the acquisition of Kindred Hospital-Corpus Christi during the first quarter of 2008 and investments in various LLCs as discussed herein.
During 2008 and 2007, we recorded equity in income of unconsolidated LLCs of $2.1 million and $2.8 million, respectively. The $769,000 decrease during 2008, as compared to 2007, was primarily due to: (i) a $600,000 decrease at a certain LLC due to the expiration of a master lease during the first quarter of 2008 and decreased occupancy; (ii) a gain of $264,000 realized during 2007 on the sale of real property by a LLC, and; (iii) approximately $100,000 of other combined net favorable changes. During 2009, we expect to recapture a portion of the income lost during 2008 resulting from the master lease expiration and decreased occupancy at the LLC mentioned above since a new lease on a significant portion . . .
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