FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [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, 2001 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. Employerincorporation 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 registeredShares 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 befiled by Section 13 or 15(d) of the Securities and Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes [X] No [ ]Indicate by check mark if disclosure of delinquent filers pursuant to Item 405of Regulation S-K is not contained herein, and will not be contained, to thebest of Registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. Aggregate market value of voting shares held by non-affiliates as of January 31,2002: $279,143,378.Number of shares of beneficial interest outstanding of registrant as of January 31, 2002: 11,679,411 DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement for its 2002 AnnualMeeting of Shareholders, which will be filed with the Securities and ExchangeCommission within 120 days after December 31, 2001 (incorporated by referenceunder Part III). PART I Item 1. BUSINESS General The Trust commenced operations on December 24, 1986. As of December 31, 2001, the Trust had investments in forty-two facilities located in fifteen states consisting of the following: Facility Name Location Type of Facility Ownership Guarantor------------------------------------------------------------------------------------------------------------------------------------ Chalmette Medical Center A Chalmette, LA Acute Care 100% Universal Health Services, Inc.Virtue Street Pavilion A Chalmette, LA Rehabilitation 100% Universal Health Services, Inc.Inland Valley Regional Medical Ctr. A Wildomar, CA Acute Care 100% Universal Health Services, Inc.McAllen Medical Center A McAllen, TX Acute Care 100% Universal Health Services, Inc.The Bridgeway A N.Little Rock, AR Behavioral Health 100% Universal Health Services, Inc.Wellington Regional Medical Center A W. Palm Beach, FL Acute Care 100% Universal Health Services, Inc.Kindred Hospital Chicago Central B Chicago, IL Sub-Acute Care 100% Kindred Healthcare, Inc. Tri-State Rehabilitation Hospital B Evansville, IN Rehabilitation 100% HEALTHSOUTH Corporation Fresno Herndon Medical Plaza B Fresno, CA MOB 100% --- Family Doctor's Medical Office Bldg. B Shreveport, LA MOB 100% HCA-The Healthcare Company Kelsey-Seybold Clinic at Kings Crossing B Kingwood, TX MOB 100% St. Lukes & Methodist Health Sys.Professional Bldgs. at Kings Crossing B Kingwood, TX MOB 100% --- Chesterbrook Academy B Audubon, PA Preschool & Childcare 100% Nobel Learning Comm. & Subs.Chesterbrook Academy B New Britain, PA Preschool & Childcare 100% Nobel Learning Comm. & Subs.Chesterbrook Academy B Newtown, PA Preschool & Childcare 100% Nobel Learning Comm. & Subs.Chesterbrook Academy B Uwchlan, PA Preschool & Childcare 100% Nobel Learning Comm. & Subs.Southern Crescent Center B Riverdale, GA MOB 100% --- Desert Samaritan Hospital MOBs C Phoenix, AZ MOB 76% --- Suburban Medical Center MOBs C Louisville, KY MOB 33% --- Maryvale Samaritan Hospital MOBs C Phoenix, AZ MOB 60% --- Desert Valley Medical Center MOB C Phoenix, AZ MOB 95% --- Thunderbird Paseo Medical Plaza I & II C Glendale, AZ MOB 75% --- Cypresswood Professional Center D Spring, TX MOB 77% --- Samaritan West Valley Medical Ctr. E Goodyear, AZ MOB, Imaging Ctr. 89% --- Edwards Medical Plaza C Phoenix, AZ MOB 95% --- Desert Springs Medical Plaza C Las Vegas, NV MOB 99% Triad Hospitals, Inc. Pacifica Palms Medical Plaza C Torrance, CA MOB 95% --- St. Jude Heritage Health Complex C Fullerton, CA MOB 48% --- Rio Rancho Medical Center C Rio Rancho, NM MOB 80% --- Orthopaedic Specialists of Nevada Bldg. B Las Vegas, NV MOB 100% --- Santa Fe Professional Plaza C Scottsdale, AZ MOB 95% --- East Mesa Medical Center C Mesa, AZ MOB 75% --- Summerlin Hospital MOB C Las Vegas, NV MOB 98% --- Sheffield Medical Building B Atlanta, GA MOB 100% --- Southern Crescent Center, II B Riverdale, GA MOB 100% --- Centinela Medical Building C Inglewood, CA MOB 67% --- Summerlin Hospital MOB II C Las Vegas, NV MOB 98% --- Skypark Professional Medical Building C Torrance, CA MOB 95% --- Medical Center of Western Connecticut B Danbury, CT MOB 100% --- Mid Coast Hospital MOB C Brunswick, ME MOB 74% --- Deer Valley Medical Office II C Phoenix, AZ MOB 80% --- (A) Real estate assets owned by the Trust and leased to subsidiaries of Universal Health Services, Inc. ("UHS"). (B) Real estate assets owned by the Trust and leased to an unaffiliated third-party or parties. (C) Real estate assets owned by a LLC in which the Trust owns a non- controlling interest as indicated above. (D) Real estate assets owned by a limited partnership in which the Trust owns a controlling interest as indicated above. (E) In January, 2002, the LLC that owns the real estate assets of Samaritan West Valley Medical Center, completed a like-kind exchange in which the real estate assets of this facility and cash were exchanged for the real estate assets of Papago Medical Park located in Phoenix, Arizona. 1 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. Included in the Trust's portfolio is ownership of eight hospital facilities (aggregate investment of $130 million). The leases with respect to hospital facilities comprised 69%, 72% and 80% of the Trust's revenues in 2001, 2000 and 1999, respectively, and as of December 31, 2001 these leases have fixed terms with an average of 3.9 years remaining and include renewal options for up to five, five-year terms. For the eight hospital facilities owned by the Trust (excluding in 2000 and 1999 the facility sold to a subsidiary of UHS in December, 2000), the combined ratio of earnings before interest, taxes, depreciation, amortization and lease and rental expense (EBITDAR) to minimum rent plus additional rent payable to the Trust was approximately 6.1 (ranging from 2.4 to 8.8), 5.6 (ranging from 2.6 to 8.3) and 5.3 (ranging from 1.1 to 9.0) for the years ended December 31, 2001, 2000 and 1999, respectively (see "Relationship to Universal Health Services, Inc."). The coverage ratio for individual facilities varies. Pursuant to the terms of the leases with subsidiaries of UHS, each individual subsidiary is responsible for building operations, maintenance and renovations required at the six hospital facilities leased from the Trust. The Trust or the LLCs in which the Trust has invested are responsible for the building operations, maintenance and renovations of the multi-tenant medical office buildings, however, a portion of the expenses associated with the medical office buildings are passed on directly to the tenants. Cash reserves have been established to fund required building maintenance and renovations at the multi-tenant medical office buildings. Lessees are required to maintain all risk, replacement cost and commercial property insurance policies on the leased properties and the Trust or the LLC in which the Trust has invested are also named insureds on these policies. In addition, the Trust or the LLCs in which the Trust has invested maintain property insurance on all properties. Although the Trust believes that generally its properties are adequately insured, four of the LLCs, in which the Trust owns various non-controlling equity interests own properties in California that are located in earthquake zones. These properties, in which the Trust has invested a total of $7.5 million, are not covered by earthquake insurance since earthquake insurance is not available at rates which are economically practicable in relation to the risks covered. Relationship to Universal Health Services, Inc. Leases. As of December 31, 2001, subsidiaries of UHS leased six of the eight hospital facilities owned by the Trust with terms expiring in 2003 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 renewal options of up to five, five-year periods. These leases accounted for 67% of the total revenue of the Trust for the five years ended December 31, 2001 (60% for the year ended December 31, 2001). Including 100% of the revenues generated at the unconsolidated LLCs in which the Trust has various non-controlling equity interests ranging from 33% to 99%, the UHS leases accounted for 39% of the combined consolidated and unconsolidated revenue for the five years ended December 31, 2001 (31% for the year ended December 31, 2001). For the six hospital facilities owned by the Trust and leased to subsidiaries of UHS, the combined ratio of EBITDAR to minimum rent plus additional rent payable to the Trust (excluding in 2000 and 1999 the facility sold to a subsidiary of UHS in December, 2000) was approximately 6.2, 5.7 and 5.6 for the years ended December 31, 2001, 2000 and 1999, respectively. The coverage ratios for 2 individual facilities vary and range from 2.4 to 8.8 in 2001, 2.7 to 8.3 in 2000 and 1.1 to 9.0 in 1999. Management of the Trust cannot 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 lease terms. If the leases are not renewed at their current rates, the Trust would be required to find other operators for those facilities and/or enter into leases on terms potentially less favorable to the Trust than the current leases. 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 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 2002. 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 3 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 2001, 2000 and 1999. The advisory fee is payable quarterly, subject to adjustment at year end based upon audited financial statements of the Trust. The Trust's officers are all employees of UHS and as of December 31, 2001, the Trust had no salaried employees. Commencing in 1999, Mr. Kirk E. Gorman, President, Chief Financial Officer, Secretary and Trustee of the Trust, received $50,000 annual bonuses awarded by the Trustees, subject to UHS agreeing to a $50,000 reduction in the advisory fee paid by 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, 2001, UHS owned 6.6% of the outstanding shares of beneficial interest. Competition The Trust believes that it is one of approximately 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's staff and to attract other qualified doctors by improving facilities and maintaining high ethical and professional standards. Since the majority Trust's income is derived from lease payments on hospital facilities and medical office buildings, the Trust is substantially dependent on such things as healthcare regulations and reimbursement to healthcare facilities since these factors, among other things, affect the lease payments to the Trust and the underlying property values. A significant portion of the revenues from the Trust's facilities are derived from the Medicare and Medicaid programs as well as managed care plans which include health maintenance organizations ("HMOs") and preferred provider organizations ("PPOs"). Generally, the Trust's hospital facilities continue to experience an increase in revenues attributable to managed care payors. Pressures to control healthcare costs and a shift away from traditional Medicare to Medicare managed care plans have resulted in an increase in the number of patients whose healthcare coverage is provided under managed care plans. Typically, the Trust's hospital facilities receive lower payments per patient from managed care payors than from traditional indemnity insurers. However, during the past year, many of the Trust's hospital facilities secured price increases from many of its commercial payors including managed care companies. 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. 4 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, HMOs, 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 and admission constraints. A large portion of the Trust's non-hospital properties consist of medical office buildings which are located either close to or on the campuses of hospital facilities. These properties are either directly or indirectly affected by the factors discussed above as well as general real estate factors such as the supply and demand of office space and market rental rates. 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 Federal government makes payments to participating hospitals under its Medicare program based on various formulas. The operators of the Trust's general acute care hospitals are subject to a prospective payment system ("PPS"). For inpatient services, PPS pays acute care hospitals a predetermined amount per diagnostic related group ("DRG") based upon a hospital's location and the patient's diagnosis. Behavioral health facilities, which are excluded from the inpatient services PPS, are cost reimbursed by the Medicare program, but are generally subject to a per discharge ceiling, calculated based on an annual allowable rate of increase over the hospital's base year amount under the Medicare law and regulations. Beginning August 1, 2000 under a new outpatient prospective payment system ("OPPS") mandated by the Balanced Budget Act of 1997 ("BBA- 97"), both general acute and behavioral health hospitals' outpatient services are paid a predetermined amount per Ambulatory Payment Classification based upon a hospital's location and the procedures performed. The Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999 ("BBRA of 1999") included "transitional corridor payments" through fiscal year 2003, which provide some financial relief for any hospital that generally incurs a reduction to its Medicare outpatient reimbursement under the new OPPS. BBRA of 1999 required that the Health Care Financing Administration, now known as the Centers for Medicare and Medicaid Services, develop an inpatient psychiatric per diem prospective payment system effective for the federal fiscal year beginning October 1, 2002, however, it is possible that the implementation may be delayed. Upon implementation, this new prospective payment system will replace the current inpatient psychiatric payment system. In addition to the trends described above that continue to have an impact on the operating results of the Trust's hospital facilities, there are a number of other more general factors affecting the operators of the Trust's facilities. BBA-97 called for the government to trim the growth of federal spending on Medicare by $115 billion and on Medicaid by $13 billion over the following years. The act also called for reductions in the future rate of increases to payments made to hospitals and reduced the amount of reimbursement for outpatient services, bad debt expense and capital costs. Some of these reductions were reversed with the passage on December 15, 2000 of the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 ("BIPA") which, among 5 other things, increased Medicare and Medicaid payments to healthcare providers by $35 billion over 5 years with approximately $12 billion of this amount targeted for hospitals and $11 billion for managed care payors. These increased reimbursements to hospitals pursuant to the terms of BIPA commenced in April, 2001. BBA-97 established the annual update for Medicare at market basket minus 1.1% in both fiscal years 2001 (October 1, 2000 and through September 30, 2001) and 2002 and BIPA revised the update at the full market basket in fiscal year 2001 and market basket minus .55% in fiscal years 2002 and 2003. Additionally, BBA-97 reduced reimbursement to hospitals for Medicare bad debts to 55% and BIPA increased the reimbursement to 70%. It is possible that future federal budgets will contain certain further reductions or increases in the rate of increase of Medicare and Medicaid spending. The Trust can provide no assurance that the reductions in the PPS update, and other changes required by BBA-97, will not adversely affect the operators of the Trust's facilities. However, within certain limits, a hospital can manage its costs, and, to the extent this is done effectively, a hospital may benefit from the DRG system. However, many hospital operating costs are incurred in order to satisfy licensing laws, standards of the Joint Commission on the Accreditation of Healthcare Organizations ("JCAHO") and quality of care concerns. In addition, hospital costs are affected by the level of patient acuity, occupancy rates and local physician practice patterns, including length of stay, judgments and number and type of tests and procedures ordered. A hospital's ability to control or influence these factors which affect costs is, in many cases, limited. 6 Executive Officers of the Registrant Name Age Position ---- --- -------- Alan B. Miller 64 Chairman of the Board and Chief Executive Officer Kirk E. Gorman 51 President, Chief Financial Officer, Secretary and Trustee Charles F. Boyle 42 Vice President and Controller Cheryl K. Ramagano 39 Vice President and Treasurer Timothy J. Fowler 46 Vice President, Acquisition and Development Mr. Alan B. Miller has been Chairman of the Board and Chief Executive Officer ofthe Trust since its inception in 1986. He served as President of the Trust untilMarch, 1990. Mr. Miller has been Chairman of the Board, President and ChiefExecutive Officer of UHS since its inception in 1978. Mr. Miller also serves asa director of Penn Mutual Life Insurance Company, CDI Corp. (provides staffingservices and placements) and Broadlane, Inc. (an e-commerce marketplace forhealthcare supplies, equipment and services). Mr. Kirk E. Gorman has been President and Chief Financial Officer of the Trustsince March, 1990 and was elected to the Board of Trustees and Secretary inDecember, 1994. Mr. Gorman had previously served as Vice President and ChiefFinancial Officer of the Trust since April, 1987. Mr. Gorman was elected SeniorVice President, Treasurer and Chief Financial Officer of UHS in 1992 and servedas its Senior Vice President and Treasurer since 1989. Mr. Gorman also serves asa director of VIASYS Healthcare, Inc. (a medical technology products company)and Physician's Dialysis, Inc. (provides dialysis services).Mr. Charles F. Boyle was elected Vice President and Controller of the Trust inJune, 1991. Mr. Boyle was promoted to Assistant Vice President -CorporateAccounting of UHS in 1994 and served as its Director of Corporate Accountingsince 1989.Ms. Cheryl K. Ramagano was elected Vice President and Treasurer of the Trust inSeptember, 1992. Ms. Ramagano was promoted to Assistant Treasurer of UHS in 1994and served as its Director of Finance since 1990.Mr. Timothy J. Fowler was elected Vice President, Acquisition and Development ofthe 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, 2001, theTrust had no salaried employees. Commencing in 1999, Mr. Kirk E. Gorman,President, Chief Financial Officer, Secretary and Trustee of the Trust, received$50,000 annual bonuses awarded by the Trustees, subject to UHS agreeing to a$50,000 reduction in the advisory fee paid by the Trust. 7 Item 2. PropertiesThe following table shows the Trust's investments in hospital facilities leasedto Universal Health Services, Inc. and other non-related parties. The table onthe next page provides information related to various properties in which theTrust has significant investments, some of which are accounted for by the equitymethod. 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 available Type of beds @ Average Occupancy (1) -------------------------------------------Hospital Facility Name and Location facility 12/31/01 2001 2000 1999 1998 1997----------------------------------------------------------------------------------------------------------------------------- Chalmette Medical Centers (2) Virtue Street Pavilion Rehabilitation 57 58% 56% 61% 63% 64% Chalmette Medical Center Acute Care 138 60% 55% 65% 61% 64% Chalmette, LouisianaInland Valley Regional Medical Center Acute Care 80 80% 76% 68% 60% 52% Wildomar, CaliforniaMcAllen Medical Center (3) Acute Care 612 69% 76% 69% 69% 76% McAllen, TexasWellington Regional Medical Center Acute Care 120 52% 45% 41% 37% 36% West Palm Beach, FloridaThe Bridgeway Behavioral Health 70 91% 82% 78% 79% 68% North Little Rock, ArkansasTri-State Rehabilitation Hospital Rehabilitation 80 71% 73% 74% 82% 74% Evansville, IndianaKindred Hospital Chicago Central (4) Sub-Acute Care 87 64% 50% 46% 42% 50% Chicago, Illinois Lease Term------------------------------------------------ Minimum End of initial Renewal rent or renewed term term (years)------------------------------------------------- $1,261,000 2004 25 1,229,000 2003 15 1,857,000 2006 25 5,485,000 2006 25 2,495,000 2006 25 683,000 2004 25 1,206,000 2004 20 1,224,000 2006 20 8 Item 2. Properties (continued) Type of Average Occupancy (1) ------------------------------------------- Facility Name and Location facility 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------ Fresno Herndon Medical Plaza Medical 95% 99% 100% 100% 100% Fresno, California Office Building Kelsey-Seybold Clinic at Kings Crossing Medical 100% 100% 100% 100% 100% Professional Bldgs. at Kings Crossing Office Buildings 88% 96% 100% 100% 100% Kingwood, Texas Southern Crescent Center Medical 77% 77% 100% 100% 100% Riverdale, Georgia Office Building Cypresswood Professional Center Medical 100% 100% 100% 100% 96% Spring, Texas Office Building Desert Springs Medical Plaza Medical 100% 99% 99% 100% - Las Vegas, Nevada Office Building Orthopaedic Specialists of Nevada Building Medical 100% 100% 100% - - Las Vegas, Nevada Office Building Sheffield Medical Building Medical 99% 95% 90% - - Atlanta, Georgia Office Building Southern Crescent Center, II Medical 88% 88% - - - Riverdale, Georgia Office Building Medical Center of Western Connecticut Medical 95% 100% - - - Danbury, Connecticut Office Building Chesterbrook Academy Preschool - - - - - Audubon, New Britain, Newtown and and Uwchlan, Pennsylvania Childcare Family Doctor's Medical Office Building Medical 100% 100% 100% 100% 100% Shreveport, Louisiana Office Building Lease Term --------------------------------------------------- Minimum End of initial RenewalFacility Name and Location rent or renewed term term (years)--------------------------------------------------------------------------------------------------- Fresno Herndon Medical Plaza $ 701,000 2002 -2007 various Fresno, California Kelsey-Seybold Clinic at Kings Crossing 289,000 2005 10Professional Bldgs. at Kings Crossing 234,000 2002-2005 various Kingwood, Texas Southern Crescent Center 653,000 2003-2006 various Riverdale, Georgia Cypresswood Professional Center 465,000 2002-2007 various Spring, Texas Desert Springs Medical Plaza 1,778,000 2002-2006 various Las Vegas, Nevada Orthopaedic Specialists of Nevada Building 194,000 Bldg. 2009 20 Las Vegas, Nevada Sheffield Medical Building 1,447,000 2002-2012 various Atlanta, Georgia Southern Crescent Center, II 868,000 2010 10 Riverdale, Georgia Medical Center of Western Connecticut 773,000 2009 various Danbury, Connecticut Chesterbrook Academy 528,000 2010 10 Audubon, New Britain, Newtown and Uwchlan, Pennsylvania Family Doctor's Medical Office Building 203,000 2011 10 Shreveport, Louisiana 9 (1) Average occupancy rate for the hospital facilities is based on the averagenumber of available beds occupied during the five years ended December 31, 2001.Average occupancy rate for the multi-tenant medical office buildings is based onthe occupied square footage of each building. See "Management's Discussion andAnalysis of Financial Condition and Results of Operations" for effects ofvarious occupancy levels at the Trust's hospital facilities. Average availablebeds is the number of beds which are actually in service at any given time forimmediate patient use with the necessary equipment and staff available forpatient care. A hospital may have appropriate licenses for more beds than are inservice for a number of reasons, including lack of demand, incompleteconstruction 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 atthe end of 1989. Each facility is leased pursuant to a separate lease. Noassurance can be given as to the effect, if any, the consolidation of the twofacilities as mentioned above, had on the underlying value of the Virtue StreetPavilion and Chalmette Medical Center. Rental commitments and the guarantee byUHS under the existing leases continue for the remainder of the respective termsof the leases. The lease between Chalmette Medical Center and the Trust isscheduled to expire on March 29, 2003. The renewal option requires the leaserate to be reset based on the prevailing five year U.S. Treasury bill rate. Thisformula could result in decreased rental income to the Trust.(3) During the first quarter of 2001, UHS purchased the assets and operations ofthe 60-bed McAllen Heart Hospital located in McAllen, Texas. Upon theacquisition by UHS, the Heart Hospital began operating under the same license asan integrated department of McAllen Medical Center. As a result of combining theoperations of the two facilities, the revenues of McAllen Medical Center includerevenues generated by the Heart Hospital, the real property of which is notowned by the Trust. Accordingly, since the bonus rent calculation for McAllenMedical Center is based on net revenues and since the financial results of thetwo facilities are no longer separable, the McAllen Medical Center lease wasamended during 2001 to exclude from the bonus rent calculation, the estimatednet revenues generated at the Heart Hospital. Base rental commitments and theguarantee by UHS under the original lease continue for the remainder of thelease terms. During 2000, UHS purchased a non-acute care facility located inMcAllen, Texas that had been closed. The license for this facility was mergedwith the license for McAllen Medical Center and this non-acute facility, thereal property of which is not owned by the Trust, was re-opened during 2001.There was no amendment to the McAllen Medical Center lease related to this non-acute care facility. No assurance can be given as to the effect, if any, theconsolidation of the two facilities as mentioned above, had on the underlyingvalue of McAllen Medical Center.(4) During December of 1993, UHS, the former lessee and operator of BelmontCommunity Hospital, sold the operations of the facility to THC-Chicago, Inc., anindirect wholly-owned subsidiary of Community Psychiatric Centers ("CPC").Concurrently, the Trust purchased certain related real property from UHS for $1million in cash and a note payable in the amount of $1,446,000, includingaccrued interest, which will be paid by the Trust on April 30, 2002. No furtherobligation will be owed by the Trust to UHS in connection with this transaction.Included in the Trust's financial results was $87,000 in 2001, $70,000 in 2000and $76,000 in 1999 of interest expense recorded in connection with this note.In connection with this transaction, UHS's lease with the Trust was terminatedand the Trust entered into an eight year lease agreement with THC-Chicago. Thelease is scheduled to expire in December, 2006. In 1997, CPC was acquired byVencor, Inc. who assumed their obligations under the lease and renamed thefacility Vencor Hospital-Chicago. During 1999, Vencor, Inc. filed for bankruptcy. Vencor, Inc. emerged from bankruptcy on April 20, 2001 and changedtheir name to Kindred Healthcare, Inc. The lease is guaranteed by KindredHealthcare, Inc. As of December 31, 2001, the Trust received all rent amountsdue related to this property. 10 Item 3. LEGAL PROCEEDINGSNot applicable.Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSNot applicable. No matter was submitted during the fourth quarter of the yearended December 31, 2001 to a vote of security holders. PART IIItem 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERSThe Trust's shares of beneficial interest are listed on the New York StockExchange. The high and low closing sales prices for the Trust shares ofbeneficial interest for each quarter in the two years ended December 31, 2001and 2000 are summarized below: 2001 2000 ------------------------ ------------------------ High Price Low Price High Price Low Price ------------------------ ------------------------First Quarter $21.02 $18.9375 $16.6875 $14.3125Second Quarter $23.96 $ 19.63 $18.9375 $ 15.25Third Quarter $24.70 $ 21.12 $ 19.375 $ 17.00Fourth Quarter $25.70 $ 23.50 $ 19.875 $ 17.125As of January 31, 2002, there were approximately 737 shareholders of record ofthe Trust's shares of beneficial interest. It is the Trust's intention todeclare quarterly dividends to the holders of its shares of beneficial interestso as to comply with applicable sections of the Internal Revenue Code governingreal estate investment trusts. Covenants relating to the revolving creditfacility limit the Trust's ability to increase dividends in excess of 95% ofcash available for distribution unless additional distributions are required tobe made so as to comply with applicable sections of the Internal Revenue Codeand related regulations governing real estate investment trusts. In each of thepast five years, dividends per share were declared as follows: 2001 2000 1999 1998 1997 -------- -------- -------- -------- -------First Quarter $ .465 $ .455 $ .450 $ .435 $ .425Second Quarter .465 .460 .450 .435 .425Third Quarter .470 .460 .455 .440 .425Fourth Quarter .475 .465 .455 .445 .430 -------- -------- -------- -------- ------- $1.875 $1.840 $1.810 $1.755 $1.705 ======== ======== ======== ======== ======= 11 Item 6. SELECTED FINANCIAL DATAFinancial highlights for the Trust for the five years ended December 31, 2001were as follows: (000s, except per share amounts) ------------------------------------------------------------------------ 2001 (1) 2000 (1) 1999 (1) 1998 1997 ---------------------------------------------------------------------------------------------------------------- Operating Results:Total revenue $ 27,574 $ 27,315 $ 23,865 $ 23,234 $ 22,764Net income 18,349 16,256 13,972 14,337 13,967 Balance Sheet Data:Real estate investments, net of accumulated depreciation $139,215 $143,092 $141,367 $129,838 $133,486Investments in LLCs 46,939 39,164 35,748 38,165 11,075Total assets 187,904 183,658 178,821 169,406 146,755Total indebtedness (3) 33,432 82,031 76,889 66,016 42,347 Other Data:Funds from operations (2) $ 25,968 $ 22,878 $ 21,772 $ 19,857 $ 18,809Cash provided by (used in): Operating activities 22,778 19,970 19,579 18,655 17,706 Investing activities (8,332) (8,913) (14,437) (27,215) (541) Financing activities (14,111) (11,615) (4,862) 7,894 (16,064) Per Share Data:Net income-Basic $ 1.75 $ 1.81 $ 1.56 $ 1.60 $ 1.56Net income-Diluted 1.74 1.81 1.56 1.60 1.56Dividends 1.875 1.840 1.810 1.755 1.705(1) See "Management's Discussion and Analysis of Financial Condition and Resultsof Operations."(2) Funds from operations ("FFO") is the sum of net income plus depreciationexpense for consolidated investments and unconsolidated investments (in 1997through 2001); amortization of interest rate cap (in 1999, 1998 and 1997);provision for investment loss, net (in 1999); equity in provision loss of LLC(in 2000), and; less gain on sale of real property to UHS (in 2000), and gain onderivatives (in 2001). FFO may not be calculated in the same manner for allcompanies, and accordingly, FFO as presented above may not be comparable tosimilarly titled measures by other companies. FFO does not represent cash flowsfrom operations as defined by generally accepted accounting principles andshould not be considered as an alternative to net income as an indicator of theTrust's operating performance or to cash flows as a measure of liquidity. InJune of 2001, the Trust issued 2.6 million additional shares of beneficialinterest at $21.57 per share generating net proceeds of $53.9 million to theTrust. These proceeds were used to repay outstanding borrowings under theTrust's $100 million revolving credit facility thereby decreasing interestexpense and increasing the FFO from June through December of 2001.(3) Excludes $115.6 million of third-party debt as of December 31, 2001 that isnon-recourse to the Trust, incurred by LLCs in which the Trust holds various non-controlling equity interests (see Note 10 to the Trust's ConsolidatedFinancial Statements). 12 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSForward Looking Statements--------------------------The matters discussed in this report, as well as the news releases issued fromtime 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 PrivateSecurities Litigation Reform Act of 1995. Such forward-looking statementsinvolve known and unknown risks, uncertainties and other factors that may causethe actual results, performance or achievements of the Trust's or industryresults to be materially different from any future results, performance orachievements expressed or implied by such forward-looking statements. Suchfactors include, among other things, the following: a substantial portion of theTrust's revenues are dependent on one operator, Universal Health Services, Inc.,("UHS"); a substantial portion of the Trust's leases are involved in thehealthcare industry which is undergoing substantial changes and is subject topossible changes in the levels and terms of reimbursement from third-partypayors and government reimbursement programs, including Medicare and Medicaid;the Trust's ability to finance its growth on favorable terms; liability andother 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: industrycapacity; demographic changes; existing laws and government regulations andchanges in or failure to comply with laws and governmental regulations; theability to enter into managed care provider agreements on acceptable terms;competition; the loss of significant customers; technological and pharmaceuticalimprovements that increase the cost of providing, or reduce the demand forhealthcare; the ability to attract and retain qualified personnel, includingphysicians, and; other factors referenced in the Trust's 2001 10-K or herein.Management of the Trust is unable to predict the effect, if any, these factorswill have on the operating results of its lessees, including the facilitiesleased to subsidiaries of UHS. Given these uncertainties, prospective investorsare cautioned not to place undue reliance on such forward-looking statements.The Trust disclaims any obligation to update any such factors or to publiclyannounce the result of any revisions to any of the forward-looking statementscontained herein to reflect future events or developments.Results of Operations---------------------The Trust commenced operations on December 24, 1986. As of December 31, 2001,the Trust had investments in forty-two facilities located in fifteen states.Total revenues increased 1% or $259,000 to $27.6 million in 2001 as compared to2000 and 14% or $3.5 million to $27.3 million in 2000 as compared to 1999. The$259,000 increase in net revenues during 2001 as compared to 2000 was dueprimarily to a $924,000 increase in base rentals from non-related parties and a$406,000 increase in bonus rental from UHS facilities that was partially offsetby a $1.1 million decrease in base rental from UHS facilities. The increases inbase rentals from non-related parties resulted primarily from the revenuesgenerated from the Southern Crescent II medical office building which was openedduring the third quarter of 2000. The decrease in base rentals from UHSfacilities resulted from the purchase of previously leased property from theTrust by Meridell Achievement Center, Inc., (a subsidiary of UHS) in December,2000. The $3.5 million increase during 2000 over 1999 was due primarily to a$3.3 million increase in base rentals from non-related parties resultingprimarily from revenues generated from the Sheffield Medical Building, theOrthopaedic Specialists of Nevada Building, the medical office building locatedin Danbury, Connecticut as well as the Southern Crescent Center II medicaloffice building, all of which were acquired/opened during or subsequent to thefourth quarter of 1999. 13 Interest expense decreased $2.2 million or 36% in 2001 as compared to 2000. The reduction in interest expense during 2001 as compared to 2000 resulted primarily from a reduction in the average outstanding borrowings under the Trust's revolving credit agreement due primarily to the repayment of outstanding borrowings using the $53.9 million of net proceeds generated from the issuance of an additional 2.6 million shares of beneficial interest in June, 2001. Interest expense increased $2.1 million or 53% in 2000 as compared to 1999 due primarily to the additional borrowings used to finance additional investments during 2000 and 1999 and an increase in the effective rate on the Trust's revolving credit facility, including commitment fees and interest rate swap expense, which increased to 7.1% in 2000 as compared to 6.2% in 1999. Depreciation and amortization expense decreased slightly in 2001 as compared to 2000 and increased $604,000 or 16% in 2000 as compared to 1999. The increase in 2000 as compared to 1999 was due primarily to the depreciation expense related to various acquisitions made in 2000 and 1999. Other operating expenses increased $405,000 or 14% in 2001 as compared to 2000 primarily due to expenses related to Southern Crescent II medical office building which opened during the third quarter of 2000. Other operating expenses increased $1.0 million or 57% in 2000 as compared to 1999 primarily due to the expenses related to acquisitions made in 2000 and 1999. Included in the Trust's other operating expenses were expenses related to the medical office buildings, in which the Trust has a controlling ownership interest which totaled $2.5 million in 2001, $2.1 million in 2000 and $1.0 million in 1999. A portion of the expenses associated with the medical office buildings are passed on directly to the tenants and are included as revenues in the Trust's statements of income. During 1999, the Trust sold the real estate assets of Lakeshore Hospital for net cash proceeds of $998,000. Since the book value of this facility was reduced to zero in a prior year, the net cash proceeds received were recorded as a gain and netted against the provision for investment loss. Also during 1999, a provision for investment loss of $2.6 million was recorded on Meridell Achievement Center, Inc., a behavioral health services facility operated by, and formerly leased from the Trust, by a wholly-owned subsidiary of UHS pursuant to the terms of a lease that expired in December, 2000. In measuring the provision for investment loss in 1999, the Trust estimated fair value by discounting (using the Trust's internal hurdle rate) expected future cash flows, consisting of estimated future rental payments and residual value. During the second quarter of 2000, the wholly-owned subsidiary of UHS exercised its option pursuant to the lease to purchase the leased property upon the December 31, 2000 expiration of the initial lease. Pursuant to the terms of the lease agreement, three appraisals were obtained to determine the fair market value of the property and accordingly, the sale price was determined to be $5,450,000. This sale was completed in December, 2000 resulting in a gain of approximately $1.9 million which is included in the Trust's 2000 results of operations. Also during 2000, the Trust recorded a provision for investment loss of $1.1 million to reflect its share of an asset impairment charge recorded at a limited liability company (in which the Trust owns a 60% non-controlling interest) resulting from declines in the performance of a medical office complex located in Phoenix, Arizona. In measuring the provision for investment loss of the limited liability company in 2000, management of the Trust concluded that the estimated fair value of the real property (calculated by discounting expected future cash flows, consisting of estimated future rental payments and residual value) did not exceed the mortgage, that is non-recourse to the Trust, held on the property by a third-party lending institution. Accordingly, the $1.1 million charge was recorded during the fourth quarter of 2000 to reduce the Trust's investment in this limited liability company to zero. 14 Included in the Trust's financial results was $3.6 million in 2001, $2.9 million in 2000 and $2.6 million in 1999, of income generated from the Trust's ownership of equity interests in limited liability companies which own medical office buildings in Arizona, California, Kentucky, New Mexico, Nevada and Maine (see Note 10 to the Consolidated Financial Statements). The Trust adopted SFAS No. 133 effective January 1, 2001. The adoption of this new standard in 2001 resulted in a gain on derivatives of $17,000. Net income for 2001 was $18.4 million or $1.74 per diluted share compared to $16.3 million or $1.81 per diluted share in 2000 and $14.0 million or $1.56 per diluted share in 1999. The 2001 net income per diluted share reflects the weighted effect of the 2.6 million newly issued shares of beneficial interest that were issued in June of 2001. Funds from operations ("FFO"), which is the sum of net income plus depreciation expense for consolidated investments and unconsolidated investments (in 2001, 2000 and 1999); amortization of interest rate cap (in 1999); provision for investment loss (in 1999); equity in provision loss of LLC (in 2000), and; less gain on sale of real property to UHS (in 2000) and gain on derivatives (in 2001) totaled $26.0 million in 2001, $22.9 million in 2000 and $21.8 million in 1999. 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. In June of 2001, the Trust issued 2.6 million additional shares of beneficial interest at $21.57 per share generating net proceeds of $53.9 million to the Trust. These proceeds were used to repay outstanding borrowings under the Trust's $100 million revolving credit facility thereby decreasing interest expense and increasing the FFO from June through December of 2001. General ------- 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. A significant portion of the revenues from the Trust's hospital facilities are derived from the Medicare and Medicaid programs as well as managed care plans which include health maintenance organizations ("HMOs") and preferred provider organizations ("PPOs"). Generally, the Trust's hospital facilities continue to experience an increase in revenues attributable to managed care payors as pressures to control healthcare costs, as well as a shift away from traditional Medicare to Medicare managed care plans, have resulted in an increase in the number of patients whose healthcare coverage is provided under managed care plans. Typically, the Trust's hospital facilities receive lower payments per patient from managed care payors than from traditional indemnity insurers. However, during the past year, many of the Trust's hospital facilities secured price increases from many of its commercial payors including managed care companies. 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. 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, HMOs, PPOs and insurers to reduce hospital stays and provide services, where possible, on a less expensive outpatient basis. The 15 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 and admission constraints. The Federal government makes payments to participating hospitals under its Medicare program based on various formulas. The operators of the Trust's general acute care hospitals are subject to a prospective payment system ("PPS"). For inpatient services, PPS pays acute care hospitals a predetermined amount per diagnostic related group ("DRG") based upon a hospital's location and the patient's diagnosis. Behavioral health facilities, which are excluded from the inpatient services PPS, are cost reimbursed by the Medicare program, but are generally subject to a per discharge ceiling, calculated based on an annual allowable rate of increase over the hospital's base year amount under the Medicare laws and regulations. Beginning August 1, 2000 under a new outpatient prospective payment system ("OPPS") mandated by the Balanced Budget Act of 1997 ("BBA- 97"), both general acute and behavioral health hospitals' outpatient services are paid a predetermined amount per Ambulatory Payment Classification based upon a hospital's location and the procedures performed. The Medicare, Medicaid and SCHIP Balanced Budget Refinement Act of 1999 ("BBRA of 1999") included "transitional corridor payments" through fiscal year 2003, which provide some financial relief for any hospital that generally incurs a reduction to its Medicare outpatient reimbursement under the new OPPS. BBRA of 1999 required that the Health Care Financing Administration, now known as the Centers for Medicare and Medicaid Services ("CMS"), develop an inpatient psychiatric per diem prospective payment system effective for the federal fiscal year beginning October 1, 2002, however, it is possible that the implementation may be delayed. Upon implementation, this new prospective payment system will replace the current inpatient psychiatric payment system. In addition to the trends described above that continue to have an impact on the operating results of the Trust's hospital facilities, there are a number of other more general factors affecting the operators of the Trust's facilities. BBA-97 called for the government to trim the growth of federal spending on Medicare by $115 billion and on Medicaid by $13 billion over the following years. BBA-97 also called for reductions in the future rate of increases to payments made to hospitals and reduced the amount of reimbursement for outpatient services, bad debt expense and capital costs. Some of these reductions were reversed with the passage on December 15, 2000 of the Medicare, Medicaid and SCHIP Benefits Improvement and Protection Act of 2000 ("BIPA") which, among other things, increased Medicare and Medicaid payments to healthcare providers by $35 billion over 5 years with approximately $12 billion of this amount targeted for hospitals and $11 billion for managed care payors. These increased reimbursements to hospitals pursuant to the terms of BIPA commenced in April, 2001. BBA-97 established the annual update for Medicare at market basket minus 1.1% in both fiscal years 2001 (October 1, 2000 and through September 30, 2001) and 2002 and BIPA revised the update at the full market basket in fiscal year 2001 and market basket minus .55% in fiscal years 2002 and 2003. Additionally, BBA-97 reduced reimbursement to hospitals for Medicare bad debts to 55% and BIPA increased the reimbursement to 70%. It is possible that future federal budgets will contain certain further reductions or increases in the rate of increase of Medicare and Medicaid spending. The Trust can provide no assurance that the reductions in the PPS update, and other changes required by BBA-97, will not adversely affect the operators of the Trust's facilities. However, within certain limits, a hospital can manage its costs, and, to the extent this is done effectively, a hospital may benefit from the DRG system. However, many hospital operating costs are incurred in order to satisfy licensing laws, standards of the Joint Commission on the Accreditation of 16 Healthcare Organizations ("JCAHO") and quality of care concerns. In addition, hospital costs are affected by the level of patient acuity, occupancy rates and local physician practice patterns, including length of stay, judgments and number and type of tests and procedures ordered. A hospital's ability to control or influence these factors which affect costs is, in many cases, limited. A large portion of the Trust's non-hospital properties consist of medical office buildings which are located either close to or on the campuses of hospital facilities. These properties are either directly or indirectly affected by the factors discussed above as well as general real estate factors such as the supply and demand of office space and market rental rates. 17 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 rate 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 commencement of the swap agreements. The interest rate swap agreements do not constitute positions independent of the underlying exposures. The Trust does not hold or 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, 2001, 2000 and 1999, the Trust received a weighted average rate of 4.14%, 6.80% and 6.09%, respectively, and paid a weighted average rate on its interest rate swap agreements of 5.98%, 6.02% and 6.02%, 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, 2001. 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, 2001. Maturity Date, Fiscal Year Ending December 31 --------------------------------------------- There- (Dollars in thousands) 2002 2003 2004 2005 2006 after Total ---- ---- ---- ---- ---- ---- ----- Long-term debt: Fixed rate $ 89 $ 97 $ 105 $ 114 $ 124 $3,839 $ 4,368 Average interest rates 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% Variable rate long-term debt $27,600 $27,600 Interest rate swaps: Pay fixed/receive Variable notional amounts $ 4,000 $ 0 $10,000 $ 0 $20,000 $ 0 $34,000 (a) (b) Average pay rate 6.6025% 5.65% 6.02% Average receive rate 6 month 3 month 3 month LIBOR LIBOR LIBOR(a) The counterparty has the one time option to cancel this interest rate SWAP early on May 17, 2002.(b) The counterparty has the one time option to cancel a $10 million interest rate SWAP on November 3, 2003. 18 Liquidity and Capital Resources ------------------------------- 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 to comply with applicable sections of the Internal Revenue Code and related regulations governing real estate investment trusts. Dividends were declared and paid as follows: (i) $1.875 per share or $20.6 million in the aggregate in 2001; (ii) $1.840 per share or $16.5 million in the aggregate in 2000, and; (iii) $1.810 per share or $16.2 million in the aggregate in 1999. Net cash generated by operating activities was $22.8 million in 2001, $20.0 million in 2000 and $19.6 million in 1999. The $2.8 net million increase in 2001 as compared to 2000 was due primarily to an increase in net income plus or minus the non-cash adjustments (depreciation, amortization, gain on sale of real property and equity in provision for investment loss of LLC). This increase was caused primarily by a reduction in interest expense in 2001 as compared to 2000 resulting primarily from the repayment of borrowings under the Trust's revolving credit agreement using proceeds generated from the issuance of 2.6 million newly issued shares of beneficial interest in June, 2001. The $400,000 net increase in 2000 as compared to 1999 was due primarily to: (i) a $487,000 increase in net income plus or minus the non-cash adjustments (depreciation, amortization, amortization of interest rate cap expense, gain on sale of real property, equity in provision for investment loss of LLC and provision for investment loss); (ii) a $129,000 unfavorable change in rent receivable; (iii) a $149,000 unfavorable change in accrued interest, and; (iv) a $179,000 favorable change in other working capital accounts. During 2001, the $22.8 million of cash generated from operating activities, the $55.2 million of net proceeds generated from the issuance of 2.7 million shares of beneficial interest (2.6 million shares issued in the public offering and approximately 100,000 shares issued in connection with the Trust's Dividend Reinvestment and Non-Statutory Stock Option Plans) and the $1.4 million of cash distributions received in excess of income from the Trust's investments in LLCs were used primarily to: (i) repay debt ($48.7 million); (ii) purchase of a 75% equity interest in a LLC that owns and operates the Thunderbird Paseo Medical Plaza II located in Glendale, Arizona ($1.4 million of cash invested in the LLC which also obtained a $3.1 million third-party mortgage that is non-recourse to the Trust); (iii) purchase a 74% equity interest in a LLC that owns and operates the Mid Coast Hospital Medical Office Building located in Brunswick, Maine ($1.9 million of cash invested in the LLC which also obtained a $8.9 million third-party mortgage that is non-recourse to the Trust); (iv) purchase an additional equity interest and fund additional investments and loans to various LLCs in which the Trust has various non-controlling equity interests ($3.0 million); (v) finance capital expenditures ($600,000), and; (vi) pay dividends ($20.6 million). Also during 2001, the Trust invested $2.8 million of cash in a LLC for the purpose of effecting a like-kind exchange which was completed in January, 2002. In connection with this transaction, the LLC in which the Trust owns an 89% non-controlling equity interest, acquired the real estate assets of Papago Medical Park located in Phoenix, Arizona in exchange for cash and the real estate assets of Samaritan West Valley Medical Center located in Goodyear, Arizona. The completion of this transaction, which was a like-kind exchange for income tax purposes, resulted in $2.5 million of cash received by the Trust in January, 2002 and a book gain of approximately $1.1 million which will be included in the Trust's first quarter of 2002 results of operations. During 2000, the $20.0 million of cash flows generated from operating activities, the $5.5 million proceeds received from the sale of Meridell Achievement Center, the $1.3 million of cash 19 distributions received in excess of income from the Trust's investments in LLCs and the $5.1 million of additional borrowings were used primarily to: (i) purchase a medical office building located in Danbury, Connecticut ($1.9 million of cash invested in addition to a $4.5 million third-party mortgage that is non-recourse to the Trust); (ii) purchase a 95% equity interest in a limited liability company that owns and operates Skypark Professional Medical Building located in Torrance, California ($1.8 million of cash invested in the LLC which also obtained a $4.3 million third-party mortgage that is non-recourse to the Trust); (iii) purchase a 67% equity interest in a limited liability company that owns and operates the Centinela Medical Building Complex located in Inglewood, California ($2.0 million of cash invested in the LLC which also obtained a $7.5 million third-party mortgage that is non-recourse to the Trust); (iv) finance capital expenditures, including the construction of the Southern Crescent Center II, which was completed and opened during the third quarter of 2000, ($3.4 million); (v) purchase a 98% equity interest in a limited liability company that owns and operates the Summerlin Hospital Medical Office Building II ($2.0 million of cash invested in the LLC which also obtained a $9.8 million of third-party mortgage that is non-recourse to the Trust), and; (vi) pay dividends ($16.5 million). During 1999, the $19.6 million of cash flows generated from operating activities, the $10 million of cash received for the repayments of three short-term loans advanced to separate LLCs during 1998, the $1.2 million of cash distributions received in excess of income from the Trust's investments in LLCs, the $10.8 million of additional borrowings and the $998,000 of proceeds received from the sale of Lakeshore Hospital were used primarily to: (i) purchase a 95% equity interest in a limited liability company that owns the Santa Fe Professional Plaza located in Scottsdale, Arizona ($1.2 million of cash invested in the LLC which also obtained a $1.9 million third-party mortgage that is non-recourse to the Trust); (ii) purchase a 98% equity interest in a limited liability company that owns the Summerlin Hospital Medical Office Building located in Las Vegas, Nevada ($5.0 million of cash invested in the LLC which also obtained a $8.3 million third-party mortgage that is non-recourse to the Trust); (iii) purchase a 75% equity interest in a limited liability company that owns the East Mesa Medical Center located in Mesa, Arizona ($1.6 million of cash invested in the LLC which also obtained a $4.2 million third-party mortgage that is non-recourse to the Trust); (iv) invest additional capital in existing LLCs ($1.0 million); (v) purchase the single-tenant Orthopaedic Specialists of Nevada Building in Las Vegas, Nevada ($1.6 million of cash invested); (vi) acquire the Sheffield Medical Building ($11.5 million of cash invested); (vii) finance capital expenditures ($4.4 million); (viii) purchase land ($307,000), and; (ix) pay dividends ($16.2 million). In June, 2001, the Trust issued 2.6 million shares of beneficial interest at a price of $21.57 per share. The shares were offered under the Trust's previously filed $100 million shelf registration statement. The equity issuance generated net proceeds of $53.9 million which were used to repay outstanding borrowings under the Trust's $100 million revolving credit facility. The Trust has an unsecured, non-amortizing $100 million 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 .625% to 1.125%, Eurodollar rate plus .50% to 1.125% 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, 2001, the applicable margin over the certificate of deposit and Eurodollar rates were .625% and .50%, respectively, and the commitment fee was .17%. 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. The Trust was granted a one-time waiver of this provision in connection with its issuance of 2.6 million shares, as mentioned above. The average 20 amounts outstanding under the Trust's revolving credit agreement were $46.1 million in 2001, $78.5 million in 2000 and $62.0 million in 1999 with corresponding effective interest rates, including commitment fees and interest rate swap expense, of 7.4% in 2001, 7.1% in 2000 and 6.2% in 1999. At December 31, 2001, the Trust had approximately $67 million of available borrowing capacity. The book value of the amounts borrowed approximates fair market value. The Trust has entered into interest rate swap agreements which are designed to reduce the impact of changes in interest rates on its floating rate revolving credit notes. At December 31, 2001, the Trust had four outstanding swap agreements having a total notional principal amount of $34 million which mature from July, 2002 through November, 2006. These swap agreements effectively fix the interest rate on $34 million of variable rate debt at 6.48% including the revolver spread of .50%. The interest rate swap agreements were entered into in anticipation of certain borrowing transactions made by the Trust. Additional interest expense/(income) recorded as a result of the Trust's hedging activity, which is included in the effective interest rates shown above, was $680,000, ($164,000) and $135,000 in 2001, 2000 and 1999, respectively. The Trust is exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swap 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, 2001 would have resulted in payments to the counterparties to the Trust of approximately $2,165,000. The fair value of the interest rate swap agreements at December 31, 2001 reflects the estimated amounts that the Trust would pay or receive to terminate the contracts and are based on quotes from the counterparties. 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 is in compliance with such covenants at December 31, 2001. The following represents the scheduled maturities of the Trust's contractual obligations as of December 31, 2001: Payments Due by Period (dollars in thousands) Less than 2 - 3 4 - 5 After Contractual Obligation Total 1 Year years years 5 years ---------------------- ------------ -------------- -------------- ------------- ------------ Long-term debt fixed $ 4,368 $ 447 $ 894 $ 894 $ 2,133Long-term debt-variable 29,064 1,464 27,600 --- ---Accrued interest 330 330 --- --- ---Construction commitments (a) 3,400 3,400 --- --- --- --------- ----------- ----------- ---------- ----------Total contractual cash obligations $ 37,162 $ 5,641 $ 28,494 $ 894 $ 2,133 ========= =========== =========== ========== ========== (a) The Trust has committed to invest a total of $3.4 million in exchange for an 80% non-controlling interest in a limited liability company that will construct and own the Deer Valley Medical Office II located in Phoenix, Arizona. Related Party Transactions -------------------------- UHS of Delaware, Inc. (the "Advisor"), a wholly owned subsidiary of UHS, serves as Advisor 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 21 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 2002. All transactions with UHS must be approved by the Independent Trustees. For the years ended December 31, 2001, 2000 and 1999, 60%, 63% and 70%, respectively, of the Trust's revenues were earned under the terms of the leases with wholly-owned subsidiaries of UHS. Including 100% of the revenues generated at the unconsolidated LLCs in which the Trust has various non-controlling equity interests ranging from 33% to 99%, the UHS leases accounted for 31% in 2001, 35% in 2000 and 39% in 1999 of the combined consolidated and unconsolidated revenues. The leases to subsidiaries of UHS are guaranteed by UHS and cross-defaulted with one another. See Note 2 to the Consolidated Financial Statements for additional disclosure. Significant Accounting Policies ------------------------------- The Trust has determined that the following accounting policies are critical to the understanding of the Trust's Consolidated Financial Statements. Investments in Limited Liability Companies ("LLCs") 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 investments in LLCs 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 the net income, cash contributions and distributions of the investments. Since 1995 through December 31, 2001, the Trust invested $54.9 million of cash in LLCs in which it owns various non-controlling equity interests ranging from 33% to 99%. On a combined basis, these LLCs generated revenues of $26.5 million in 2001, $22.2 million in 2000 and $18.4 million in 1999 and net income of $3.9 million in 2001, $3.3 million in 2000 and $2.8 million in 1999. Also on a combined basis, as of December 31, 2001 and 2000, these LLCs had total assets of $174.5 million and $154.2 million, respectively, and third-party financing that is non-recourse to the Trust of $115.6 million and $98.8 million, respectively (see Note 10 to the Consolidated Financial Statements). 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, the Trust is exempt from Federal Income Taxes and it is required to distribute at least 90% 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. 22 Earnings and profits, which determine the taxability of dividends toshareholders, will differ from net income reported for financial reportingpurposes due to the differences for federal tax purposes in the cost basis ofassets and in the estimated useful lives used to compute depreciation and therecording of provision for investment losses.Item 7.a. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKSee Item 7. Management's Discussion and Analysis of Operations and FinancialCondition - Market Risks Associated with Financial Instruments.Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe Trust's Balance Sheets and its Statements of Income, Changes inShareholders' Equity and Cash Flows, together with the report of Arthur AndersenLLP, independent public accountants, are included elsewhere herein. Reference ismade to the "Index to Financial Statements and Schedules."Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURENot applicable. PART IIIItem 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTThere is hereby incorporated by reference the information to appear under thecaption "Election of Trustees" in the Trust's definitive Proxy Statement to befiled with the Securities and Exchange Commission within 120 days after December31, 2001. See also "Executive Officers of the Registrant" appearing in Part Ihereof.Item 11. EXECUTIVE COMPENSATIONThere is hereby incorporated by reference the information under the caption"Executive Compensation" and "Compensation Pursuant to Plans" in the Trust'sdefinitive Proxy Statement to be filed with the Securities and ExchangeCommission within 120 days after December 31, 2001.Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENTThere is hereby incorporated by reference the information under the caption"Security Ownership of Certain Beneficial Owners and Management" in the Trust'sdefinitive Proxy Statement to be filed with the Securities and ExchangeCommission within 120 days after December 31, 2001.Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSThere is hereby incorporated by reference the information under the caption"Transactions With Management and Others" in the Trust's definitive ProxyStatement to be filed with the Securities and Exchange Commission within 120days after December 31, 2001. 23 PART IVItem 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, 2001 and 2000 Consolidated Statements of Income - Years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Shareholders' Equity - Years Ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows - Years Ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements - December 31, 2001 (3) Schedules Schedule II - Valuation and Qualifying Accounts - Years Ended December 31, 2001, 2000 and 1999 Schedule III - Real Estate and Accumulated Depreciation - December 31, 2001 Notes to Schedule III - December 31, 2001 (b) Reports on Form 8-K: No reports on Form 8-K were filed during the last quarter of the year ended December 31, 2001 (c) Exhibits: 3.1 Declaration of Trust, dated as of August 1986, previously filed asExhibit 3.1 Amendment No. 3 of the Registration Statement on Form S-11 and FormS-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 forthe year ended December 31, 1993, is incorporated herein by reference. 3.3 Amended and restated bylaws, filed as Exhibit 10.1 to the Trust'sForm 10-Q for the quarter ended March 31, 1998, is incorporated herein byreference. 10.1 Advisory Agreement, dated as of December 24, 1986, between UHS ofDelaware, Inc. and The Trust, previously filed as Exhibit 10.2 to the Trust'sCurrent Report on Form 8-K dated December 24, 1986, is incorporated herein byreference. 10.2 Agreement effective January 1, 2002, to renew Advisory Agreementdated as of December 24, 1986 between Universal Health Realty Income Trust andUHS of Delaware, Inc. 24 10.3 Contract of Acquisition, dated as of August 1986, between the Trustand certain subsidiaries of Universal Health Services, Inc., previously filed asExhibit 10.2 to Amendment No. 3 of the Registration Statement on Form S-11 andS-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 RegistrationStatement on Form S-11 and Form S-2 of Universal Health Services, Inc. and theTrust (Registration No. 33-7872), is incorporated herein by reference. 10.5 Share Option Agreement, dated as of December 24, 1986, between theTrust and Universal Health Services, Inc., previously filed as Exhibit 10.4 tothe Trust's Current Report on Form 8-K dated December 24, 1986, is incorporatedherein by reference. 10.6 Corporate Guaranty of Obligations of Subsidiaries Pursuant to Leasesand Contract of Acquisition, dated December 1986, issued by Universal HealthServices, Inc. in favor of the Trust, previously filed as Exhibit 10.5 to theTrust's Current Report on Form 8-K dated December 24, 1986, is incorporatedherein by reference. 10.7 Share Compensation Plan for Outside Trustees, previously filed asExhibit 10.12 to the Trust's Annual Report on Form 10-K for the year endedDecember 31, 1991, is incorporated herein by reference. 10.8 Lease dated December 22, 1993, between Universal Health Realty IncomeTrust and THC-Chicago, Inc. as lessee, previously filed as Exhibit 10.14 to theTrust's Annual Report on Form 10-K for the year ended December 31, 1993, isincorporated herein by reference. 10.9 Universal Health Realty Income Trust 1997 Incentive Plan, previouslyfiled as Exhibit 10.1 to the Trust's Form 10-Q for the quarter ended September30, 1997, is incorporated herein by reference. 10.10 Amendment No. 1 to Lease, made as of July 31, 1998, between UniversalHealth 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 thequarter ended September 30, 1998, is incorporated herein by reference. 10.11 Amendment No. 1 to Lease, made as of July 31, 1998, between UniversalHealth 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 ofDecember 24, 1986, between Lessor and Lessee, previously filed as Exhibit 10.2to the Trust's Form 10-Q for the quarter ended September 30, 1998, isincorporated herein by reference. 10.12 Amendment to REVOLVING CREDIT AGREEMENT as of April 30, 1999 among(i) UNIVERSAL HEALTH REALTY INCOME TRUST, a real estate investment trustorganized under the laws of the State of Maryland and having its principal placeof business at 367 South Gulph Road, King of Prussia, Pennsylvania 19406, (ii)VARIOUS FINANCIAL INSTITUTIONS and (iii) FIRST UNION NATIONAL BANK, asadministrative agent for the Banks, previously filed as exhibit 10.1 to theTrusts' Form 10-Q for the quarter ended March 31, 1999, is incorporated hereinby reference. 25 10.13 Dividend Reinvestment and Share Purchase Plan is hereby incorporatedby reference from Registration Statement Form S-3, Registration No. 333-81763,as filed on June 28, 1999. 10.14 Sale agreement, dated October 26, 1999, by and among FB SheffieldPartners, LLC, a Georgia limited liability company having an office at 1827Powers Ferry Road, Building 13, Atlanta, Georgia 30339, Health America RealtyGroup, LLC, a Georgia limited liability company and Universal Health RealtyIncome Trust, having an office at 367 South Gulph Road, King of Prussia,Pennsylvania 19406, previously filed as exhibit 10.23 to the Trusts' Form 10-Kfor the year ended December 31, 1999, is incorporated herein by reference. 10.15 Amendment No. 2 to Revolving Credit Agreement made as of June 6,2001 to the Revolving Credit Agreement dated as of June 24, 1998, as amended byan Amendment to Revolving Credit Agreement dated as of April 30, 1999 amongUniversal Health Realty Income Trust, First Union National Bank, Bank ofAmerica, N.A., Fleet National Bank and PNC Bank, National Association and FirstUnion National Bank, as administrative agent for the banks, previously filed asExhibit 10.1 to the Trust's Form 10-Q for the quarter ended June 30, 2001, isincorporated herein by reference. 10.16 Lease amendment dated as of February 28, 2001 between Universal Health Realty Income Trust and McAllen Hospitals, L.P. 11 Statement re computation of per share earnings is set forth on page F-4, the Trust's Consolidated Statements of Income. 23 Consent of Independent Public Accountants. 99.1 Letter to the Security and Exchange Commission Pursuant toTemporary Note 3T. 26 SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized. Date: March 15, 2002 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 reporthas been signed below by the following persons on behalf of the registrant andin the capacities and on the dates indicated. Date Signature and Title ---- ------------------- /s/ Alan B. Miller ------------------------------------------------March 15, 2002 Alan B. Miller, Chairman of the Board and Chief Executive Officer /s/ Kirk E. Gorman ------------------------------------------------March 15, 2002 Kirk E. Gorman, President, Chief Financial Officer, Secretary and Trustee /s/ James E. Dalton, Jr. ------------------------------------------------March 15, 2002 James E. Dalton, Jr., Trustee /s/ Myles H. Tanenbaum ------------------------------------------------March 15, 2002 Myles H. Tanenbaum, Trustee /s/ Daniel M. Cain ------------------------------------------------March 15, 2002 Daniel M. Cain, Trustee /s/ Miles L. Berger ------------------------------------------------March 15, 2002 Miles L. Berger, Trustee /s/ Elliot J. Sussman ------------------------------------------------March 15, 2002 Elliot J. Sussman, M.D., M.B.A., Trustee 27 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES Page ---- Report of Independent Public Accountants F-2Consolidated Balance Sheets - December 31, 2001 and December 31, 2000 F-3Consolidated Statements of Income - Years Ended December 31, 2001, F-4 2000 and 1999 Consolidated Statements of Shareholders' Equity - Years Ended F-5 December 31, 2001, 2000 and 1999 Consolidated Statements of Cash Flows - Years Ended December 31, F-6 2001, 2000 and 1999 F-7 Notes to the Consolidated Financial Statements - December 31, 2001 Schedule II - Valuation and Qualifying Accounts - Years Ended December F-2231, 2001, 2000 and 1999 Schedule III - Real Estate and Accumulated Depreciation - December 31, F-23 2001 F-24 Notes to Schedule III - December 31, 2001 F-1 Report of Independent Public Accountants ----------------------------------------To The Shareholders and Board of Trustees ofUniversal Health Realty Income Trust:We have audited the accompanying consolidated balance sheets of Universal HealthRealty Income Trust and Subsidiaries (a Maryland real estate investment trust)as of December 31, 2001 and 2000 and the related consolidated statements ofincome, shareholders' equity and cash flows for each of the three years in theperiod ended December 31, 2001. These consolidated financial statements and theschedules referred to below are the responsibility of the Trust's management.Our responsibility is to express an opinion on these consolidated financialstatements and schedules based on our audits.We conducted our audits in accordance with auditing standards generally acceptedin the United States. Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.In our opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the consolidated financial position ofUniversal Health Realty Income Trust and Subsidiaries, as of December 31, 2001and 2000 and the consolidated results of their operations and their cash flowsfor each of the three years in the period ended December 31, 2001, in conformitywith accounting principles generally accepted in the United States. Our audits were made for the purpose of forming an opinion on the basicconsolidated financial statements taken as a whole. The schedules listed in theIndex to Financial Statements and Schedules on Page F-1 are presented for thepurpose of complying with the Securities and Exchange Commission's rules and arenot part of the basic consolidated financial statements. These schedules havebeen subjected to the auditing procedures applied in the audit of the basicconsolidated financial statements and, in our opinion, fairly state in allmaterial respects the financial data required to be set forth therein inrelation to the basic consolidated financial statements taken as a whole. Arthur Andersen LLP Philadelphia, Pennsylvania January 17, 2002 F-2 Universal Health Realty Income Trust ------------------------------------ Consolidated Balance Sheets -------------------------- (dollar amounts in thousands) December 31, December 31,Assets: 2001 2000------- ------------- -------------- Real Estate Investments: Buildings and improvements $ 159,718 $ 159,243 Accumulated depreciation (43,432) (39,080) ------------- -------------- 116,286 120,163 Land 22,929 22,929 ------------- -------------- Net Real Estate Investments 139,215 143,092 ------------- -------------- Investments in limited liability companies ("LLCs") 46,939 39,164 Other Assets: Cash 629 294 Bonus rent receivable from UHS 898 796 Rent receivable from non-related parties 100 208 Deferred charges and other assets, net 123 104 ------------- -------------- $ 187,904 $ 183,658 ============= ============== Liabilities and Shareholders' Equity: -------------------------------------Liabilities: Bank borrowings $ 31,986 $80,672 Note payable to UHS 1,446 1,359 Accrued interest 330 392 Accrued expenses and other liabilities 3,702 1,459 Tenant reserves, escrows, deposits and prepaid rents 363 459 Minority interest 43 60 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: 2001 - 11,678,816 2000 - 8,980,064 117 90 Capital in excess of par value 184,277 129,110 Cumulative net income 175,035 156,686 Accumulated other comprehensive loss on cash flow hedges (2,183) -- Cumulative dividends (207,212) (186,629) ------------- -------------- Total Shareholders' Equity 150,034 99,257 ------------- -------------- $ 187,904 $ 183,658 ============= ==============The accompanying notes are an integral part of these financial statements. F-3 Universal Health Realty Income Trust ------------------------------------ Consolidated Statements of Income --------------------------------- (amounts in thousands, except per share amounts) Year ended December 31, ------------------------------------------------ 2001 2000 1999 ------------ ------------ ------------ Revenues (Note 2): ------------------ Base rental - UHS facilities $ 13,011 $ 14,082 $ 13,828 Base rental - Non-related parties 11,093 10,169 6,844 Bonus rental - UHS facilities 3,470 3,064 2,817 Bonus rental - Non-related parties -- -- 95 Interest -- -- 281 ------------ ------------ ------------ 27,574 27,315 23,865 ------------ ------------ ------------ Expenses: --------- Depreciation and amortization 4,401 4,461 3,857 Interest expense 3,896 6,114 4,004 Advisory fees to UHS (Note 2) 1,346 1,349 1,214 Other operating expenses 3,209 2,804 1,789 Provision for investment loss, net -- -- 1,583 ------------ ------------ ------------ 12,852 14,728 12,447 ------------ ------------ ------------ Income before equity in LLCs and other items 14,722 12,587 11,418 Equity in income of LLCs 3,610 2,913 2,554 Equity in provision for investment loss of LLC -- (1,139) -- Gain on sale of real property to UHS -- 1,895 -- Gain on derivatives 17 -- -- ------------ ------------ ------------ Net Income $ 18,349 $ 16,256 $ 13,972 ============ ============ ============ Net Income Per Share - Basic $ 1.75 $ 1.81 $ 1.56 ============ ============ ============ Net Income Per Share - Diluted $ 1.74 $ 1.81 $ 1.56 ============ ============ ============ Weighted average number of shares outstanding - Basic 10,492 8,981 8,956 Weighted average number of share equivalents 44 22 21 ------------ ------------ ------------ Weighted average number of shares and equivalents outstanding - Diluted 10,536 9,003 8,977 ============ ============ ============ 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, 2001, 2000 and 1999 ---------------------------------------------------- (amounts in thousands, except per share amounts) ------------------------------------------------ Accumulated Common Shares Capital in other --------------------- Number excess of Cumulative Cumulative comprehensive of Shares Amount par value net income dividends loss Total ----------- -------- ----------- ------------ ------------ --------------- --------- January 1, 1999 8,956 $ 90 $128,685 $126,458 ($153,885) -- $101,348 Net income -- -- -- 13,972 -- -- 13,972 Issuance of shares of beneficial interest 35 -- 570 -- -- -- 570 Dividends ($1.810/share) -- -- -- -- (16,215) -- (16,215) ----------------------------------------------------------------------------------------------------------------------------------- January 1, 2000 8,991 90 129,255 140,430 (170,100) -- 99,675 Net income -- -- -- 16,256 -- -- 16,256 Repurchase shares of beneficial interest (12) -- (181) -- -- -- (181) Issuance of shares of beneficial interest 1 -- 36 -- -- -- 36 Dividends ($1.840/share) -- -- -- -- (16,529) -- (16,529) ----------------------------------------------------------------------------------------------------------------------------------- January 1, 2001 8,980 90 129,110 156,686 (186,629) -- 99,257 Issuance of shares of beneficial interest 2,699 27 55,167 -- -- -- 55,194 Dividends ($1.875/share) -- -- -- -- (20,583) -- (20,583) Comprehensive income: Net income -- -- -- 18,349 -- -- 18,349Cumulative effect of change in accounting principle (SFAS No. 133) on other comprehensive loss -- -- -- -- -- (533) (533)Unrealized derivative losses on cash flow hedges -- -- -- -- -- (1,650) (1,650)-----------------------------------------------------------------------------------------------------------------------------------Total - comprehensive income -- -- -- 18,349 -- (2,183) 16,166----------------------------------------------------------------------------------------------------------------------------------- December 31, 2001 11,679 $117 $184,277 $175,035 ($207,212) ($2,183) $150,034=================================================================================================================================== The accompanying notes are an integral part of these financial statements. F-5 Universal Health Realty Income Trust ------------------------------------ Consolidated Statements of Cash Flows ------------------------------------- (amounts in thousands) Year ended December 31, ----------------------------------------------- 2001 2000 1999 --------- --------- --------- Cash flows from operating activities: Net income $ 18,349 $ 16,256 $ 13,972 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 4,401 4,461 3,857 Gain on derivatives (17) -- -- Amortization of interest rate cap -- -- 62 Gain on sale of real property sold to UHS -- (1,895) -- Equity in provision for investment loss of LLC -- 1,139 -- Provision for investment loss, net -- -- 1,583 Changes in assets and liabilities: Rent receivable 6 (214) (85) Accrued expenses and other liabilities 158 188 150 Tenant reserves, escrows, deposits and prepaid rents (96) 55 30 Accrued interest (62) (19) 130 Deferred charges and other assets 39 (1) (120) --------- --------- --------- Net cash provided by operating activities 22,778 19,970 19,579 --------- --------- --------- Cash flows from investing activities: Investments in LLCs (8,748) (5,888) (8,713) Advances (made to) received from LLCs, net (441) -- 9,980 Acquisitions and additions to land, buildings and CIP (555) (9,808) (17,852) Proceeds received from sales of assets -- 5,450 998 Cash distributions in excess of income from LLCs 1,412 1,333 1,150 --------- --------- --------- Net cash used in investing activities (8,332) (8,913) (14,437) --------- --------- --------- Cash flows from financing activities: Net (repayments) borrowings on revolving credit facility (48,606) 600 10,800 Borrowings from mortgage notes payable -- 4,539 -- Repayments of mortgage notes payable (80) (67) -- Dividends paid (20,583) (16,529) (16,215) Repurchase shares of beneficial interest -- (181) -- Issuance of shares of beneficial interest 55,158 23 553 --------- --------- --------- Net cash used in financing activities (14,111) (11,615) (4,862) --------- --------- --------- Increase (decrease) in cash 335 (558) 280Cash, beginning of period 294 852 572 --------- --------- ---------Cash, end of period $ 629 $ 294 $ 852 ========= ========= ========= Supplemental disclosures of cash flow information: Interest paid $ 3,871 $ 6,063 $ 3,739 ========= ========= ========= 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, 2001(1) Summary of Significant Accounting Policies----------------------------------------------Nature of OperationsUniversal Health Realty Income Trust and Subsidiaries (the "Trust") is organizedas a Maryland real estate investment trust. As of December 31, 2001 the Trusthad investments in forty-two facilities located in fifteen states consisting ofinvestments in healthcare and human service related facilities including acutecare hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute care facilities, surgery centers, childcare centers and medical officebuildings. Six of the Trust's hospital facilities and three medical officebuildings are leased to subsidiaries of Universal Health Services, Inc.,("UHS").Federal Income TaxesNo provision has been made for federal income tax purposes since the Trustqualifies as a real estate investment trust under Sections 856 to 860 of theInternal Revenue Code of 1986, and intends to continue to remain so qualified.As such, the Trust is exempt from Federal Income Taxes and it is required todistribute at least 90% of its real estate investment taxable income to itsshareholders.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 ordinaryincome plus 95% of any capital gain income for the calendar year over cashdistributions during the calendar year, as defined. No provision for excise taxhas been reflected in the financial statements as no tax was due.Earnings and profits, which determine the taxability of dividends toshareholders, will differ from net income reported for financial reportingpurposes due to the differences for federal tax purposes in the cost basis ofassets and in the estimated useful lives used to compute depreciation and therecording of provision for investment losses.Real Estate PropertiesThe Trust records acquired real estate at cost and uses the straight-line methodto calculate depreciation expense for buildings and improvements over theirestimated useful lives of 25 to 45 years.It is the Trust's policy to review the carrying value of long-lived assets forimpairment whenever events or changes in circumstances indicate that thecarrying value of such assets may not be recoverable. Measurement of theimpairment loss is based on the fair value of the asset. Generally, theestimated fair value will be determined using valuation techniques such as thepresent value of expected future cash flows. In assessing the carrying value ofthe Trust's real estate investments for possible impairment, management reviewsestimates of future cash flows expected from each of its facilities andevaluates the creditworthiness of its lessees based on their current operatingperformance and on current industry conditions. Since the Trust has significant investments in hospital facilities, whichcomprised 69%, 72% and 80% of net revenues in 2001, 2000 and 1999, respectively,it is subject to certain industry risk factors which directly impact theoperating results of its lessees. In recent years, an increasing F-7 number of legislative initiatives have been introduced or proposed in Congressand in state legislatures that would effect major changes in the healthcaresystem, either nationally or at the state level. In addition, the healthcareindustry has been characterized in recent years by increased competition andconsolidation.During the third quarter of 1999, the Trust sold the real estate assets ofLakeshore Hospital for net cash proceeds of $998,000. Since the book value ofthis facility was reduced to zero in a prior year, the net cash proceedsreceived were recorded as a gain and netted against the provision for investmentloss. Also during the third quarter of 1999, a provision for investment loss of$2.6 million was recorded on Meridell Achievement Center, Inc., a behavioralhealth services facility operated by, and formerly leased by the Trust to, awholly-owned subsidiary of UHS, pursuant to the terms of a lease that expired inDecember, 2000. In measuring the provision for investment loss during the thirdquarter of 1999, the Trust estimated fair value by discounting (using theTrust's internal hurdle rate) expected future cash flows, consisting ofestimated future rental payments and residual value. During the second quarterof 2000, the wholly-owned subsidiary of UHS exercised its option pursuant to thelease to purchase the leased property upon the December 31, 2000 expiration ofthe initial lease. Pursuant to the terms of the lease agreement, threeappraisals were obtained to determine the fair market value of the property andaccordingly, the sale price was determined to be $5,450,000. This sale wascompleted in December, 2000 resulting in a gain of approximately $1.9 millionwhich is included in the Trust's 2000 results of operations.Management of the Trust is unable to predict the effect, if any, that theindustry factors discussed above will have on the operating results of itslessees or on their ability to meet their obligations under the terms of theirleases with the Trust. In addition, management of the Trust cannot predictwhether any of the leases will be renewed on their current terms or at all. Asa result, management's estimate of future cash flows from its leased propertiescould be materially affected in the near term, if certain of the leases are notrenewed at the end of their lease terms.Investments in Limited Liability Companies ("LLCs")The consolidated financial statements of the Trust include the consolidatedaccounts of its controlled investments. In accordance with the AmericanInstitute of Certified Public Accountants' Statement of Position 78-9"Accounting for Investments in Real Estate Ventures" and Emerging Issues TaskForce Issue 96-16, "Investor's Accounting for an Investee When the Investor Hasa Majority of the Voting Interest but the Minority Shareholder or ShareholdersHave Certain Approval or Veto Rights", the Trust accounts for its investments inLLCs which it does not control using the equity method of accounting. Theseinvestments, which represent 33% to 99% non-controlling ownership interests, arerecorded initially at the Trust's cost and subsequently adjusted for the Trust'snet equity in the net income, cash contributions and distributions of theinvestments.Since 1995 through December 31, 2001, the Trust invested $54.9 million of cashin LLCs in which it owns various non-controlling equity interests ranging from33% to 99%. On a combined basis, these LLCs generated revenues of $26.5 millionin 2001, $22.2 million in 2000 and $18.4 million in 1999 and net income of $3.9million in 2001, $3.3 million in 2000 and $2.8 million in 1999. Also on acombined basis, as of December 31, 2001, these LLCs had total assets of $174.5million and $115.6 million third-party financing that is non-recourse to theTrust (see Note 10 to the Consolidated Financial Statements). During the fourth quarter of 2000, the Trust recorded a provision for investmentloss in a LLC of F-8 $1.1 million to reflect its share of an asset impairment charge recorded at aLLC resulting from declines in the performance of a medical office complexlocated in Phoenix, Arizona. In measuring the provision for investment loss ofthe limited liability company in 2000 (in which the Trust owns a 60% non-controlling interest), management of the Trust concluded that the estimated fairvalue of the real property (calculated by discounting expected future cashflows, consisting of estimated future rental payments and residual value) didnot exceed the mortgage, that is non-recourse to the Trust, held on the propertyby a third-party lending institution. Accordingly, the $1.1 million charge wasrecorded during the fourth quarter of 2000 to reduce the Trust's investment inthis LLC to zero.Earnings Per ShareBasic earnings per share are based on the weighted average number of commonshares outstanding during the year. Diluted earnings per share are based on theweighted average number of common shares during the year adjusted to give effectto common stock equivalents. In June, 2001, the Trust issued 2.6 million sharesof beneficial interest at a price of $21.57 per share generating $53.9 millionof net proceeds to the Trust which were used to repay borrowings under theTrust's revolving credit agreement.Stock-Based CompensationStatement of Financial Accounting Standards ("SFAS") No. 123, "Accounting forStock-Based Compensation" encourages a fair value based method of accounting foremployee stock options and similar equity instruments, which generally wouldresult in the recording of additional compensation expense in the Trust'sfinancial statements. The Statement also allows the Trust to continue toaccount for stock-based employee compensation using the intrinsic value-basedmethod of accounting as prescribed by Accounting Principals Board ("APB")Opinion No. 25, "Accounting for Stock Issued to Employees." The Trust hasadopted the disclosure-only provisions of SFAS No. 123. Accordingly, nocompensation cost has been recognized for the stock option plans in theaccompanying financial statements.Cash and Cash EquivalentsThe Trust considers all highly liquid investment instruments with originalmaturities of three months or less to be cash equivalents.Fair Value of Financial InstrumentsThe fair value of the Trust's interest rate swap agreements and investments arebased on quoted market prices. The carrying amounts reported in the balancesheet for cash, accrued liabilities, and short-term borrowings approximate theirfair values due to the short-term nature of these instruments. Accordingly,these items have been excluded from the fair value disclosures includedelsewhere in these notes to consolidated financial statements.Use of EstimatesThe preparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.Accounting for Derivative Instruments and Hedging ActivitiesEffective January 1, 2001, the Trust adopted Statement of Financial Accounting Standards F-9 ("SFAS") No. 133, "Accounting for Derivative Instruments and HedgingActivities", and its corresponding amendments under SFAS No. 138. SFAS No. 133requires the Trust to measure every derivative instrument (including certainderivative instruments embedded in other contracts) at fair value and recordthem in the balance sheet as either an asset or liability. Changes in fair valueof derivatives are recorded currently in earnings unless special hedgeaccounting criteria are met. For derivatives designated as fair value hedges,the changes in fair value of both the derivative instrument and the hedged itemare recorded in earnings. For derivatives designated as cash flow hedges, theeffective portions of changes in the fair value of the derivative are reportedin other comprehensive income ("OCI"). The ineffective portions of hedges arerecognized in earnings in the current period.The Trust formally assesses, both at inception of the hedge and on an ongoingbasis, whether each derivative is highly effective in offsetting changes in fairvalues or cash flows of the hedged item. If it is determined that a derivativeis not highly effective as a hedge or if a derivative ceases to be a highlyeffective hedge, the Trust will discontinue hedge accounting prospectively.The Trust manages its ratio of fixed to floating rate debt with the objective ofachieving a mix that management believes is appropriate. To manage this mix ina cost-effective manner, the Trust, from time to time, enters into interest rateswap agreements, in which it agrees to exchange various combinations of fixedand/or variable interest rates based on agreed upon notional amounts. All ofthe Trust's cash flow hedges at December 31, 2001 relate to the payment ofvariable interest on existing debt.New Accounting StandardsIn June 2001, the FASB issued SFAS No. 143, "Accounting for Asset RetirementObligations". The Statement addresses financial accounting and reporting forobligations associated with the retirement of tangible long-lived assets andassociated asset retirement costs. The Statement requires that the fair valueof a liability for an asset retirement obligation be recognized in the period inwhich it is incurred. The asset retirement obligations will be capitalized aspart of the carrying amount of the long-lived asset. The Statement applies tolegal obligations associated with the retirement of long-lived assets thatresult from the acquisition, construction, development and normal operation oflong-lived assets. The Statement is effective for years beginning after June15, 2002, with earlier adoption permitted. Management does not believe thatthis Statement will have a material effect on the Trust's financial statements.In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment orDisposal of Long-Lived Assets". The Statement supersedes SFAS No. 121,"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets toBe Disposed Of". This Statement also supersedes Accounting Principles BoardOpinion (APB) No. 30 provisions related to accounting and reporting for thedisposal of a segment of a business. This Statement establishes a singleaccounting model, based on the framework established in SFAS No. 121, for long-lived assets to be disposed of by sale. The Statement retains most of therequirements in SFAS No. 121 related to the recognition of impairment of long-lived assets to be held and used. The Statement is effective for fiscal yearsbeginning after December 15, 2001, with earlier adoption encouraged. Managementdoes not believe that this Statement will have a material effect on the Trust'sfinancial statements. F-10 (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, 1986between the Advisor and the Trust (the "Advisory Agreement"). Under the AdvisoryAgreement, the Advisor is obligated to present an investment program to theTrust, to use its best efforts to obtain investments suitable for such program(although it is not obligated to present any particular investment opportunityto the Trust), to provide administrative services to the Trust and to conductthe Trust's day-to-day affairs. In performing its services under the AdvisoryAgreement, the Advisor may utilize independent professional services, includingaccounting, legal and other services, for which the Advisor is reimburseddirectly by the Trust. The Advisory Agreement expires on December 31 of eachyear; however, it is renewable by the Trust, subject to a determination by theIndependent Trustees that the Advisor's performance has been satisfactory. TheAdvisory Agreement may be terminated for any reason upon sixty days writtennotice by the Trust or the Advisor. The Advisory Agreement has been renewed for2002. All transactions with UHS must be approved by the Independent Trustees.The Advisory Agreement provides that the Advisor is entitled to receive anannual advisory fee equal to .60% of the average invested real estate assets ofthe Trust, as derived from its consolidated balance sheet from time to time. Inaddition, the Advisor is entitled to an annual incentive fee of 20% of theamount by which cash available for distribution to shareholders, as defined inthe Advisory Agreement, for each year exceeds 15% of the Trust's equity as shownon its balance sheet, determined in accordance with accounting principlesgenerally accepted in the United States, without reduction for return of capitaldividends. No incentive fees were paid during 2001, 2000 and 1999. Theadvisory fee is payable quarterly, subject to adjustment at year end based uponthe audited consolidated financial statements of the Trust.Pursuant to the terms of the leases with UHS, the lessees have rights of firstrefusal to: (i) purchase the respective leased facilities during and for 180days 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 theend of, and for 180 days after, the lease term at the same terms and conditionspursuant to any third-party offer. The leases also grant the lessees options,exercisable on at least six months notice, to purchase the respective leasedfacilities at the end of the lease term or any renewal term at the facility'sthen fair market value. The terms of the leases also provide that in the eventUHS discontinues operations at the leased facility for more than one year, orelects to terminate its lease prior to the expiration of its term for prudentbusiness reasons, UHS is obligated to offer a substitution property. If theTrust does not accept the substitution property offered, UHS is obligated topurchase the leased facility back from the Trust at a price equal to the greaterof its then fair market value or the original purchase price paid by the Trust.For the years ended December 31, 2001, 2000 and 1999, 60%, 63% and 70%,respectively, of the Trust's revenues were earned under the terms of the leaseswith wholly-owned subsidiaries of UHS. Including 100% of the revenues generatedat the unconsolidated LLCs in which the Trust has various non-controlling equityinterests ranging from 33% to 99%, the UHS leases accounted for 31% in 2001, 35%in 2000 and 39% in 1999 of the combined consolidated and unconsolidatedrevenues. The leases to subsidiaries of UHS are guaranteed by UHS and cross-defaulted with one another. The bonus rents from the subsidiaries of UHS, whichare based upon each facility's net patient revenue in excess of base amounts,are computed and paid on a quarterly basis based upon F-11 a computation that compares current quarter revenue to the corresponding quarterin the base year.At December 31, 2001, approximately 6.6% of the Trust's outstanding shares ofbeneficial interest were held by UHS. The Trust has granted UHS the option topurchase Trust shares in the future at fair market value to enable UHS tomaintain a 5% interest in the Trust.During 2001, McAllen Hospitals, L.P., a subsidiary of UHS, exercised theirrenewal option to renew their lease with the Trust at substantially the same terms for another five years commencing January 1, 2002 and expiring December31, 2006.During the third quarter of 1999, a provision for investment loss of $2.6million was recorded on Meridell Achievement Center, Inc., a behavioral healthservices facility operated by, and leased to, a wholly-owned subsidiary of UHS,pursuant to the terms of a lease that expired in December, 2000. In measuringthe provision for investment loss during the third quarter of 1999, the Trustestimated fair value by discounting (using the Trust's internal hurdle rate)expected future cash flows, consisting of estimated future rental payments andresidual value. During the second quarter of 2000, the wholly-owned subsidiaryof UHS exercised its option pursuant to the lease to purchase the leasedproperty upon the December 31, 2000 expiration of the initial lease. Pursuantto the terms of the lease agreement, three appraisals were obtained to determinethe fair market value of the property and accordingly, the sale price wasdetermined to be $5,450,000. This sale was completed in December, 2000resulting in a gain of approximately $1.9 million which is included in theTrust's 2000 results of operations. Also during 2000, the Trust invested $2.0million to acquire a 98% interest in a LLC that purchased the Summerlin HospitalMedical Office Building II which is connected to the Summerlin Hospital MedicalCenter in Las Vegas, Nevada. This medical office building was purchased from aLLC in which UHS holds a 72% ownership interest. The purchase price paid forthe property to the UHS majority-owned LLC was $10.5 million. The Trust made acash investment of $2.0 million, and the LLC, which is majority-owned by theTrust, obtained a $9.8 million third-party mortgage which is non-recourse to theTrust to fund the balance of the purchase price and finance tenant improvements.During 1999, the Trust paid $5.0 million to acquire a 98% interest in a LLC thatpurchased the Summerlin Hospital MOB, which is connected to the SummerlinHospital Medical Center in Las Vegas, Nevada. This medical office building waspurchased from a LLC in which UHS holds a 72% ownership interest. The totalpurchase price paid for the property to the UHS majority-owned LLC was $13.0million consisting of the $5.0 of cash invested by the Trust and a $8.0 millionthird-party mortgage, that is non-recourse to the Trust, obtained by the LLCwhich is majority-owned by the Trust. Also during 1999, the Trust acquired theOrthopaedic Specialists of Nevada Building in Las Vegas, Nevada for $1.6million. The ground lease on this medical office building is based upon anagreement between Valley Health System, LLC (a UHS 72% owned subsidiary) and theTrust.During December of 1993, UHS, the former lessee and operator of BelmontCommunity Hospital, sold the operations of the facility to THC-Chicago, Inc., anindirect wholly-owned subsidiary of Community Psychiatric Centers.Concurrently, the Trust purchased certain related real property from UHS for $1million in cash and a note payable in the amount of $1,446,000, includingaccrued interest, which will be paid by the Trust on April 30, 2002. No furtherobligation will be owed by the Trust to UHS in connection with this transaction.The Trust's officers are all employees of UHS and as of December 31, 2001, theTrust had no salaried employees. Commencing in 1999, Mr. Kirk E. Gorman,President, Chief Financial F-12 Officer, Secretary and Trustee of the Trust, received $50,000 annual bonusesawarded by the Trustees, subject to UHS agreeing to a $50,000 reduction in theadvisory fee paid by the Trust.(3) Acquisitions and Dispositions---------------------------------2002 - During 2001, the Trust invested $2.8 million of cash in a LLC for thepurpose of effecting a like-kind exchange which was completed in January, 2002resulting in $2.5 million of cash distributed to the Trust. In connection withthis transaction, the LLC in which the Trust owns an 89% non-controlling equityinterest, acquired the real estate assets of Papago Medical Park located inPhoenix, Arizona in exchange for cash and the real estate assets of Samaritan West Valley Medical Center located in Goodyear, Arizona. This transaction,which was a like-kind exchange for income tax purposes, resulted in a book gainof approximately $1.1 million which will be included in the Trust's firstquarter of 2002 results of operations.2001 - During 2001, the Trust added the following investments to its portfolio:(i) the purchase of a 75% equity interest in a LLC that owns and operates theThunderbird Paseo Medical Plaza II located in Glendale, Arizona ($1.4 million ofcash invested by the Trust in the LLC which also obtained a $3.1 million third-party mortgage that is non-recourse to the Trust), and; (ii) the purchase of a74% equity interest in a LLC that owns and operates the Mid-Coast HospitalMedical Office Building located in Brunswick, Maine ($1.9 million of cashinvested by the Trust in the LLC which also obtained a $8.9 million third-partymortgage that is non-recourse to the Trust). Also during 2001 the Trustinvested: (i) $3.0 million to purchase an additional equity interest and fundadditional investments and loans to various LLCs in which the Trust has variousnon-controlling equity interests; (ii) $2.8 million of cash in a LLC for thepurpose of effecting a like-kind exchange which was completed in January, 2002(as mentioned above), and; (iii) $45,000 and committed to invest a total of $3.4million in exchange for an 80% non-controlling interest in a limited liabilitycompany that will construct and own the Deer Valley Medical Office II located inPhoenix, Arizona (the LLC will obtain a $7.0 million third-party mortgage thatwill be non-recourse to the Trust). The Deer Valley Medical Office II isexpected to be completed and opened during the second quarter of 2002.2000 - During 2000, the Trust added four new investments to its portfolioconsisting of the following: (i) the purchase of a medical office buildinglocated in Danbury, Connecticut ($1.9 million of cash invested by the Trust inaddition to a $4.5 million third-party mortgage that is non-recourse to theTrust); (ii) the purchase of a 95% equity interest in a LLC that owns andoperates Skypark Professional Medical Building located in Torrance, California($1.8 million of cash invested by the Trust in the LLC which also obtained a$4.3 million third-party mortgage that is non-recourse to the Trust); (iii) thepurchase of a 67% equity interest in a LLC that owns and operates the CentinelaMedical Building Complex located in Inglewood, California ($2.0 million of cashinvested by the Trust in the LLC which also obtained a $7.5 million third-partymortgage that is non-recourse to the Trust), and; (iv) the purchase of a 98%equity interest in a LLC that owns and operates the Summerlin Hospital MOB II($2.0 million of cash invested by the Trust in the LLC which also obtained a$9.8 million third-party mortgage that is non-recourse to the Trust).Additionally, during 2000, Meridell Achievement Center, Inc., a subsidiary ofUHS, exercised its option pursuant to the lease to purchase the leased property.This sale was completed in 2000, resulting in a gain of $1.9 million which isincluded in the Trust's 2000 results of operations. F-13 1999 - During 1999, the Trust added five new investments to its portfolioconsisting of the following: (i) the purchase of a 95% equity interest in a LLCthat owns the Santa Fe Professional Plaza located in Scottsdale, Arizona ($1.2million of cash invested by the Trust in the LLC which also obtained a $1.9million third-party mortgage that is non-recourse to the Trust); (ii) thepurchase of a 98% equity interest in a LLC that owns the Summerlin Hospital MOBlocated in Las Vegas, Nevada ($5.0 million of cash invested by the Trust in theLLC which also obtained a $8.3 million third-party mortgage that is non-recourseto the Trust); (iii) the purchase of a 75% equity interest in a LLC that ownsthe East Mesa Medical Center located in Mesa, Arizona ($1.6 million of cashinvested by the Trust in the LLC which also obtained a $4.2 million third-partymortgage that is non-recourse to the Trust); (iv) the purchase of the single-tenant medical office building, Orthopaedic Specialists of Nevada Building ($1.6million of cash invested by the Trust), and; (v) the purchase of a multi-tenantmedical office building located in Atlanta, Georgia ($11.5 million of cashinvested by the Trust).(4) Leases----------- All of the Trust's leases are classified as operating leases with initial termsranging from 5 to 15 years with up to five, five-year renewal options. Underthe terms of the leases, the Trust earns fixed monthly base rents and pursuantto the leases with subsidiaries of UHS, the Trust may earn periodic additionalrents (see Note 2). The bonus rents from the subsidiaries of UHS, which arebased upon each facility's net patient revenue in excess of base amounts, arecomputed and paid on a quarterly basis based upon a computation that comparescurrent quarter revenue to the corresponding quarter in the base year.Minimum future base rents on non-cancelable leases are as follows (000s): 2002 $ 21,849 2003 20,933 2004 19,204 2005 15,283 2006 13,611 Later Years 11,079 -------- Total Minimum Base Rents $101,959 ========Under the terms of the hospital leases, the lessees are required to pay alloperating costs of the properties including property insurance and real estatetaxes. Tenants of the medical office buildings generally are required to paytheir pro-rata share of the property's operating costs above a stipulatedamount.(5) Financial Instruments--------------------------Cash Flow HedgesUpon the January 1, 2001 adoption of SFAS No. 133, the Trust recorded acumulative effect of accounting change of approximately $533,000 in othercomprehensive income to recognize at fair value all derivatives that aredesignated as cash flow hedging instruments. The Trust recorded an additionalloss of $1,650,000 in other comprehensive income to recognize the change invalue during 2001. The gains and losses are reclassified into earnings as theunderlying hedged item affects earnings, such as when the forecast interestpayment occurs. Assuming market interest rates remain unchanged from December31, 2001, it is expected that F-14 $1,202,000 of net losses in accumulated other comprehensive income will bereclassified into earnings within the next twelve months. The Trust alsorecorded a favorable $17,000 adjustment to current earnings during 2001 torecognize the ineffective portion of the cash flow hedging instruments. As ofDecember 31, 2001, the maximum length of time over which the Trust is hedgingits exposure to the variability in future cash flows for forecasted transactionsis through November, 2006. In June 2001, the Trust reclassified a loss of$41,000 from accumulated other comprehensive income into earnings as a result ofthe discontinuance of a cash flow hedge due to the probability of the originalforecasted transaction not occurring. As of the date of adoption and throughDecember 31, 2001, the Trust was not party to any derivative contractsdesignated as fair value hedges.(6) Debt---------The Trust has an unsecured, non-amortizing $100 million revolving creditagreement (the "Agreement"), which expires on June 24, 2003. The Agreementprovides for interest at the Trust's option, at the certificate of deposit rateplus .625% to 1.125%, the Eurodollar rate plus .50% to 1.125% or the prime rate.A fee of .175% to .375% is paid on the unused portion of this commitment. Themargins 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 theAgreement. At December 31, 2001 the applicable margin over the certificate ofdeposit and Eurodollar rates were .625% and .50%, respectively, and thecommitment fee was .17%. The Trust had $4.9 million of letters of creditoutstanding against the Agreement. There are no compensating balancerequirements. The Agreement contains a provision whereby the commitments will bereduced by 50% of the proceeds generated from any new equity offering. TheTrust was granted a one-time waiver of this provision in connection with itsissuance of 2.6 million shares of beneficial interest in June, 2001. The averageamounts outstanding under the Trust's revolving credit agreement were $46.1million in 2001, $78.5 million in 2000 and $62.0 million in 1999 withcorresponding effective interest rates, including commitment fees and interestrate swap expense, of 7.4% in 2001, 7.1% in 2000 and 6.2% in 1999. At December31, 2001, the Trust had approximately $67 million of available borrowingcapacity. The book value of the amounts borrowed approximates fair marketvalue.Covenants relating to the revolving credit facility require the maintenance of aminimum tangible net worth and specified financial ratios, limit the Trust'sability to incur additional debt, limit the aggregate amount of mortgagereceivables and limit the Trust's ability to increase dividends in excess of 95%of cash available for distribution, unless additional distributions are requiredto comply with the applicable section of the Internal Revenue Code and relatedregulations governing real estate investment trusts. The Company is incompliance with all their covenants at December 31, 2001.The Trust has one mortgage with an outstanding balance of $4,368,000 at December31, 2001. The mortgage, which carries an 8.3% interest rate and matures onFebruary 1, 2010, is non-recourse to the Trust and is secured by the MedicalCenter of Western Connecticut.The Trust has entered into interest rate swap agreements which are designed toreduce the impact of changes in interest rates on its floating rate revolvingcredit notes. At December 31, 2001, the Trust had four outstanding swapagreements for notional principal amounts of $34,000,000 which mature from July,2002 through November, 2006. These swap agreements effectively fix the interestrate on $34,000,000 of variable rate debt at 6.48% including the revolver spreadof .50%. Additional F-15 interest expense/(income) recorded as a result of the Trust's hedging activity,which is included in the effective interest rates shown above, was $680,000,($164,000) and $135,000 in 2001, 2000 and 1999, respectively. The interest rateswap agreements were entered into in anticipation of certain borrowingtransactions made by the Trust. The Trust is exposed to credit loss in the eventof nonperformance by the counterparties to the interest rate swap agreements.These counterparties are major financial institutions and the Trust does notanticipate nonperformance by the counterparties which are rated A or better byMoody's Investors Service. Termination of the interest rate swaps at December31, 2001 would have resulted in payments from the counterparties to the Trust ofapproximately $2,165,000. The fair value of the interest rate swap agreements atDecember 31, 2001 reflects the estimated amounts that the Trust would pay orreceive to terminate the contracts and are based on quotes from thecounterparties.(7) Dividends--------------Dividends of $1.875 per share were declared and paid in 2001, of which $1.8118per share was ordinary income and $.0632 per share was a return of capitaldistribution. Dividends of $1.84 per share were declared and paid in 2000, ofwhich $1.694 per share was ordinary income and $.146 per share was a return ofcapital distribution. Dividends of $1.81 per share were declared and paid in1999, of which $1.4664 per share was ordinary income and $.3436 per share was areturn of capital distribution. (8) Issuance of Shares of Beneficial Interest---------------------------------------------In June, 2001, the Trust issued 2.6 million shares of beneficial interest at aprice of $21.57 per share. The equity issuance generated net proceeds of $53.9million which were used to repay outstanding borrowings under the Trust's $100million revolving credit facility.(9) Incentive Plans--------------------In 1991, the Trustees adopted a share compensation plan for Trustees who areneither employees nor officers of the Trust ("Outside Trustees"). Pursuant tothe plan, each Outside Trustee may elect to receive, in lieu of all or a portionof the quarterly cash compensation for services as a Trustee, shares of theTrust based on the closing price of the shares on the date of issuance. As ofDecember 31, 2001 no shares have been issued under the terms of this plan.During 1997, the Trust's Board of Trustees approved the Universal Health RealtyIncome Trust 1997 Incentive Plan ("The Plan"), a stock option and dividendequivalents rights plan for employees of the Trust, including officers andtrustees. There are 400,000 shares reserved for issuance under The Plan. Sinceinception through December 31, 2001, there have been 105,000 stock options withdividend equivalent rights granted to officers and trustees of the Trust. Allstock options were granted with an exercise price equal to the fair market valueon the date of the grant. The options granted vest ratably at 25% per yearbeginning one year after the date of grant, and expire in ten years. Dividendequivalent rights reduce the exercise price of the 1997 Incentive Plan optionsby an amount equal to the cash or stock dividends distributed subsequent to thedate of grant. The Trust recorded expenses relating to the dividend equivalentrights of $188,000 in 2001, $184,000 in 2000 and $132,000 in 1999. As ofDecember 31, 2001, there were 78,750 options exercisable under The Plan with anaverage exercise price, adjusted to give effect to the dividend equivalentrights, of $10.80 per share. F-16 SFAS No. 123 requires the Trust to disclose pro-forma net income and pro-formaearnings per share as if compensation expense were recognized for optionsgranted beginning in 1995. Using this approach, the Trust's net income and netincome per share would have been the pro forma amounts indicated below: (000s, except per share amounts) ------------------------------------------------ Year Ended December 31, 2001 2000 1999 ------------------------------------------------------------------------------- Net Income: As Reported $18,349 $16,256 $13,972 Pro Forma $18,233 $16,077 $13,833 Earnings Per Share: As Reported: Basic $ 1.75 $ 1.81 $ 1.56 Diluted $ 1.74 $ 1.81 $ 1.56 Pro Forma: Basic $ 1.74 $ 1.79 $ 1.54 Diluted $ 1.73 $ 1.79 $ 1.54 The fair value of each option grant was estimated on the date of grant using theBlack-Scholes option-pricing model with the following range of assumptions usedfor the four option grants that occurred during 2000. No options were granted during 2001 or 1999, therefore the following table is not applicable ("N/A") forthose years: Year Ended December 31, 2001 2000 1999 -------------------------------------------------------------------------------------- Volatility N/A 14%-15% N/AInterest rate N/A 5%-7% N/AExpected life (years) N/A 8.0 N/AForfeiture rate N/A 2% N/A -------------------------------------------------------------------------------------- Stock-based compensation costs on a pro forma basis would have reduced netincome by $116,000 in 2001, $179,000 in 2000 and $139,000 in 1999. F-17 Stock options to purchase shares of beneficial interest have been granted toofficers and trustees of the Trust under various plans. Information withrespect to these options, before adjustment to the option price to give effectto the dividend equivalent rights, is summarized as follows: Exercise Grant Price Number of Weighted- Range Outstanding Options Shares Average Price (High-Low)---------------------------------------------------------------------------------------------------- Balance, January 1, 1999 133,024 $17.88 $21.4375/$16.125 Granted 0 N/A N/A Exercised 0 N/A N/A Cancelled 0 N/A N/A----------------------------------------------------------------------------------------------------Balance, January 1, 2000 133,024 $17.88 $21.4375/$16.125 Granted 25,000 $14.75 $ 14.75 Exercised 0 N/A N/A Cancelled 0 N/A N/A----------------------------------------------------------------------------------------------------Balance, January 1, 2001 158,024 $17.38 $ 21.4375/$14.75 Granted 0 N/A N/A Exercised 58,024 $16.77 $ 16.875/$16.125 Cancelled 0 N/A N/A----------------------------------------------------------------------------------------------------Balance, December 31, 2001 100,000 $17.74 $ 21.4375/$14.75====================================================================================================(10) Summarized Financial Information of Equity Affiliates-----------------------------------------------------------The consolidated financial statements of the Trust include the consolidatedaccounts of its controlled investments. In accordance with the AmericanInstitute of Certified Public Accountants' Statement of Position 78-9"Accounting for Investments in Real Estate Ventures" and Emerging Issues TaskForce Issue 96-16, "Investor's Accounting for an Investee When the Investor Hasa Majority of the Voting Interest but the Minority Shareholder or ShareholdersHave Certain Approval or Veto Rights", the Trust accounts for its investment inLLCs which it does not control using the equity method of accounting. Theseinvestments, which represent 33% to 99% non-controlling ownership interests, arerecorded initially at the Trust's cost and subsequently adjusted for the Trust'snet equity in the net income, cash contributions and distributions of theinvestments.Since 1995 through December 31, 2001, the Trust invested $54.9 million of cashin LLCs in which it owns various non-controlling equity interests ranging from33% to 99%. On a combined basis, these LLCs generated revenues of $26.5 millionin 2001, $22.2 million in 2000 and $18.4 million in 1999 and net income of $3.9million in 2001, $3.3 million in 2000 and $2.8 million in 1999. Also on a combined basis, as of December 31, 2001, these LLCs had total assets of $174.5million and $115.6 million third-party financing that is non-recourse to theTrust. F-18 The following table represents summarized unaudited financial information of thelimited liability companies ("LLCs") accounted for by the equity method.Amounts presented include investments in the following LLCs as of December 31,2001: Name of LLC Ownership Property Owned by LLC ------------ --------- --------------------- DSMB Properties 76% Desert Samaritan Hospital MOBs DVMC Properties 95% Desert Valley Medical Center MOBs Parkvale Properties 60% Maryvale Samaritan Hospital MOBs Suburban Properties 33% Suburban Medical Center MOBs Litchvan Investments (a.) 89% Samaritan West Valley Medical Center Paseo Medical Properties II 75% Thunderbird Paseo Medical Plaza I & II Willetta Medical Properties 95% Edwards Medical Plaza DesMed 99% Desert Springs Medical Plaza PacPal Investments 95% Pacifica Palms Medical Plaza RioMed Investments 80% Rio Rancho Medical Center West Highland Holdings 48% St. Jude Heritage Health Complex Santa Fe Scottsdale 95% Santa Fe Professional Plaza Bayway Properties 75% East Mesa Medical Center 653 Town Center Drive (b.) 98% Summerlin Hospital MOB 575 Hardy Investors 67% Centinela Medical Building Complex 653 Town Center Phase II (b.) 98% Summerlin Hospital MOB II 23560 Madison 95% Skypark Professional Medical Building Brunswick Associates 74% Mid Coast Hospital MOB Deerval Properties (c.) 80% Deer Valley Medical Office II(a.) During 2001, the Trust invested $2.8 million of cash in a LLC for thepurpose of effecting a like-kind exchange which was completed in January, 2002resulting in $2.5 million of cash distributed to the Trust. As a result of thislike-kind exchange transaction, Litchvan Investments acquired the real estateassets of Papago Medical Park located in Phoenix, Arizona in exchange for cashand the real estate assets of Samaritan West Valley Medical Center located inGoodyear, Arizona.(b.) Tenants of this medical office building include a subsidiary of UHS.(c.) As of December 31, 2001, the Trust has invested $45,000 in the Deer ValleyMedical Office II project. The Trust has committed to invest a total of $3.4million in exchange for an 80% non-controlling interest in a LLC that willconstruct and own a medical office building in Phoenix, Arizona, scheduled to becompleted and opened during the second quarter of 2002. F-19 December 31, ------------------------------- 2001 2000 ------------------------------- (amounts in thousands) Net property $158,109 $141,120 Other assets 16,428 13,095 Liabilities and third-party debt 123,820 105,732 Equity 50,717 45,721 UHT's share of equity 46,939 39,164 For the Year Ended December 31, ---------------------------------------- 2001 2000 1999 ---------------------------------------- (amounts in thousands) Revenues $26,451 $22,227 $18,387 Operating expenses 9,760 7,976 6,772 Depreciation & amortization 4,741 4,155 3,385 Interest, net 8,001 6,797 5,436 Net income 3,949 3,299 2,794 UHT's share of net income before investment loss of LLC 3,610 2,913 2,554 Provision for investment loss of LLC -- (1,139) -- UHT's share of net income after investment loss of LLC 3,610 1,774 2,554As of December 31, 2001, these LLCs had $115.6 million of debt, which is non-recourse to the Trust, payable to third-party lending institutions. Aggregatematurities of non-recourse debt payable to third-parties are as follows (000s): 2002 $ 9,088 2003 4,564 2004 7,817 2005 9,515 2006 22,232 Later 62,405 ---------- Total $115,621 ========== F-20 (11) Segment Reporting----------------------The Trust has only one service, leasing of healthcare and human servicefacilities, and all revenues from external customers relate to the same service.Operating results and assessment of performance are reviewed by the chiefoperating decision-maker on a company-wide basis and no discrete financialinformation is available or produced on any one component of the business.Accordingly, the disclosure requirements of SFAS 131 are not relevant to theTrust.(12) Quarterly Results---------------------- (amounts in thousands, except per share amounts) 2001-------------------------------------------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total-------------------------------------------------------------------------------------------------------- Revenues $6,885 $6,859 $6,890 $6,940 $27,574Net Income $4,140 $4,303 $4,877 $5,029 $18,349Earnings Per Share-Basic $ 0.46 $ 0.44 $ 0.42 $ 0.43 $ 1.75Earnings Per Share-Diluted $ 0.46 $ 0.44 $ 0.42 $ 0.43 $ 1.74In June, 2001, the Trust issued 2.6 million shares of beneficial interest at aprice of $21.57 per share. The equity issuance generated net proceeds of $53.9million which were used to repay outstanding borrowings under the Trust's $100million revolving credit facility. 2000-------------------------------------------------------------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total-------------------------------------------------------------------------------------------------------- Revenues $6,685 $6,728 $6,901 $7,001 $27,315Net Income $3,916 $3,800 $3,866 $4,674 $16,256Earnings Per Share-Basic $ 0.44 $ 0.42 $ 0.43 $ 0.52 $ 1.81Earnings Per Share-Diluted $ 0.44 $ 0.42 $ 0.43 $ 0.52 $ 1.81A wholly-owned subsidiary of UHS exercised its option pursuant to the lease topurchase the leased property of a behavioral health care facility upon theDecember 31, 2000 expiration of the initial lease. This sale was completed inDecember, 2000 for cash proceeds to the Trust of $5,450,000 resulting in a gainof approximately $1.9 million, or $.21 per basic and diluted share, which isincluded in the Trust's fourth quarter of 2000 results of operations.Additionally, during the fourth quarter of 2000, the Trust recorded a provisionfor investment loss of $1.1 million, or $.13 per basic and diluted share, toreflect its share of an asset impairment charge recorded at a LLC which owns amedical office complex located in Phoenix, Arizona. F-21 Universal Health Realty Income Trust ------------------------------------ Schedule II - Valuation and Qualifying Accounts ----------------------------------------------- (amounts in thousands) Balance at Charged to Balance beginning costs and at end Description of period expenses Other of period ----------- ----------- ------------ --------- ------------- Reserve for Investment Losses: Year ended December 31, 2001 - - - - ============ ============ ============ =========== Year ended December 31, 2000 - - - - ============ ============ ============ =========== Year ended December 31, 1999 $116 $1,583 (b) ($1,699)(a) - ============ ============ ============ =========== (a) Amounts charged against the reserve. (b) Consists of the following: Provision for investment loss recorded on Behavioral Health Services facility $2,581 Cash proceeds generated from sale of Lake Shore Hospital (998) ------ $1,583 ====== F-22 Schedule III Universal Health Realty Income Trust Real Estate and Accumulated Depreciation - December 31, 2001 (amounts in thousands) Initial Cost to Net cost --------------- -------- Universal Health capitalized/divested Gross amount at which ---------------- -------------------- --------------------- Realty Income Trust subsequent to acquisition carried at close of period ------------------- ------------------------- -------------------------- Building Land & Building &Description Land & Improv. Improv. Land Improvements Total----------- ---- --------- ------- ---- ------------ ----- Virtue Street Pavilion $1,825 $ 9,445 - $ 1,770 $ 9,445 $ 11,215Chalmette Medical Center 2,000 7,473 $ 3,148 2,000 10,621 12,621 Chalmette, Louisiana Inland Valley Regional Medical Center Wildomar, California 2,050 10,701 2,868 2,050 13,569 15,619McAllen Medical Center McAllen, Texas 4,720 31,442 10,188 6,281 40,069 46,350Wellington Regional Medical Center West Palm Beach, Florida 1,190 14,652 4,822 1,663 19,001 20,664The Bridgeway North Little Rock, Arkansas 150 5,395 499 150 5,894 6,044Tri-State Rehabilitation Hospital Evansville, Indiana 500 6,945 1,062 500 8,007 8,507Kindred Hospital Chicago Central Chicago, Illinois 158 6,404 1,837 158 8,241 8,399Fresno-Herndon Medical Plaza Fresno, California 1,073 5,266 35 1,073 5,301 6,374Family Doctor's Medical Office Building Shreveport, Louisiana 54 1,526 494 54 2,020 2,074Kelsey-Seybold Clinic at King's Crossing 439 1,618 6 439 1,624 2,063Professional Center at King's Crossing 439 1,837 43 439 1,880 2,319 Kingwood, Texas Chesterbrook Academy Audubon, Pennsylvania 307 996 - 307 996 1,303Chesterbrook Academy New Britain, Pennsylvania 250 744 - 250 744 994Chesterbrook Academy Uwchlan, Pennsylvania 180 815 - 180 815 995Chesterbrook Academy Newtown, Pennsylvania 195 749 - 195 749 944The Southern Crescent Center 1,130 5,092 69 1,130 5,161 6,291The Southern Crescent Center II - - 5,373 806 4,567 5,373 Riverdale, Georgia The Cypresswood Professional Center Spring ,Texas 573 3,842 187 573 4,029 4,602Orthopaedic Specialists of Nevada Building Las Vegas, Nevada - 1,579 - - 1,579 1,579Sheffield Medical Building Atlanta, Georgia 1,760 9,766 410 1,760 10,176 11,936Medical Center of Western Connecticut - Bldg. 73 Danbury, Connecticut 1,151 5,176 54 1,151 5,230 6,381 ------- -------- ------- ------- -------- -------- TOTALS $20,144 $131,463 $31,095 $22,929 $159,718 $182,647 ======= ======== ======= ======= ======== ======== Accumulated Date of construction Depreciation or most recent Average as of significant expansion Date DepreciableDescription Dec. 31, 2001 or renovation Acquired Life----------- ------------- ------------- -------- ---- $ 4,055 1975 1986 35 Years Virtue Street Pavilion 3,227 1999 1988 34 Years Chalmette Medical Center Chalmette, Louisiana Inland Valley Regional Medical Center Wildomar, California 4,105 1986 1986 43 Years McAllen Medical Center McAllen, Texas 12,098 1994 1986 42 Years Wellington Regional Medical Center West Palm Beach, Florida 5,699 1986 1986 42 Years The Bridgeway North Little Rock, Arkansas 2,511 1983 1986 35 Years Tri-State Rehabilitation Hospital Evansville, Indiana 2,428 1993 1989 40 Years Kindred Hospital Chicago Central Chicago, Illinois 4,566 1993 1986 25 Years Fresno-Herndon Medical Plaza Fresno, California 833 1992 1994 45 Years Family Doctor's Medical Office Building Shreveport, Louisiana 284 1991 1995 45 Years Kelsey-Seybold Clinic at King's Crossing 225 1995 1995 45 Years Professional Center at King's Crossing Kingwood, Texas 254 1995 1995 45 Years Chesterbrook Academy Audubon, Pennsylvania 125 1996 1996 45 Years Chesterbrook Academy New Britain, Pennsylvania 94 1991 1996 45 Years Chesterbrook Academy Uwchlan, Pennsylvania 102 1992 1996 45 Years Chesterbrook Academy Newtown, Pennsylvania 95 1992 1996 45 Years The Southern Crescent Center 631 1994 1996 45 Years The Southern Crescent Center II Riverdale, Georgia 209 1998 1998 35 Years The Cypresswood Professional Center Spring ,Texas 520 1997 1997 35 Years Orthopaedic Specialists of Nevada Building Las Vegas, Nevada 142 1999 1999 25 Years Sheffield Medical Building Atlanta, Georgia 880 1999 1999 25 Years Medical Center of Western Connecticut - Bldg. 73 Danbury, Connecticut 349 2000 2000 30 Years ------- TOTALS $43,432 ======= F-23 Universal Health Realty Income Trust ------------------------------------ Notes to Schedule III --------------------- December 31, 2002 ----------------- (amount in thousands)(1) Reconciliation of Real Estates PropertiesThe following table reconciles the Real Estate Properties from January 1, 1999to December 31, 2001: 2001 2000 1999 ------------- ------------- ------------- Balance at January 1 $ 182,172 $ 177,920 $ 163,932 Additions and acquisitions 475 9,702 16,639 SFAS 121 asset write-down -- -- (2,581) Reclasses from construction in progress -- 1,240 -- Dispositions -- (6,690) (70) ------------- ------------- ------------- Balance at December 31 $ 182,647 $ 182,172 $ 177,920 ============= ============= ============= (2) Reconciliation of Accumulated Depreciation The following table reconciles the Accumulated Depreciation from January 1, 1999 to December 31, 2001: 2001 2000 1999 ------------- ------------- ------------- Balance at January 1 $ 39,080 $ 37,800 $ 34,006 Current year depreciation expense 4,352 4,414 3,832 Dispositions -- (3,134) (38) ------------- ------------- ------------- Balance at December 31 $ 43,432 $ 39,080 $ 37,800 ============= ============= ============= The aggregate cost basis and net book value of the properties for Federal incometax purposes at December 31, 2001 are approximately $167,000,000 and$124,000,000, respectively. F-24 Exhibit 10.2 [LETTERHEAD OF UNIVERSAL HEALTH] December 31, 2001Mr. Alan B. MillerPresidentUHS of Delaware, Inc.367 South Gulph RoadKing of Prussia, PA 19406Dear Alan: The Board of Trustees of Universal Health Realty Income Trust at their December 3, 2001 meeting, authorized the renewal of the current Advisory Agreement between the Trust and UHS of Delaware, Inc. ("Agreement") upon the same terms and conditions. This letter constitutes the Trust's offer to renew the Agreement, until December 31, 2002, upon the same terms and conditions. Please acknowledge UHS ofDelaware's acceptance of this offer by signing in the space provided belowand returning one copy of this letter to me. Sincerely, Kirk E. Gorman President and Secretarycc: Warren J. Nimetz, Esq. Charles BoyleAgreed to and Accepted:UHS OF DELAWARE, INC.By: ------------------------- Alan B. Miller, President Exhibit 10.16 AMENDMENT TO LEASE THIS AMENDMENT (the "Amendment"), dated as of the 28th day of February,2001, between Universal Health Realty Income Trust ("Lessor"), a Maryland realestate investment trust having an address at 367 South Gulph Road, King ofPrussia, Pennsylvania 19406, and McAllen Hospitals, L.P. ("Lessee"), a Delawarelimited partnership having an address at 367 South Gulph Road, King of Prussia,Pennsylvania 19406, which is a subsidiary of Universal Health Services, Inc., aDelaware corporation. W I T N E S S E T H - - - - - - - - - - WHEREAS, by Lease, dated as of December 24, 1986, as the same heretoforehas been amended (said Lease, as amended, is hereinafter referred to as the"Lease"), certain premises (the "Leased Property"), as therein described, arenow leased and demised by Lessor to Lessee, as successor by merger to McAllenMedical Center, L.P. (f/k/a Universal Health Services of McAllen, Inc.); and WHEREAS, Lessee also has an interest in that certain facility in McAllen,Texas, commonly referred to as McAllen Medical Heart Hospital (the "HeartHospital"); and WHEREAS, for operational, administrative, reimbursement and other purposes,Lessee desires to combine the operations of the Heart Hospital and the LeasedProperty for bookkeeping purposes, and as a result of such combination, theaccounts will not distinguish between gross revenues generated by the LeasedProperty and gross revenues generated by the Heart Hospital; and WHEREAS, Lessee has requested that Lessor modify certain provisions of theLease and Lessor has agreed to do so subject to and in accordance with the termsand provisions of this Amendment; and WHEREAS, the parties hereto mutually desire to amend the Lease as hereinset forth, and are executing and delivering this Amendment for such purpose; NOW, THEREFORE, the parties hereto, in consideration of the terms andconditions herein contained and other good and valuable consideration, thereceipt and sufficiency of which are hereby acknowledged, hereby amend the Leaseas follows. 1. Amendment. Notwithstanding anything to the contrary contained in theLease, effective on and after February 28, 2001, (a) the defined term "Excess Gross Revenues" in Article II of the Master Lease shall be restated in its entirety to read as follows: "Excess Gross Revenues: The amount by which (i) (y) with respect to --------------------- any measuring period to the extent occurring prior to February 28, 2001, One Hundred (100%) percent of Gross Revenues for such measuring period and (z) with respect to any measuring period to the extent occurring on or after February 28, 2001, Eighty-four point four (84.4%) percent of Gross Revenues for such measuring period exceeds (ii) the Gross Revenues for the equivalent period of the Base Year." (b) for the purpose of determining Gross Revenues with respect to any measuring period to the extent occurring on or after February 28, 2001 and not encompassing all or any portion of the Base Year, the defined term "Gross Revenues" in Article II of the Master Lease is amended by adding the words "and the Heart Hospital" immediately after "Leased Property" in all instances where the term "Leased Property" occurs in the first sentence of the first paragraph thereof. (c) for the purpose of determining Gross Revenues with respect to any measuring period to the extent occurring on or after February 28, 2001 and not encompassing all or any portion of the Base Year, the defined term "Gross Revenues" in Article II of the Master Lease is amended by adding the words "or the Heart Hospital" immediately after "Leased Property" in all instances where the term "Leased Property" occurs in the first sentence of the second paragraph thereof. 2. Brokerage. Lessee represents that it has not dealt with a broker orfinder in connection with this Amendment. Lessee shall indemnify, defend (withlegal counsel reasonably acceptable to Lessor) and save harmless Lessor from andagainst all liability, claims, suits, demands, judgments, costs, interest andexpenses (including, without limitation, reasonable counsel fees anddisbursements incurred in the defense thereof) to which Lessor may be subject orsuffer by reason of any claim made for any commission, reimbursement or othercompensation arising from or as a result of the execution and delivery of thisAmendment. 3. Full Force and Effect. The Lease, as hereby amended, shall remain infull force and effect according to its terms and conditions. 4. Defined Terms. All terms used but not defined in this Amendment shall,for the purposes hereof, have the respective meanings ascribed to such terms inthe Lease. 5. Successors and Assigns. The covenants, agreements, terms andconditions contained in this Amendment shall bind and inure to the benefit ofthe parties hereto and their respective successors and assigns. 6. Amendments in Writing. This Amendment may not be changed orally, butonly by a writing signed by the party against whom enforcement thereof issought. 7. Effectiveness. This Amendment shall not be binding in any respect uponLessor until a counterpart hereof is executed by Lessor and delivered to Lessee. 2 IN WITNESS WHEREOF, the parties hereto have duly executed this Amendment asof the day and year first above written. UNIVERSAL HEALTH REALTY INCOME TRUST By:____________________________________ Name: Cheryl K. Ramagano Title: Vice President McALLEN HOSPITALS, LP By: South Texas Heart, Inc., general partner By:____________________________________ Name: Steve Filton Title: Vice President 3 Exhibit 23 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTSAs independent public accountants, we hereby consent to the incorporation of ourreport included in this Form 10-K, into the Trust's previously filedRegistration Statements on Forms S-8 and S-3: 1988 Non-Statutory Stock OptionPlan, Share Compensation Plan for Outside Trustees, 1997 Incentive Plan (FileNo. 333-57815), Dividend Reinvestment Plan for Shareholders (File No. 333-81763)and (File No. 333-60638). ARTHUR ANDERSEN LLPPhiladelphia, PAMarch 26, 2002 Exhibit 99.1 UNIVERSAL HEALTH REALTY INCOME TRUST 367 South Gulph Road P.O. Box 61558 King of Prussia, PA 19406-0958 LETTER TO COMMISSION PURSUANT TO TEMPORARY NOTE 3T March 26, 2002 Securities and Exchange Commission450 Fifth Street, N.W.Washington, D.C. 20549-0408Ladies and Gentlemen:Pursuant to Temporary Note 3T to Article 3 of Regulation S-X, Universal HealthRealty Income Trust has obtained a letter of representation from Arthur AndersenLLP ("Andersen") stating that the December 31, 2001 audit was subject to theirquality control system for the U.S. accounting and auditing practice to providereasonable assurance that the engagement was conducted in compliance withprofessional standards, that there was appropriate continuity of Andersenpersonnel working on the audit and that there was availability of nationaloffice consultation on such audit. Availability of personnel at foreignaffiliates of Andersen is not relevant to this audit. Very truly yours, Universal Health Realty Income Trust /s/ Alan B. Miller Alan B. Miller Chairman of the Board and Chief Executive Officer