Universal Health Realty Income Trust Annual Report 2003

Plain-text annual report

Table of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K xx ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES AND EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 OR ¨¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 ofincorporation or organization) (I.R.S. EmployerIdentification Number)Universal Corporate Center 367 South Gulph Road 19406-0958P.O. Box 61558 (Zip Code)King of Prussia, Pennsylvania (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 be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements forthe past 90 days.Yes üü No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. x Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes üü No Aggregate market value of voting shares held by non-affiliates as of June 30, 2003: $314,667,099. The number of shares of beneficial interest outstanding ofregistrant as of January 31, 2004: 11,736,609 DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant’s definitive proxy statement for our 2004 Annual Meeting of Shareholders, which will be filed with the Securities and ExchangeCommission within 120 days after December 31, 2003 (incorporated by reference under Part III). Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST2003 FORM 10-K ANNUAL REPORTTABLE OF CONTENTS PART I Item 1 Business 4Item 2 Properties 12Item 3 Legal Proceedings 16Item 4 Submission of Matters to a Vote of Security Holders 16 PART II Item 5 Market for the Registrant’s Common Equity and Related Stockholder Matters 16Item 6 Selected Financial Data 17Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 18Item 7A Quantitative and Qualitative Disclosures About Market Risk 27Item 8 Financial Statements and Supplementary Data 28Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 28Item 9A Controls and Procedures 28 PART III Item 10 Directors and Executive Officers of the Registrant 29Item 11 Executive Compensation 29Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 29Item 13 Certain Relationships and Related Transactions 29Item 14 Principal Accountant Fees and Services 29 PART IV Item 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 30SIGNATURES 33Table of ContentsThis Annual Report on Form 10-K is for the year ended December 31, 2003. This Annual Report modifies and supersedes documents filed prior to thisAnnual Report. Information that we file with the SEC in the future will automatically update and supersede information contained in this Annual Report. Inthis Annual Report, “we,” “us,” “our” and the “Trust” refer to Universal Health Realty Income Trust. You should carefully review all of the information contained in this Annual Report, and should particularly consider any risk factors that we set forth inthis Annual Report and in other reports or documents that we file from time to time with the SEC. In this Annual Report, we state our beliefs of future eventsand of our future financial performance. In some cases, you can identify those so-called “forward-looking statements” by words such as “may,” “will,”“should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue” or the negative of those words and othercomparable words. You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating thosestatements, you should specifically consider various factors, including the risks outlined below. Those factors may cause our actual results to differmaterially from any of our forward-looking statements. In this Annual Report on Form 10-K, the term “revenues” does not include the revenues of the unconsolidated limited liability companies in which wehave various non-controlling equity interests ranging from 33% to 99%. We currently account for our share of the income/loss from these investments by theequity method. Risks Affecting Future Operations Factors that may cause our actual results to differ materially from any of our forward-looking statements presented in this Annual Report include, butare not limited to: • a substantial portion of our revenues are dependent upon one operator, Universal Health Services, Inc., (“UHS”); • UHS is our Advisor and our officers are all employees of UHS which may create the potential for conflicts of interest; • a substantial portion of our leases are involved in the healthcare industry which is undergoing substantial changes and is subject to possiblechanges in the levels and terms of reimbursement from third-party payors and government reimbursement programs, including Medicare andMedicaid; • management cannot predict whether leases on its properties, including leases on the properties leased to subsidiaries of UHS, will be renewed attheir current rates at the end of the lease terms and if the leases are not renewed, we may be required to find other operators for these facilities and/orenter into leases with less favorable terms; • our ability to finance our growth on favorable terms; • liability and other claims asserted against us or operators of our facilities; • the fact that we have majority ownership interests in various LLCs in which we hold non-controlling equity interests; • a large portion of our non-hospital properties consist of medical office buildings which are either directly or indirectly affected by the factorsdiscussed herein as well as general real estate factors such as the supply and demand of office space and market rental rates; • the operators of our facilities, including UHS, are confronted with other issues such as: industry capacity; demographic changes; existing laws andgovernment regulations and changes in or failure to comply with laws and governmental regulations; the ability to enter into managed care provideragreements on acceptable terms; competition; the loss of significant customers; technological and pharmaceutical improvements that increase thecost of providing, or reduce the demand for healthcare; the ability to attract and retain qualified personnel, including physicians; 2Table of Contents • operators of our facilities, particularly UHS, have experienced a significant increase in property insurance (including earthquake insurance inCalifornia) and general and professional liability insurance and as a result, certain operators have assumed a greater portion of their liability riskand there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against the operators of ourfacilities, which are self-insured, will not have a material adverse effect on their future results of operations, and; • other factors referenced herein or in our other filings with the Securities and Exchange Commission. In addition, in order to qualify as a real estate investment trust (“REIT”) we must comply with certain highly technical and complex requirements.Although we intend to remain so qualified, there may be facts and circumstances beyond our control that may affect our ability to qualify as a REIT. Failureto qualify as a REIT may subject us to income tax liabilities, including federal income tax at regular corporate rates. The additional income tax incurred maysignificantly reduce the cash flow available for distribution to shareholders and for debt service. In addition, if disqualified, we might be barred fromqualification as a REIT for four years following disqualification. Although we believe we have been qualified as a REIT since our inception, there can be noassurance that we have been so qualified or will remain qualified in the future. Management is unable to predict the effect, if any, these factors will have on our operating results or our lessees, including the facilities leased tosubsidiaries of UHS. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements.Management of the Trust disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-lookingstatements contained herein to reflect future events or developments. 3Table of ContentsPART I ITEM 1. Business General We are a real estate investment trust which commenced operations in 1986. We invest in healthcare and human service related facilities including acutecare hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers and medical office buildings. Asof December 31, 2003, we have forty-four real estate investments located in fifteen states consisting of: (i) eight hospital facilities including four acute care, onebehavioral healthcare, two rehabilitation and one sub-acute; (ii) thirty-two medical office buildings, and; (iii) four preschool and childcare centers. We have our principal executive offices at 367 South Gulph Road, King of Prussia, PA 19406. Our telephone number is (610) 265-0688. UniversalHealth Realty Income Trust has an Internet website at http://www.uhrit.com. Copies of the annual, quarterly and current reports we file with the SEC, and anyamendments to those reports, are available on our website. Additionally, we have adopted governance guidelines, a Code of Conduct and Business Ethicsapplicable to all officers and directors of the Trust, a Code of Ethics for Senior Financial Officers and new charters for each of the Audit Committee,Compensation Committee and Nominating and Corporate Governance Committee of the board of trustees. These documents are also available on the Trust’sInternet website. Copies of these documents are also available in print to any shareholder upon request. We intend to satisfy the disclosure requirement underItem 10 of Form 8-K relating to amendments to or waivers from any provision of our Code of Ethics for Senior Financial Officers by posting this informationon our Internet website. Our website address is listed above. The information posted on our website is not incorporated into this Annual Report. As of December 31, 2003, we have forty-four real estate investments located in fifteen states consisting of the following: Facility Name Location Type of Facility Ownership GuarantorChalmette Medical Center(A) Chalmette, LA Acute Care 100% Universal Health Services, Inc.Virtue Street Pavilion(A) Chalmette, LA Rehabilitation 100% Universal Health Services, Inc.Southwest Healthcare System Inland Valley Campus(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 Regional Rehabilitation Hospital(E) Evansville, IN Rehabilitation 100% HealthSouth CorporationFresno-Herndon Medical Plaza(B) Fresno, CA MOB 100% —Family Doctor’s Medical Office Bldg.(B) Shreveport, LA MOB 100% HCA Inc.Kelsey-Seybold Clinic at Kings Crossing(B) Kingwood, TX MOB 100% St. Lukes Episcopal 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) Mesa, AZ MOB 76% —Suburban Medical Plaza II(C) Louisville, KY MOB 33% —Maryvale Hospital MOB(C) Phoenix, AZ MOB 60% —Desert Valley Medical Center(C) Phoenix, AZ MOB 95% —Thunderbird Paseo Medical Plaza I & II(C) Glendale, AZ MOB 75% —Cypresswood Professional Center(B) Spring, TX MOB 100% —Papago Medical Park(C) Phoenix, AZ MOB 89% —Edwards Medical Plaza(C) Phoenix, AZ MOB 94% —Desert Springs Medical Plaza(D) Las Vegas, NV MOB 99% Triad Hospitals, Inc.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 94% —East Mesa Medical Center(C) Mesa, AZ MOB 73% — 4Table of ContentsFacility Name Location Type of Facility Ownership GuarantorSummerlin Hospital MOB(D) 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 Complex(C) Inglewood, CA MOB 73% —Summerlin Hospital MOB II(D) Las Vegas, NV MOB 98% —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 90% —Rosenberg Children’s Medical Plaza(B) Phoenix, AZ MOB 85% —700 Shadow Lane & Goldring MOBs(D) Las Vegas, NV MOB 98% —The Medical Plaza at Saint Mary’s(F) Reno, NV MOB 75% —Apache Junction Medical Plaza(C) Apache Junction, AZ MOB 85% —Spring Valley Medical Office Building(D) Las Vegas, NV MOB 95% —(A) Real estate assets owned by us and leased to subsidiaries of Universal Health Services, Inc. (“UHS”).(B) Real estate assets owned by us and leased to an unaffiliated third-party or parties.(C) Real estate assets owned by a LLC in which we own a non-controlling interest as indicated above.(D) Real estate assets owned by a LLC in which we have a non-controlling interest as indicated above and include tenants who are unaffiliated third-parties or subsidiaries of UHS.(E) During the first quarter of 2003, HealthSouth Corp. (“HealthSouth”), the guarantor of the lease on the Tri-State Rehabilitation Hospital (“Tri-State”) facility announced that in light of the Securities and ExchangeCommission and Department of Justice investigations into its financial reporting and related activity calling into question the accuracy of HealthSouth’s previously filed financial statements, such financial statementsshould no longer be relied upon. The lessee on the Tri-State facility is HealthSouth/Deaconess L.L.C., a joint venture between HealthSouth Properties Corporation and Deaconess Hospital, Inc. During 2003, 2002and 2001, Tri-State had reported information to us that indicated that the ratio of earnings before interest, taxes, depreciation, amortization and lease and rental expense was many times its annual lease payments tous. However, there can be no assurance that the financial condition of HealthSouth will not have an adverse effect on Tri-State’s ability to make future lease payments to us. The lease with Tri-State was scheduled toexpire in June 2004, however, the lessee has given the required notice extending their lease for another five-year period to June of 2009. The renewal rate on this facility is based upon the five-year Treasury rateimmediately preceding the commencement of the lease renewal. Based upon the Treasury rate in early March, 2004, it is estimated that the annual base rental on Tri-State will be reduced by approximately$350,000.(F) We have committed to invest a total of $8.9 million ($6.4 million in equity and $2.5 million in debt financing) in exchange for a 75% non-controlling interest in a LLC that will construct and own the Medical Plazaat Saint Mary’s located in Reno, Nevada. As of December 31, 2003, we have provided a loan of $959,000 in connection with this project, which is scheduled to be completed and opened in the first quarter of 2005. Included in our portfolio are eight hospital facilities with an aggregate investment of $129.4 million. The leases with respect to hospital facilitiescomprised 70%, 69% and 69% of our revenues in 2003, 2002 and 2001, respectively, and as of December 31, 2003 these leases have fixed terms with anaverage of 2.5 years remaining and include renewal options ranging from two to five, five-year terms. We believe earnings before interest, taxes, depreciation, amortization and lease rental expense (“EBITDAR”), which is a non-GAAP financial measure, ishelpful to us and our investors, as a measure of the operating performance of a hospital facility. EBITDAR, which is used as an indicator of a facility’sestimated cash flow generated from operations (before rent expense, capital additions and debt service), is used by us in evaluating a facility’s financialviability and its ability to pay rent. For the eight hospital facilities owned by us the combined ratio of EBITDAR to minimum rent plus additional rent payable to us was approximately 8.4(ranging from 1.9 to 17.1) during 2003, 8.0 (ranging from 2.2 to 16.8) during 2002 and 6.1 (ranging from 2.4 to 8.8) during 2001 (see “Relationship toUniversal Health Services, Inc.”). The coverage ratio for individual facilities varies. The increase in the coverage ratio during 2003 and 2002, as compared to2001, was partially due to the merger of Inland Valley Regional Medical Center during 2002, as discussed below in Relationship to Universal Health Services,Inc. Pursuant to the terms of the leases with the hospital facilities, including subsidiaries of UHS, each individual hospital (the “lessee”) is responsible forbuilding operations, maintenance and renovations required at the eight hospital facilities leased from us. One of the subsidiaries of UHS which leases ahospital facility from us, is located in California and is covered by a commercial earthquake insurance policy which has a 5% deductible for which UHS isliable. We, or the LLCs in which we have invested, are responsible for the building operations, maintenance and renovations of the preschool and childcarecenters and the multi-tenant medical office buildings, however, a portion of the expenses associated with the medical office buildings are passed on directly tothe tenants. Cash reserves have been established to fund required building 5Table of Contentsmaintenance and renovations at the multi-tenant medical office buildings. Lessees are required to maintain all risk, replacement cost and commercial propertyinsurance policies on the leased properties and we, or the LLC in which we have invested, are also named insureds on these policies. In addition, we, or theLLCs in which we have invested, maintain property insurance on all properties. Although we believe that generally our properties are adequately insured, twoof the LLCs in which we own various non-controlling equity interests, own properties in California that are located in earthquake zones. These properties, inwhich we have invested a total of $3.8 million, are not covered by earthquake insurance since earthquake insurance is not available at rates which areeconomically beneficial in relation to the risks covered. Relationship to Universal Health Services, Inc. Leases. As of December 31, 2003, subsidiaries of Universal Health Services, Inc, (“UHS”), leased six of the eight hospital facilities owned by uswith terms expiring in 2004 through 2008. The leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with oneanother. Pursuant to the terms of our leases with subsidiaries of UHS, we earn fixed monthly base rents plus bonus rents based upon each facility’s net patientrevenue in excess of base amounts. The bonus rents are computed and paid on a quarterly basis upon a computation that compares current quarter revenue tothe corresponding quarter in the base year. These leases contain remaining renewal options ranging from two to five, five-year periods. These leases accountedfor 63% of our total revenue for the five years ended December 31, 2003 (61% for the year ended December 31, 2003). Including 100% of the revenuesgenerated at the unconsolidated LLCs in which we have various non-controlling equity interests ranging from 33% to 99%, the UHS leases accounted for 32%of our combined consolidated and unconsolidated revenue for the five years ended December 31, 2003 (28% for the year ended December 31, 2003). For the six hospital facilities owned by us and leased to subsidiaries of UHS, the combined ratio of EBITDAR to minimum rent plus additional rentpayable to us was approximately 9.2, 8.4 and 6.2 for the years ended December 31, 2003, 2002 and 2001, respectively. The coverage ratios for individualfacilities vary and range from 1.9 to 17.1 in 2003, 2.2 to 16.8 in 2002 and 2.4 to 8.8 in 2001. During the fourth quarter of 2003, we invested $1.6 million, and committed to invest an additional $2.3 million, in exchange for a 95% non-controllinginterest in a limited liability company that acquired the Spring Valley Medical Office Building, a 60,000 square foot medical office building on the campus ofSpring Valley Hospital in Las Vegas, Nevada. This MOB will be 75% master leased for five years by Valley Health System (“VHS”), a majority ownedsubsidiary of UHS, on a triple net basis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenant acceptable to usand VHS, for a minimum term of five years. As of December 31, 2003, letters of intent or lease agreements have been executed on more than 75% of therentable space of this MOB. Commencement of these leases will take place upon completion of the space, which is expected to occur during the first andsecond quarters of 2004. During the third quarter of 2003 we invested $8.9 million ($3.0 million in equity and a $5.9 million of debt financing) for the purchase of a 98% non-controlling equity interest in a limited liability company that simultaneously purchased the 700 Shadow Lane & Goldring MOBs, consisting of three medicaloffice buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada. These medical office buildings were purchased from VHS and havetenants which are subsidiaries of UHS. The lease on the Virtue Street Pavilion facility (lessee is a wholly-owned subsidiary of UHS), is scheduled to expire in December, 2004. This facility’sratio of earnings before interest, taxes, depreciation, amortization and lease and rental expense (“EBITDAR”) to minimum rent plus additional rent payable tous was approximately 1.9 times for the twelve month period ended December 31, 2003 and approximately 2.2 times for the twelve months ended December 31,2002. The lease on The Bridgeway facility (lessee is a wholly-owned subsidiary of UHS) is also scheduled to expire in December, 2004. The ratio ofEBITDAR to minimum rent plus additional rent payable to us for The Bridgeway was approximately 3.8 times for the twelve month period ended December31, 2003 and 3.6 times for the twelve month period ended December 31, 2002. The lessees on both of 6Table of Contentsthese facilities have an option at the end of the lease terms to purchase the properties at their fair market value or renew the leases at the same terms for anotherfive years. Management cannot predict whether the leases with these UHS subsidiaries will be renewed at the current rates at the end of their lease terms or ifeither or both of the lessees will exercise their options to purchase the properties. If the leases are not renewed at the current rates or if the purchase options arenot exercised, we would be required to find other operators for these facilities and/or enter into leases on terms potentially less favorable to us than the currentleases. The lessee of Chalmette Medical Center, a wholly-owned subsidiary of UHS, exercised its renewal option and extended the lease on this facility for afive-year term to 2008. The renewal rate was based upon the then five-year Treasury rate plus a spread. As a result, beginning at the end of March, 2003, theannual base rental on this facility was reduced by approximately $270,000 from $1,230,000 to $960,000. In July, 2002, the operations of Inland Valley Regional Medical Center (“Inland Valley”) were merged with the operations of Rancho Springs MedicalCenter (“Rancho Springs”), an acute care hospital located in California and also operated by UHS, the real estate assets of which are not owned by us. InlandValley, our lessee, was merged into Universal Health Services of Rancho Springs, Inc. The merged entity is now doing business as Southwest HealthcareSystem (“Southwest Healthcare”). As a result of merging the operations of the two facilities, the revenues of Southwest Healthcare include the revenues of bothInland Valley and Rancho Springs. Although we do not own the real estate assets of the Rancho Springs facility, Southwest Healthcare became the lessee on thelease relating to the real estate assets of the Inland Valley campus. Since the bonus rent calculation for the Inland Valley campus is based on net revenues andthe financial results of the two facilities are no longer separable, the lease was amended during 2002 to exclude from the bonus rent calculation, the estimatednet revenues generated at the Rancho Springs campus (as calculated pursuant to a percentage based allocation determined at the time of the merger). Noassurance can be given as to the effect, if any, the consolidation of the two facilities as mentioned above, had on the underlying value of Inland Valley. During the first quarter of 2001, UHS purchased the assets and operations of the 60-bed McAllen Heart Hospital located in McAllen, Texas. Upon theacquisition by UHS, the Heart Hospital began operating under the same license as an integrated department of McAllen Medical Center. As a result ofcombining the operations of the two facilities, the revenues of McAllen Medical Center include revenues generated by the Heart Hospital, the real property ofwhich is not owned by us. Accordingly, since the bonus rent calculation for McAllen Medical Center is based on net revenues and since the financial results ofthe two facilities are no longer separable, the McAllen Medical Center lease was amended during 2001 to exclude from the bonus rent calculation, the estimatednet revenues generated at the Heart Hospital (as calculated pursuant to a percentage based allocation determined at the time of the merger). Base rentalcommitments and the guarantee by UHS under the original lease continue for the remainder of the lease terms. During 2000, UHS purchased a non-acute carefacility located in McAllen, Texas that had been closed. The license for this facility was merged with the license for McAllen Medical Center and this non-acute facility, the real property of which is not owned by us, was re-opened during 2001. There was no amendment to the McAllen Medical Center lease relatedto this non-acute care facility. No assurance can be given as to the effect, if any, the consolidation of the two facilities as mentioned above, had on theunderlying value of McAllen Medical Center. During 2001, McAllen Hospitals, L.P., a subsidiary of UHS, exercised their option to renew their lease with us at substantially the same terms foranother five years commencing January 1, 2002 and expiring December 31, 2006. In recent years, an increasing number of legislative initiatives have been introduced or proposed in Congress and in state legislatures that would effectmajor changes in the healthcare system, either nationally or at the state level (see “Regulation”). In addition, the healthcare industry has been characterized inrecent years by increased competition and consolidation. Management is unable to predict the effect, if any, these industry factors will have on the operatingresults of our lessees, including the facilities leased to subsidiaries of UHS, or on their ability to meet their obligations under the terms of their leases with us. 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 180days after the lease terms at the same price, terms and conditions of 7Table of Contentsany 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 andconditions pursuant to any third-party offer. The leases also grant the lessees options, exercisable on at least six months notice, to purchase the respectiveleased 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 eventUHS 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 businessreasons, UHS is obligated to offer a substitution property. If we do not accept the substitution property offered, UHS is obligated to purchase the leasedfacility back from us at a price equal to the greater of its then fair market value or the original purchase price paid by us. As of December 31, 2003, theaggregate fair market value of our facilities leased to subsidiaries of UHS is not known, however, the aggregate original purchase price paid by us for theseproperties was $112.5 million. 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 our ability to sell or lease a facility, and may present a potential conflict of interest between us andUHS 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 yearsof the lease term. Management cannot predict whether the leases with subsidiaries of UHS, which have renewal options at existing lease rates, or any of our other leases,will be renewed at the end of their lease terms. If the leases are not renewed at their current rates, we would be required to find other operators for those facilitiesand/or enter into leases on terms potentially less favorable to us than the current leases. Advisory Agreement. UHS of Delaware, Inc. (the “Advisor”), a wholly-owned subsidiary of UHS, serves as Advisor to us under an AdvisoryAgreement dated December 24, 1986 between the Advisor and us (the “Advisory Agreement”). Under the Advisory Agreement, the Advisor is obligated topresent an investment program to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present anyparticular investment opportunity to us), to provide administrative services to us and to conduct our day-to-day affairs. In performing its services under theAdvisory Agreement, the Advisor may utilize independent professional services, including accounting, legal and other services, for which the Advisor isreimbursed directly by us. The Advisory Agreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by theIndependent Trustees that the Advisor’s performance has been satisfactory. The Advisory Agreement may be terminated for any reason upon sixty days writtennotice by us or the Advisor. The Advisory Agreement has been renewed for 2004. 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 our average invested real estate assets, asderived from our consolidated balance sheet from time to time. In addition, the Advisor is entitled to an annual incentive fee equal to 20% of the amount bywhich cash available for distribution to shareholders for each year, as defined in the Advisory Agreement, exceeds 15% of our equity as shown on ourconsolidated balance sheet, determined in accordance with generally accepted accounting principles without reduction for return of capital dividends. Noincentive fees were paid during 2003, 2002 and 2001. The advisory fee is payable quarterly, subject to adjustment at year end based upon our auditedfinancial statements. Our officers are all employees of UHS and as of December 31, 2003, we had no salaried employees. During each of 2003, 2002 and 2001, Mr. Kirk E.Gorman, former Trustee of the Trust and former President, Chief Financial Officer and Secretary received a $50,000 annual bonus awarded by the Trustees,subject to UHS having agreed to a $50,000 reduction in the advisory fee paid by us. During 2003, Mr. Gorman received $12,000 representing a pro-ratedamount of the annual bonus. Share Purchase Option. UHS has the option to purchase our shares of beneficial interest at fair market value to maintain a 5% interest in the Trust.As of December 31, 2003, UHS owned 6.6% of the outstanding shares of beneficial interest. 8Table of ContentsCompetition We compete for the acquisition, leasing and financing of healthcare related facilities. Our competitors include, but are not limited to, other REITs, banksand other companies, including UHS. In most geographical areas in which our facilities operate, there are other facilities which provide services comparable to those offered by our facilities,some of which are owned by governmental agencies and supported by tax revenues, and others which are owned by nonprofit corporations and may besupported to a large extent by endowments and charitable contributions. Such support is not available to our facilities. In addition, certain hospitals which arelocated in the areas served by our facilities are special service hospitals providing medical, surgical and behavioral health services that are not available at ourhospitals 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 operators of our hospitals seek to retain doctors of variedspecializations on its staff and to attract other qualified doctors by improving facilities and maintaining high ethical and professional standards. In addition,in certain markets, including McAllen, Texas, competition from other healthcare providers, including physician owned facilities, has increased. Acontinuation of the increased provider competition in the markets in which our hospital facilities operate could have an adverse effect on the net revenues andfinancial results of the operators of our hospital facilities which may negatively impact the bonus rentals earned by us on these facilities. A large portion of our non-hospital properties consist of medical office buildings which are located either close to or on the campuses of hospitalfacilities. We anticipate investing in additional healthcare related facilities and leasing the facilities to qualified operators, perhaps including UHS andsubsidiaries of UHS. Regulation and Other Factors During 2003, 2002 and 2001, the 54%, 53% and 52%, respectively, of our revenues were earned pursuant to leases with operators of acute care serviceshospitals, all of which are subsidiaries of UHS. A significant portion of the revenue earned by the operators of our acute care hospitals is derived from federaland state healthcare programs, including Medicare and Medicaid. The healthcare industry is heavily regulated by federal, state and local laws. This government regulation of the healthcare industry affects us because: (i) The financial ability of lessees to make rent payments to us may be affected by governmental regulations such as licensure, certification forparticipation in government programs, and government reimbursement, and; (ii) Our bonus rents are based on our lessees’ net revenues which in turn are affected by the amount of reimbursement such lessees receive from thegovernment. Under the statutory framework of the Medicare and Medicaid programs, many of the general acute care operations are subject to administrative rulings,interpretations and discretion that may affect payments made under either or both of such programs as well as by other third party payors. The federalgovernment makes payments to participating hospitals under its Medicare program based on various formulas. For inpatient services, the operators of ouracute care hospitals are subject to a prospective payment system (“PPS”) under which the hospitals are paid a predetermined amount per admission. Thepayment is based upon a diagnostic related group (“DRG”), for which payment amounts are adjusted to account for geographic wage differences. Foroutpatient services, both general acute and behavioral health hospitals are paid under an outpatient prospective payment system (“OPPS”) according toambulatory procedure codes (“APC”) that group together services that are comparable both clinically and with respect to the use of resources, as adjusted toaccount for certain geographic wage differences. 9Table of ContentsThere are also a number of other more general federal regulatory trends and factors affecting the hospital industry. Federal legislation continues to call forthe government to trim the growth of federal spending on Medicare and Medicaid, including reductions in the future rate of increases to payments made tohospitals and reduced the amount of payments for outpatient services, bad debt expense and capital costs. In federal fiscal year 2003, hospitals were receivingless than a full market basket inflation adjustment for services paid under the inpatient PPS (inpatient PPS update of the market basket minus 0.55percentage points is 2.95% in fiscal year 2003), although CMS estimates that for the same time period, Medicare payment rates under OPPS were to increase,for each service, by an average of 3.7%. Under the Medicare Modernization Act of 2003, which was signed into law in November 2003, the update wasrestored to the full market basket for fiscal year 2004; however, for fiscal years 2005 through 2007, operating updates equal to the market basket will begranted only to those hospitals that submit data on the ten quality indicators established by CMS. The operators of our acute care hospital facilities intend tosubmit the required quality data to CMS. For federal fiscal year 2004, CMS will increase the inpatient Medicare unadjusted standard base rate by a fullmarket basket increase of 3.4%, absent any legislative action by Congress. However, this Medicare payment increase will be mitigated by changes in otherfactors that directly impact a hospital’s DRG payment including, but not limited to, annual Medicare wage index updates, expansion of the DRG transferpayment policy and the annual recalibration of DRG relative payment weights. The healthcare industry is subject to numerous laws, regulations and rules including among others those related to government healthcare participationrequirements, various licensure and accreditations, reimbursement for patient services, health information privacy and security rules, and Medicare andMedicaid fraud and abuse provisions (including, but not limited to, federal statutes and regulations prohibiting kickbacks and other illegal inducements topotential referral sources, false claims submitted to federal health care programs and self-referrals by physicians). Providers that are found to have violatedany of these laws and regulations may be excluded from participating in government healthcare programs, subjected to significant fines or penalties or requiredto repay amounts received from government for previously billed patient services. Although the operators of our acute care facilities believes its policies, procedures and practices comply with governmental regulations, no assurance canbe given that they will not be subjected to governmental inquiries or actions, or that they would not be faced with sanctions, fines or penalties if so subjected.Even if they were to ultimately prevail, a significant governmental inquiry or action under one of the above laws, regulations or rules could have a materialadverse effect upon them, and in turn, us. A large portion of our non-hospital properties consist of medical office buildings which are located either close to or on the campuses of hospitalfacilities. These properties are either directly or indirectly affected by the factors discussed above as well as general real estate factors such as the supply anddemand of office space and market rental rates. Executive Officers of the Registrant Name Age PositionAlan B. Miller 66 Chairman of the Board, Chief Executive Officer and PresidentCharles F. Boyle 44 Vice President, Chief Financial Officer and ControllerCheryl K. Ramagano 41 Vice President, Treasurer and SecretaryTimothy J. Fowler 48 Vice President, Acquisition and Development Mr. Alan B. Miller has been Chairman of the Board and Chief Executive Officer of the Trust since our inception in 1986 and was appointed Presidentin February of 2003. He had previously served as President of the 10Table of ContentsTrust until March, 1990. Mr. Miller has been Chairman of the Board, President and Chief Executive Officer of UHS since its inception in 1978. Mr. Milleralso serves as a Director of Penn Mutual Life Insurance Company, CDI Corp. (provides staffing services and placements) and Broadlane, Inc. (an e-commercemarketplace for healthcare supplies, equipment and services). Mr. Charles F. Boyle was appointed Chief Financial Officer in February of 2003 and has served as Vice President and Controller of the Trust since1991. Mr. Boyle, who has held various positions at UHS since 1983, was promoted to Controller of UHS in November, 2003 and served as its AssistantVice President — Corporate Accounting since 1994. Ms. Cheryl K. Ramagano was appointed Secretary in February of 2003 and served as Vice President and Treasurer of the Trust since 1992. Ms.Ramagano, who has held various positions at UHS since 1983, was promoted to Treasurer of UHS in November, 2003 and served as its Assistant Treasurersince 1994. Mr. Timothy J. Fowler was elected Vice President, Acquisition and Development of the Trust upon the commencement of his employment with UHS in1993. Prior thereto, he served as a Vice President of The Chase Manhattan Bank, N.A. since 1986. Our officers are all employees of UHS and as of December 31, 2003, we had no salaried employees. We make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments tothose reports through our Internet website as soon as reasonably practicable after they have been electronically filed or furnished to the SEC. Our Internetaddress is: www.uhrit.com. 11Table of ContentsITEM 2. Properties The following table shows our investments in hospital facilities leased to Universal Health Services, Inc. and other non-related parties. The table on thenext page provides information related to various properties in which we have significant investments, some of which are accounted for by the equity method.The capacity in terms of beds (for the hospital facilities) and the five-year occupancy levels are based on information provided by the lessees. Average Occupancy(1) Lease Term Hospital Facility Name and Location Type offacility Numberofavailablebeds @12/31/03 2003 2002 2001 2000 1999 Minimumrent End ofinitialorrenewedterm Renewalterm(years)Chalmette Medical Centers(2) Virtue Street PavilionChalmette Medical CenterChalmette, Louisiana Rehabilitation AcuteCare 57138 6471%% 5968%% 5860%% 5655%% 6165%% $ 1,261,000960,000 20042008 2510Southwest Healthcare SystemInland Valley Campus(3)Wildomar, California Acute Care 80 74% 71% 80% 76% 68% 1,857,000 2006 25McAllen Medical Center(4)McAllen, Texas Acute Care 612 72% 73% 69% 76% 69% 5,485,000 2006 25Wellington Regional Medical CenterWest Palm Beach, Florida Acute Care 120 68% 58% 52% 45% 41% 2,495,000 2006 25The BridgewayNorth Little Rock, Arkansas BehavioralHealth 70 98% 97% 91% 82% 78% 683,000 2004 25Tri-State Rehabilitation HospitalEvansville, Indiana Rehabilitation 80 75% 74% 71% 73% 74% 856,000 2009 15Kindred Hospital Chicago CentralChicago, Illinois Sub-Acute Care 87 71% 78% 64% 50% 46% 1,246,000 2006 20 12Table of ContentsITEM 2. Properties (continued) Type offacility Average Occupancy(1) Minimumrent Lease Term End ofInitialorrenewedterm Renewalterm(years)Facility Name and Location 2003 2002 2001 2000 1999 Fresno Herndon Medical PlazaFresno, California MOB 73% 92% 95% 99% 100% $508,000 2007-2008 variousKelsey-Seybold Clinic atKings Crossing MOB 100% 100% 100% 100% 100% 289,000 2005 10Professional Bldgs. at KingsCrossingKingwood, Texas MOB 82% 83% 88% 96% 100% 275,000 2005-2011 variousSouthern Crescent CenterRiverdale, Georgia MOB 70% 77% 77% 77% 100% 496,000 2004-2006 variousCypresswood ProfessionalCenterSpring, Texas MOB 97% 99% 100% 100% 100% 607,000 2004-2008 variousDesert Springs MedicalPlaza(5)Las Vegas, Nevada MOB 100% 100% 100% 99% 99% 1,557,000 2004-2008 variousOrthopaedic Specialists ofNevada BuildingLas Vegas, Nevada MOB 100% 100% 100% 100% 100% 203,000 2009 20Sheffield Medical BuildingAtlanta, Georgia MOB 99% 98% 99% 95% 90% 1,352,000 2004-2012 variousSouthern Crescent Center, IIRiverdale, Georgia MOB 98% 88% 88% 88% — 973,000 2010 10Medical Center of WesternConnecticutDanbury, Connecticut MOB 94% 94% 95% 100% — 815,000 2005-2010 variousChesterbrook AcademyAudubon, New Britain,Newtown and Uwchlan,Pennsylvania Preschool andChildcareCenters N/A N/A N/A N/A N/A 560,000 2010 10Family Doctor’s MedicalOffice BuildingShreveport, Louisiana MOB 100% 100% 100% 100% 100% 275,000 2011 10700 Shadow Lane andGoldring MOBs(5)Las Vegas, Nevada(5) MOB 99% — — — — 1,532,000 2004-2013 variousN/A - Not Applicable (1) Average occupancy rate for the hospital facilities is based on the average number of available beds occupied during the five years ended December 31,2003. Average available beds is the number of beds which are actually in service at any given time for immediate patient use with the necessaryequipment and staff available for patient care. A hospital may have appropriate licenses for more beds than are in service for a number of reasons,including lack of demand, incomplete construction and anticipation of future needs. The average occupancy rate of a hospital is affected by a numberof factors, including the number of physicians using the hospital, changes in the number of beds, the composition and size of the population of 13Table of Contents the community in which the hospital is located, general and local economic conditions, variations in local medical and surgical practices and the degreeof outpatient use of the hospital services. Average occupancy rate for the multi-tenant medical office buildings is based on the occupied square footageof each building, including any applicable master leases.(2) The operations of the Virtue Street Pavilion and Chalmette Medical Center, two facilities which are separated by approximately one mile, werecombined at the end of 1989. Each facility is leased pursuant to a separate lease. No assurance can be given as to the effect, if any, the consolidationof the two facilities as mentioned above, had on the underlying value of the Virtue Street Pavilion and Chalmette Medical Center. Rental commitmentsand the guarantee by UHS under the existing leases continue for the remainder of the respective terms of the leases. The lease on the Virtue StreetPavilion facility is scheduled to expire in December, 2004. The lessee of this facility has an option at the end of the lease term to purchase the propertyat its fair market value or renew the lease at the same term for another five years. Management cannot predict whether this lease will be renewed at thecurrent rate at the end of the lease term. If the lease is not renewed at the current rate, we would be required to find another operator for this facilityand/or enter into lease terms potentially less favorable to us than the current lease. The lessee of Chalmette Medical Center exercised its renewal optionand extended the lease on the facility for a five-year term to 2008. The renewal rate was based upon the then five-year Treasury rate plus a spread. As aresult, beginning at the end of March, 2003, the annual base rental on this facility was reduced by approximately $270,000 from $1,230,000 to$960,000.(3) In July, 2002, the operations of Inland Valley Regional Medical Center (“Inland Valley”) were merged with the operations of Rancho Springs MedicalCenter (“Rancho Springs”), an acute care hospital located in California and also operated by UHS, the real estate assets of which are not owned by us.Inland Valley, our lessee, was merged into Universal Health Services of Rancho Springs, Inc. The merged entity is now doing business as SouthwestHealthcare System (“Southwest Healthcare”). As a result of merging the operations of the two facilities, the revenues of Southwest Healthcare includethe revenues of both Inland Valley and Rancho Springs. Although we do not own the real estate assets of the Rancho Springs facility, SouthwestHealthcare became the lessee on the lease relating to the real estate assets of the Inland Valley facility. Since the bonus rent calculation for the InlandValley campus is based on net revenues and the financial results of the two facilities are no longer separable, the lease was amended during 2002 toexclude from the bonus rent calculation the estimated net revenues generated at the Rancho Springs campus (as calculated pursuant to a percentagebased allocation determined at the time of the merger). The average occupancy rates shown for this facility in 2003 and 2002 were based on the combined number of beds occupied at the Inland Valley andRancho Springs campuses. The average occupancy rates shown for the years 1999 through 2001 were based on the average number of beds occupiedat the Inland Valley campus during those years.(4) During the first quarter of 2001, UHS purchased the assets and operations of the 60-bed McAllen Heart Hospital located in McAllen, Texas. Upon theacquisition by UHS, the Heart Hospital began operating under the same license as an integrated department of McAllen Medical Center. As a result ofcombining the operations of the two facilities, the revenues of McAllen Medical Center include revenues generated by the Heart Hospital, the realproperty of which is not owned by us. Accordingly, since the bonus rent calculation for McAllen Medical Center is based on net revenues and thefinancial results of the two facilities are no longer separable, the McAllen Medical Center lease was amended during 2001 to exclude from the bonusrent calculation, the estimated net revenues generated at the Heart Hospital (as calculated pursuant to a percentage based allocation determined at thetime of the merger). Base rental commitments and the guarantee by UHS under the original lease continue for the remainder of the lease terms. During2000, UHS purchased a non-acute care facility located in McAllen, Texas that had been closed. The license for this facility was merged with thelicense for McAllen Medical Center and this non-acute facility, the real property of which is not owned by us, was re-opened during 2001. There wasno 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 underlying value of McAllen Medical Center. The average occupancy rates shown for this facility in 2003, 2002 and 2001 were based on the combined number of beds at McAllen Medical Centerand the McAllen Heart Hospital. The average occupancy rates shown for the years 2000 and 1999 were based on the average number of beds occupiedat the McAllen Medical Center during those years.(5) The real estate assets of this facility are owned by a LLC in which we own a non-controlling equity interest and include tenants who are unaffiliatedthird-parties or subsidiaries of UHS. 14Table of ContentsSet forth is information detailing the rentable square feet (“RSF”) associated with each of our investments and the percentage of RSF on which leasesexpire during the next five years and thereafter: Availablefor leaseJan. 1,2004 % RSF lease expiring TotalRSF 2004 2005 2006 2007 2008 2009 andlater Hospital Investments McAllen Medical Center 532,403 0.0% 0.0% 0.0% 100.0% 0.0% 0.0% 0.0%Wellington Regional Medical Center 121,015 0.0% 0.0% 0.0% 100.0% 0.0% 0.0% 0.0%Kindred Hospital Chicago Central 115,554 0.0% 0.0% 0.0% 100.0% 0.0% 0.0% 0.0%Chalmette Medical Center 93,751 0.0% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0%Southwest Healthcare System—Inland Valley Campus 84,515 0.0% 0.0% 0.0% 100.0% 0.0% 0.0% 0.0%Tri-State Regional Rehabilitation Hospital 77,440 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100.0%The Bridgeway 57,901 0.0% 100.0% 0.0% 0.0% 0.0% 0.0% 0.0%Virtue Street Pavilion 54,716 0.0% 100.0% 0.0% 0.0% 0.0% 0.0% 0.0% Subtotal—Hospitals 1,137,295 0.0% 25.0% 0.0% 50.0% 0.0% 12.5% 12.5% Other Investments Desert Samaritan Hospital MOBs 201,107 3.4% 22.3% 17.0% 17.2% 28.4% 8.7% 2.9%Edwards Medical Plaza 141,583 5.6% 15.8% 20.6% 22.1% 14.7% 6.7% 14.4%700 Shadow Lane & Goldring MOBs 111,612 1.8% 40.5% 5.3% 12.5% 14.6% 17.8% 7.5%Desert Springs Medical Plaza 106,830 0.0% 24.3% 7.5% 55.7% 5.0% 7.4% 0.0%Centinela Medical Building Complex 102,898 1.5% 14.7% 5.0% 35.1% 3.2% 4.1% 36.6%Suburban Medical Plaza II 99,497 0.0% 1.7% 5.7% 18.5% 30.9% 2.1% 41.0%Thunderbird Paseo Medical Plaza I & II 96,569 2.7% 6.7% 4.0% 14.8% 20.4% 41.9% 9.6%Summerlin Hospital Medical Office Building II 92,313 0.0% 6.8% 0.0% 23.0% 14.1% 2.3% 53.8%Summerlin Hospital Medical Office Building I 90,798 0.0% 21.8% 13.3% 39.4% 12.1% 5.4% 8.0%Papago Medical Park 79,251 6.3% 6.8% 21.6% 30.7% 5.1% 25.9% 3.6%Deer Valley Medical Office II 77,264 0.0% 0.9% 0.0% 0.0% 4.2% 0.0% 94.9%Mid Coast Hospital Medical Office Building 73,762 0.0% 0.0% 0.0% 19.8% 0.0% 7.3% 72.9%Sheffield Medical Building 71,944 1.0% 25.0% 16.8% 9.2% 15.7% 7.7% 24.6%Rosenberg Children’s Medical Plaza 66,231 8.3% 0.0% 0.0% 0.0% 0.0% 21.3% 70.4%Spring Valley Medical Office Building(a) 57,754 25.3% 0.0% 0.0% 0.0% 0.0% 64.2% 10.5%Southern Crescent Center II 57,180 6.3% 0.0% 0.0% 0.0% 0.0% 0.0% 93.7%East Mesa Medical Center 56,348 3.8% 18.1% 24.0% 31.0% 11.9% 3.3% 7.9%Desert Valley Medical Plaza 53,625 0.0% 19.6% 22.8% 37.9% 7.1% 12.5% 0%Maryvale Hospital MOBs 41,956 4.4% 12.4% 7.7% 23.6% 4.6% 47.3% 0.0%St. Jude Heritage Health Complex 41,851 0.0% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0%Southern Crescent Center 41,400 29.7% 36.4% 0.0% 33.9% 0.0% 0.0% 0.0%Cypresswood Professional Center 40,082 0.0% 9.2% 0.0% 11.6% 46.5% 32.6% 0.0%Medical Center of Western Connecticut 37,522 0.0% 4.4% 5.7% 4.9% 19.0% 0.0% 66.0%Fresno-Herndon Medical Plaza 36,417 33.3% 0.0% 0.0% 0.0% 46.9% 19.9% 0.0%Apache Junction Medical Plaza 26,901 0.0% 0.0% 0.0% 5.9% 39% 20.0% 35.2%Santa Fe Professional Plaza 25,294 11.8% 2.0% 4.5% 18% 13.1% 50.4% 0.0%Professional Buildings at Kings Crossing 24,222 19.0% 0.0% 30.3% 0.0% 18.3% 12.3% 20%Rio Rancho Medical Center 22,956 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0%Kelsey-Seybold Clinic at Kings Crossing 20,470 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0%Orthopaedic Specialists of Nevada Building 11,000 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100%Family Doctor’s Medical Office Building 9,155 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100%Chesterbrook Academy—Audubon 8,300 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100%Chesterbrook Academy—Uwchlan 8,163 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100%Chesterbrook Academy—Newtown 8,100 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100%Chesterbrook Academy—New Britain 7,998 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 100% Subtotal—Other 2,048,353 4.7% 8.3% 11.8% 13.3% 10.7% 14.9% 36.4% TOTAL RSF, RSF Available for Lease, and Average RSF Expiring per Year 3,185,648 3.7% 11.7% 9.4% 20.8% 8.5% 14.4% 31.5% 15Table of ContentsITEM 3. Legal Proceedings None. ITEM 4. Submission of Matters to a Vote of Security Holders No matter was submitted during the fourth quarter of the year ended December 31, 2003 to a vote of security holders. PART II ITEM 5. Market for Registrant’s Common Equity and Related Stockholder Matters Our shares of beneficial interest are listed on the New York Stock Exchange. The high and low closing sales prices for our shares of beneficial interestfor each quarter in the two years ended December 31, 2003 and 2002 are summarized below: 2003 2002 HighPrice LowPrice HighPrice LowPriceFirst Quarter $26.93 $25.30 $25.09 $22.69Second Quarter $27.75 $25.95 $26.40 $23.14Third Quarter $28.00 $26.54 $28.50 $24.20Fourth Quarter $30.55 $27.46 $27.20 $23.94 As of January 31, 2004, there were approximately 669 shareholders of record of our shares of beneficial interest. It is our intention to declare quarterlydividends to the holders of our shares of beneficial interest so as to comply with applicable sections of the Internal Revenue Code governing real estateinvestment trusts. Covenants relating to the revolving credit facility limit our ability to increase dividends in excess of 95% of cash available for distribution,as defined, unless additional distributions are required to be made so as to comply with applicable sections of the Internal Revenue Code and relatedregulations governing real estate investment trusts. In each of the past five years, dividends per share were declared as follows: 2003 2002 2001 2000 1999First Quarter $.485 $.475 $.465 $.455 $.450Second Quarter .490 .480 .465 .460 .450Third Quarter .490 .480 .470 .460 .455Fourth Quarter .495 .485 .475 .465 .455 $1.960 $1.920 $1.875 $1.840 $1.810 16Table of ContentsITEM 6. Selected Financial Data Our financial highlights for the five years ended December 31, were as follows: (000s, except per share amounts) 2003(1) 2002(1) 2001(1) 2000 1999 Operating Results: Total revenue $28,313 $28,429 $27,574 $27,315 $23,865 Net income 24,425 21,623 18,349 16,256 13,972 Balance Sheet Data: Real estate investments, net of accumulated depreciation $130,789 $134,886 $139,215 $143,092 $141,367 Investments in LLCs 61,001 48,314 46,939 39,164 35,748 Total assets 194,291 185,117 187,904 183,658 178,821 Total indebtedness(2) 37,242 30,493 33,432 82,031 76,889 Other Data: Funds from operations(3) $30,149 $28,572 $25,985 $21,739 $20,127 Cash provided by (used in): Operating activities 29,077 26,286 22,778 19,970 19,579 Investing activities (13,053) (1,426) (8,332) (8,913) (14,437)Financing activities (15,994) (24,891) (14,111) (11,615) (4,862)Per Share Data: Net income—Basic $2.09 $1.85 $1.75 $1.81 $1.56 Net income—Diluted 2.07 1.84 1.74 1.81 1.56 Dividends 1.960 1.920 1.875 1.840 1.810 Other Information (in thousands) Weighted average number of shares outstanding—basic 11,713 11,687 10,492 8,981 8,956 Weighted average number of shares and share equivalents outstanding—diluted 11,779 11,750 10,536 9,003 8,977 (1) See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”(2) Excludes $132.7 million of third-party debt as of December 31, 2003 that is non-recourse to us, incurred by LLCs in which we hold various non-controlling equity interests (see Note 9 to the Consolidated Financial Statements).(3) Funds from operations (“FFO”), is a widely recognized measure of REIT performance. Although FFO is a non-GAAP financial measure, we believe thatinformation regarding FFO is helpful to shareholders and potential investors. We compute FFO in accordance with standards established by the NationalAssociation of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO inaccordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. To facilitate a clearunderstanding of our historical operating results, FFO should be examined in conjunction with net income, determined in accordance with GAAP. FFOdoes not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income,determined in accordance with GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordancewith GAAP; (ii) as an alternative to cash flow from operating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) noris FFO an indicator of funds available for our cash needs, including our ability to make cash distributions to shareholders. 17Table of ContentsIn June of 2001, we issued 2.6 million additional shares of beneficial interest at $21.57 per share generating net proceeds of $53.9 million to us. Theseproceeds were used to repay outstanding borrowings under our revolving credit facility thereby decreasing interest expense and increasing the FFO from June,2001 through December, 2003. FFO shown above is calculated as follows: (000s) 2003 2002 2001 2000 1999Net income $24,425 $21,623 $18,349 $16,256 $13,972Depreciation expense: Consolidated investments 4,409 4,378 4,352 4,414 3,833Unconsolidated affiliates 4,146 3,791 3,284 2,964 2,322Gain on sale of real property Consolidated investments — — — (1,895) — Unconsolidated affiliates (2,831) (1,220) — — — FFO $30,149 $28,572 $25,985 $21,739 $20,127 ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview We are a real estate investment trust that commenced operations in 1986. We invest in healthcare and human service related facilities including acutecare hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers and medical office buildings. Asof December 31, 2003, we have forty-four real estate investments located in fifteen states consisting of: • eight hospital facilities including four acute care, one behavioral healthcare, two rehabilitation and one sub-acute; • thirty-two medical office buildings, and; • four preschool and childcare centers. Forward Looking Statements and Certain Risk Factors The matters discussed in this report, as well as the news releases issued from time to time by us, 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 statements involve known and unknown risks, uncertainties and other factors that maycause our actual results, performance or achievements or industry results to be materially different from any future results, performance or achievementsexpressed or implied by such forward-looking statements. Such factors include, among other things, the following: • a substantial portion of our revenues are dependent upon one operator, Universal Health Services, Inc., (“UHS”); • UHS is our Advisor and our officers are all employees of UHS which may create the potential for conflicts of interest; • a substantial portion of our leases are involved in the healthcare industry which is undergoing substantial changes and is subject to possiblechanges in the levels and terms of reimbursement from third-party payors and government reimbursement programs, including Medicare andMedicaid; • management cannot predict whether leases on its properties, including leases on the properties leased to subsidiaries of UHS, will be renewed attheir current rates at the end of the lease terms and if the leases 18Table of Contents are not renewed, we may be required to find other operators for these facilities and/or enter into leases with less favorable terms; • our ability to finance our growth on favorable terms; • liability and other claims asserted against us or operators of our facilities; • the fact that we have majority ownership interests in various LLCs in which we hold non-controlling equity interests; • a large portion of our non-hospital properties consist of medical office buildings which are either directly or indirectly affected by the factorsdiscussed herein as well as general real estate factors such as the supply and demand of office space and market rental rates; • the operators of our facilities, including UHS, are confronted with other issues such as: industry capacity; demographic changes; existing laws andgovernment regulations and changes in or failure to comply with laws and governmental regulations; the ability to enter into managed care provideragreements on acceptable terms; competition; the loss of significant customers; technological and pharmaceutical improvements that increase thecost of providing, or reduce the demand for healthcare; the ability to attract and retain qualified personnel, including physicians; • operators of our facilities, particularly UHS, have experienced a significant increase in property insurance (including earthquake insurance inCalifornia) and general and professional liability insurance and as a result, certain operators have assumed a greater portion of their liability riskand there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted against the operators of ourfacilities, which are self-insured, will not have a material adverse effect on their future results of operations, and; • other factors referenced herein or in our other filings with the Securities and Exchange Commission. In addition, in order to qualify as a real estate investment trust (“REIT”) we must comply with certain highly technical and complex requirements.Although we intend to remain so qualified, there may be facts and circumstances beyond our control that may affect our ability to qualify as a REIT. Failureto qualify as a REIT may subject us to income tax liabilities, including federal income tax at regular corporate rates. The additional income tax incurred maysignificantly reduce the cash flow available for distribution to shareholders and for debt service. In addition, if disqualified, we might be barred fromqualification as a REIT for four years following disqualification. Although we believe we have been qualified as a REIT since our inception, there can be noassurance that we have been so qualified or will remain qualified in the future. Management is unable to predict the effect, if any, these factors will have on our operating results or our lessees, including the facilities leased tosubsidiaries of UHS. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements.Management of the Trust disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the forward-lookingstatements contained herein to reflect future events or developments. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimatesand assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. A summary of our significant accounting policies is outlined in Note 1 to the financial statements. We consider our critical accounting policies to bethose that require us to make significant judgments and estimates when we prepare our financial statements, including the following: Revenue Recognition — Revenue is recognized on the accrual basis of accounting. Our revenues consist primarily of rentals received from tenants,which are comprised of minimum rent (base rentals), bonus rentals 19Table of Contentsand reimbursements from tenants for their pro-rata share of expenses such as common area maintenance costs, real estate taxes and utilities. The minimumrent for all hospital facilities is fixed over the initial term or renewal term of the respective leases. Minimum rent for other material leases is recognized using thestraight-line method under which contractual rent increases are recognized evenly over the lease term. Bonus rents are recognized based upon increases in eachfacility’s net patient revenue in excess of stipulated amounts. Bonus rentals are determined and paid each quarter based upon a computation that compares therespective facility’s current quarter’s net revenue to the corresponding quarter in the base year. Tenant reimbursements are accrued as revenue in the sameperiod the related expenses are incurred by us. Investments in Limited Liability Companies (“LLCs”) — Our consolidated financial statements include the accounts of our controlledinvestments. In accordance with the American Institute of Certified Public Accountants’ Statement of Position 78-9 “Accounting for Investments in Real EstateVentures” 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 theMinority Shareholder or Shareholders Have Certain Approval or Veto Rights”, we account for our investments in LLCs which we do not control using theequity method of accounting. These investments, which represent 33% to 99% non-controlling ownership interests, are recorded initially at our cost andsubsequently adjusted for our net equity in the net income, cash contributions and distributions of the investments. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. During December, 2003, theFinancial Accounting Standards Board decided to defer to the first quarter of 2004, the implementation date for Interpretation No. 46. This deferral onlyapplies to variable interest entities that existed prior to February 1, 2003 as the interpretation applied immediately to variable interest entities created or obtainedafter January 31, 2003. Pursuant to our preliminary analysis of the provisions of Interpretation No. 46, beginning in the first quarter of 2004, we will begin toconsolidate the results of operations, assets, liabilities, third-party debt that is non-recourse to us and minority interest liability (to reflect the portion of theLLCs held by other third-party members) of three of our LLC investments that meet the criteria of a variable interest entity of which we are determined to bethe primary beneficiary (see Note 9 to the Consolidated Financial Statements). The 2003 annual revenue for these three LLCs was approximately $6.3 millionand the combined total assets total approximately $39.9 million as of December 31, 2003. On a combined basis, these three LLCs have approximately $22.5million in third-party debt that is non-recourse to us. There will be no impact on our net income as a result of consolidating these LLCs. Rental income recorded at the LLCs relating to leases in excess of one year in length, is recognized using the straight-line method under which contractualrents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting from straight-line rent adjustmentsis dependent on many factors including the nature and amount of any rental concessions granted to new tenants, scheduled rent increases under existingleases, as well as the acquisitions and sales of properties that have existing in-place leases with terms in excess of one year. As a result, the straight-lineadjustments to rental revenue may vary from period-to-period. Federal Income Taxes — No provision has been made for federal income tax purposes since we qualify as a real estate investment trust under Sections856 to 860 of the Internal Revenue Code of 1986, and intend to continue to remain so qualified. As such, we are exempt from federal income taxes and we arerequired to distribute at least 90% of our real estate investment taxable income to our shareholders. We are subject to a federal excise tax computed on a calendar year basis. The excise tax equals 4% of the amount by which 85% of our ordinary incomeplus 95% of any capital gain income for the calendar year exceeds cash distributions during the calendar year, as defined. No provision for excise tax hasbeen reflected in the financial statements as no tax was due. 20Table of ContentsEarnings and profits, which determine the taxability of dividends to shareholders, will differ from net income reported for financial reporting purposesdue to the differences for federal tax purposes in the cost basis of assets and in the estimated useful lives used to compute depreciation and the recording ofprovision for investment losses. Relationship with UHS and 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 us (the “Advisory Agreement”). Under the Advisory Agreement, the Advisor is obligated to present an investment program tous, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity to us),to provide administrative services to us and to conduct our day-to-day affairs. In performing its services under the Advisory Agreement, the Advisor mayutilize independent professional services, including accounting, legal and other services, for which the Advisor is reimbursed directly by us. The AdvisoryAgreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Independent Trustees that the Advisor’sperformance has been satisfactory. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. TheAdvisory Agreement has been renewed for 2004. All transactions with UHS must be approved by the Independent Trustees. Our officers are all employees ofUHS and as of December 31, 2003 we had no salaried employees. For the years ended December 31, 2003, 2002 and 2001, 61%, 60% and 60%, respectively, of our revenues were earned under the terms of the leaseswith wholly-owned subsidiaries of UHS. Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controllingequity interests ranging from 33% to 99%, the UHS leases accounted for 28% in 2003, 29% in 2002 and 31% in 2001 of the combined consolidated andunconsolidated revenues. The leases to subsidiaries of UHS are guaranteed by UHS and cross-defaulted with one another. See Note 2 to the ConsolidatedFinancial Statements for additional disclosures. Results of Operations Net income was $24.4 million or $2.07 per diluted share during 2003 as compared to $21.6 million or $1.84 per diluted share in 2002. The $2.8million or 13% increase in net income during 2003, as compared to 2002, was due primarily to a $3.0 million increase in equity in income of LLCs. Theincreased income from LLCs during 2003, as compared to 2002, resulted from: (i) $1.4 million of additional income from our non-controlling investments invarious LLCs, and; (ii) a $1.6 million increase in gains on sales of real properties by certain LLCs ($2.8 million of gains during 2003 as compared to $1.2million during 2002). Included in the income from the LLCs is rental income relating to leases in excess of one year in length, which is recognized using thestraight-line method under which contractual rents are recognized evenly over the lease term regardless of when payments are due. Net income was $21.6 million or $1.84 per diluted share during 2002 as compared to $18.3 million or $1.74 per diluted share during 2001. The $3.3million or 18% increase in net income during 2002, as compared to 2001, was due primarily to: (i) a favorable $1.3 million increase in equity in income ofLLCs due primarily to a $1.2 million gain on a LLC’s sale of a property during 2002; (ii) a favorable $1.5 million decrease in interest expense causedprimarily by reduced borrowings resulting from repayment of outstanding debt with the $53.9 million of net proceeds generated from the issuance of anadditional 2.6 million shares of beneficial interest in June of 2001, and; (iii) $500,000 of other net favorable increases to net income. Total revenues decreased by $116,000 to $28.3 million in 2003 as compared to 2002 and increased 3% or $855,000 to $28.4 million in 2002 ascompared to 2001. The $116,000 decrease in net revenues during 2003, as compared to 2002, resulted from: (i) an unfavorable $205,000 or 2% decrease in base rentalsfrom UHS facilities, resulting from the lease renewal at Chalmette Medical Center which was renewed in March, 2003 at a lower annual base rental rate; (ii) anunfavorable 21Table of Contents$302,000 or 3% decrease in base rental and tenant reimbursements from non-related parties, caused primarily by an increased vacancy rate at three medicaloffice buildings located in Fresno, California, Riverdale, Georgia and Kingwood, Texas, and; (iii) a favorable $391,000 or 9% increase in bonus rentalrevenue from UHS facilities. The $855,000 increase in revenues during 2002, as compared to 2001, was due to: (i) a favorable $701,000 or 20% increase in bonus rental from UHSfacilities, and; (ii) a favorable $154,000 or 1% increase in rentals from non-related parties resulting primarily from increases in tenant reimbursements forexpenses associated with medical office buildings due primarily to increased occupancy. Interest expense increased $94,000 or 4% in 2003, as compared to 2002, due primarily to an increase in the average outstanding borrowings to financeinvestments in various LLCs during 2003. Interest expense decreased $1.5 million or 38% in 2002, as compared to 2001. The reduction in interest expense in2002, as compared to 2001, resulted primarily from a reduction in the average outstanding borrowings under our revolving credit agreement due primarily tothe repayment of outstanding borrowings using the $53.9 million of net proceeds generated from the issuance of an additional 2.6 million shares of beneficialinterest in June, 2001. Other operating expenses increased 2% or $63,000 in 2003, as compared to 2002, and increased $81,000 or 3% in 2002, as compared to 2001. Includedin our other operating expenses were expenses related to the medical office buildings, in which we have a controlling ownership interest which totaled $2.6million in 2003, $2.5 million in 2002 and $2.5 million in 2001. A portion of the expenses associated with the medical office buildings are passed on directlyto the tenants and are included as revenues in our statements of income. Approximately $1.6 million or 60% in 2003, $1.7 million or 70% in 2002 and $1.6million or 64% in 2001, of the operating expenses related to the medical office buildings were passed on directly to the tenants. Building expenses allocated totenants for reimbursement are dependent on various factors such as overall building occupancy levels and terms of individual leases. Depreciation and amortization expense increased $105,000 or 2% in 2003, as compared to 2002, and $30,000 or 1% in 2002, as compared to 2001. Included in our financial results was $5.1 million in 2003 (before $2.8 million gains on sales of real properties), $3.7 million in 2002 (before $1.2million gain on sale of property) and $3.6 million in 2001, of operating income generated from our ownership of equity interests in limited liability companieswhich own medical office buildings in Arizona, California, Kentucky, New Mexico, Nevada and Maine (see Note 9 to the Consolidated FinancialStatements). During the fourth quarter of 2003, 23650 Madison and PacPal Investments, two LLCs in which we own 95% non-controlling ownership interests, soldthe real estate assets of Skypark Professional Medical Building and Pacifica Palms Medical Plaza, respectively, both of which are located in Torrance,California. Our share of the combined net sales proceeds resulting from these transactions was $6.3 million. The cash proceeds for both of these sales arebeing held in escrow by a like-kind-exchange agent in anticipation of possibly completing like-kind-exchange transactions during 2004. These transactionsresulted in a combined gain of $2.5 million which is included in our 2003 results of operations. Also during 2003, we received $365,000 from ParkvaleProperties, a LLC in which we own a 60% non-controlling ownership interest, representing our share of the net sale proceeds from the sale of Palo VerdeMedical Center, a medical office building located in Phoenix, Arizona. This sale resulted in a gain of $365,000, which is included in our 2003 results ofoperations, since the carrying value of this investment was reduced to zero in a prior year. During 2002, we received $2.6 million of cash for our share of the proceeds generated from the sale of the real estate assets of Samaritan West ValleyMedical Center located in Goodyear, Arizona. The transaction resulted in a gain of $1.2 million which is included in our 2002 results of operations. This salecompleted a like-kind exchange transaction whereby the LLC in which we own an 89% non-controlling equity interest, acquired the real estate assets during2001 of Papago Medical Park located in Phoenix, Arizona in exchange for cash and the real estate assets of Samaritan West Valley Medical Center located inGoodyear, Arizona. 22Table of ContentsWe adopted SFAS No. 133 effective January 1, 2001. The adoption of this standard resulted in a gain, stemming from the ineffective portion of cashflow hedges on derivatives of $10,000 during 2003, a loss of $217,000 during 2002 and a gain of $17,000 during 2001. Funds from operations (“FFO”), is a widely recognized measure of REIT performance. Although FFO is a non-GAAP financial measure, we believe thatinformation regarding FFO is helpful to shareholders and potential investors. We compute FFO in accordance with standards established by the NationalAssociation of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO inaccordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. To facilitate a clear understandingof our historical operating results, FFO should be examined in conjunction with net income, determined in accordance with GAAP. FFO does not representcash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income, determined in accordancewith GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordance with GAAP; (ii) as an alternativeto cash flow from operating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) nor is FFO an indicator of funds availablefor our cash needs, including our ability to make cash distributions to shareholders. In June of 2001, we issued 2.6 million additional shares of beneficial interest at $21.57 per share generating net proceeds of $53.9 million. Theseproceeds were used to repay outstanding borrowings under our $100 million revolving credit facility thereby decreasing interest expense and increasing FFOfrom June, 2001 through December, 2003. FFO is calculated as follows: (000s) 2003 2002 2001 2000 1999Net income $24,425 $21,623 $18,349 $16,256 $13,972Depreciation expense: Consolidated investments 4,409 4,378 4,352 4,414 3,833Unconsolidated affiliates 4,146 3,791 3,284 2,964 2,322Gain on sale of real property Consolidated investments — — — (1,895) — Unconsolidated affiliates (2,831) (1,220) — — — FFO $30,149 $28,572 $25,985 $21,739 $20,127 Effects of Inflation Although inflation has not had a material impact on our results of operations over the last three years, the healthcare industry is very labor intensive andsalaries and benefits are subject to inflationary pressures as are rising supply costs which tend to escalate as vendors pass on the rising costs through priceincreases. Operators of our hospital facilities are experiencing the effects of the tight labor market, including a shortage of nurses which has caused and maycontinue to cause an increase, in excess of the inflation rate, in salaries, wages and benefits expense. In addition, due to unfavorable pricing and availabilitytrends in the professional and general liability insurance markets, the cost of commercial professional and general liability insurance coverage has risensignificantly. As a result, certain operators of our hospital facilities, including all of the facilities leased to subsidiaries of UHS, assumed a greater portion ofthe hospital professional and general liability risk. We cannot predict the ability of the operators of our facilities to continue to cover future cost increases.Therefore, there can be no assurance that a continuation of these trends will not have a material adverse effect on the future results of operations of theoperators of our facilities which may affect their ability to make lease payments to us. Most of our leases contain provisions designed to mitigate the adverse impact of inflation. Our hospital leases require all building operating expenses,including maintenance, real estate taxes and other costs, to be paid by the lessee. In addition, certain of the hospital leases contain bonus rental provisions,which require the lessee to pay additional rent to us based on increases in the revenues of the facility over a base year amount. In addition, 23Table of Contentsmost of our medical office building leases require the tenant to pay an allocable share of operating expenses, including common area maintenance costs,insurance and real estate taxes over a base year amount. These provisions may reduce our exposure to increases in operating costs resulting from inflation. Tothe extent that some leases do not contain such provisions, our future operating results may be adversely impacted by the effects of inflation. Liquidity and Capital Resources Liquidity Net cash provided by operating activities Net cash provided by operating activities increased to $29.1 million during 2003 as compared to $26.3 million in 2002. The $2.8 million increaseduring 2003, as compared to 2002, resulted from: (i) a favorable increase of $1.6 million in gains realized from the sale of real estate assets by LLCs in whichwe own non-controlling ownership interests ($2.8 million of gains realized during 2003 as compared to $1.2 million during 2002), and; (ii) $1.2 million ofother net favorable increases due primarily to increased earnings during 2003, as compared to 2002, from the LLCs in which we own various non-controllingownership interests. Contributing to the increased earnings from the LLCs was increased rental income recorded at the LLCs relating to leases in excess of oneyear in length which is recognized using the straight-line method. Also contributing to the increase was increased cash generated from the LLCs in which weinitially invested during 2002 or 2003. Net cash provided by operating activities increased $3.5 million to $26.3 million during 2002 as compared to $22.8 million during 2001 resultingprimarily from: (i) a favorable $1.2 million gain realized during 2002 on the sale of real estate assets by a LLC in which we own a non-controlling ownershipinterest; (ii) a favorable $1.5 million reduction in interest expense resulting primarily from the repayment of borrowings under our revolving credit agreementusing the proceeds generated from the issuance of 2.6 million newly issued shares of beneficial interest in June, 2001, and; (iii) $800,000 of other net favorablechanges including a $700,000 increase in bonus rental revenues. Net cash used in investing activities During 2003, we invested a total of $16.3 million (consisting of $9.4 million of investments and $6.9 million of net loans) in the following limitedliability companies in which we own non-controlling ownership interests: • $1.2 million invested for the purchase of an 85% ownership interest in a LLC that owns a medical office building in Apache Junction, Arizona (theLLC also obtained a $3.0 million third-party mortgage that is non-recourse to us); • $1.6 million invested (and an additional $2.3 million committed) in exchange for a 95% non-controlling interest in a LLC that owns the SpringValley Medical Office Building, which it acquired from a subsidiary of UHS, located in Las Vegas, Nevada (the LLC also obtained a $4.0 millionthird-party mortgage that is non-recourse to us); • $8.9 million ($3.0 million in equity and a $5.9 million loan which is intended to be reimbursed to us upon securing third-party refinancing whichis expected to occur during the third quarter of 2004 and will be non-recourse to us) invested for the purchase of a 98% non-controlling equityinterest in a LLC that simultaneously purchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas,Nevada from a subsidiary of UHS; • $1.0 million net loan funded in connection with a total commitment of $8.9 million by us (consisting of $6.4 million in equity and $2.5 million indebt financing) in exchange for a 75% non-controlling interest in a LLC that will construct and own the Medical Plaza at Saint Mary’s located inReno, Nevada, which is scheduled to be completed and opened in the first quarter of 2005; 24Table of Contents • $2.0 million funded (remaining commitment of $300,000 after this funding) in connection with the purchase of a 85% non-controlling equityinterest in a LLC that constructed and owns the Rosenberg Children’s Medical Plaza, a medical office building that was opened in February, 2003(the LLC also obtained a $7.5 million third-party mortgage that is non-recourse to us), and; • $1.6 million of additional investments in various LLCs in which we own a non-controlling equity interest. During 2002, we invested a total of $5.3 million in the following: • $3.1 million invested in a LLC, in which we own a 90% non-controlling equity interest, that constructed the recently opened Deer Valley MedicalOffice II located in Phoenix, Arizona (the LLC also obtained a $7.0 million third-party mortgage that is non-recourse to us); • $200,000 invested (and an additional $2.3 million committed, of which $2.0 million was funded in 2003) for the purchase of a 85% non-controlling equity interest in a LLC that constructed and owns the Rosenberg Children’s Medical Plaza, a medical office building that was openedin February, 2003 (the LLC also obtained a $7.5 million third-party mortgage that is non-recourse to us), and; • $2.0 million of additional investments in various LLCs in which we own non-controlling equity interests. During 2001, we invested a total of $9.2 million (consisting of $8.8 million of investments in LLCs and $400,000 of net loans) in the following LLCs: • $1.4 million invested to purchase a 75% equity interest in a LLC that owns and operates the Thunderbird Paseo Medical Plaza II located inGlendale, Arizona (the LLC also obtained a $3.1 million third-party mortgage that is non-recourse to us); • $1.9 million invested to purchase a 74% equity interest in a LLC that owns and operates the Mid-Coast Hospital Medical Office Building located inBrunswick, Maine (the LLC also obtained a $8.9 million third-party mortgage that is non-recourse to us); • $2.8 million of cash in a LLC for the purpose of effecting a like-kind exchange which was completed in January, 2002 (the LLC purchased the realestate assets of Papago Medical Park and sold the real estate assets of Samaritan West Valley Medical Center, as mentioned above); • $45,000 of cash and a commitment to invest a total of $3.4 million in exchange for a 90% non-controlling interest in a limited liability company thatconstructed and owns the Deer Valley Medical Office II located in Phoenix, Arizona which was opened during the third quarter of 2002 (the LLCobtained a $7.0 million third-party mortgage that is non-recourse to us), and; • $3.1 million to purchase an additional equity interest and fund additional investments and loans to various LLCs in which we have various non-controlling equity interests. During 2003 and 2002, we received $9.2 million and $1.9 million, respectively, of cash distributions from sale or refinancing proceeds, in excess ofgains, in connection with our investments in LLCs. Also during 2003, our share of the combined net proceeds, amounting to $6.3 million, resulting from thesale by two LLCs of the real estate assets of Skypark Professional Medical Office Building and Pacifica Palms Medical Plaza, was held in a cash escrowaccount by a like-kind-exchange agent in anticipation of possibly completing like-kind-exchange transactions during 2004. We received cash distributions inexcess of income from LLCs, excluding gains, amounting to $671,000 during 2003, $1.9 million during 2002 and $1.4 million during 2001. The $1.2million decrease during 2003, as compared to 2002, was due primarily to an increase in straight-line rental revenue. Net cash used in financing activities We borrowed $6.8 million during 2003 and repaid $1.4 million during 2002 and $48.6 million during 2001, under our revolving credit facility. In June,2001, we issued 2.6 million shares of beneficial interest at a price of 25Table of Contents$21.57 per share, generating $53.9 million of net proceeds which were used to repay outstanding borrowings under our revolving credit facility. It is our intention to declare quarterly dividends to the holders of our shares of beneficial interest so as to comply with applicable sections of the InternalRevenue Code governing real estate investment trusts. Covenants relating to the revolving credit facility limit our 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 andrelated regulations governing real estate investment trusts. Dividends were declared and paid as follows: (i) $1.960 per share or $23.0 million in the aggregatein 2003; (ii) $1.920 per share or $22.4 million in the aggregate in 2002, and; (iii) $1.875 per share or $20.6 million in the aggregate in 2001. Dividends werereinvested under our Dividend Reinvestment and Share Purchase Plan as follows: (i) $573,000 or 20,732 shares in the aggregate during 2003; (ii) $488,000 or19,347 shares in the aggregate during 2002, and; (iii) $472,000 or 21,197 shares in the aggregate during 2001. Credit facilities and mortgage debt We have an unsecured $80 million revolving credit agreement (the “Agreement”) which expires on May 27, 2007. We have a one-time option, which canbe exercised at any time, to increase the amount by $20 million for a total commitment of $100 million. The Agreement provides for interest at our option, atthe Eurodollar rate plus 1.00% to 1.40% or the prime rate plus zero to .40%. A fee of .25% to .35% is paid on the unused portion of this commitment. Themargins over the Eurodollar rate, prime rate and the commitment fee are based upon our debt to total capital ratio as defined by the Agreement. At December 31,2003, the applicable margin over the Eurodollar rate was 1.00% and the commitment fee was .25%. At December 31, 2003, we had $13.9 million of letters ofcredit outstanding against the Agreement. There are no compensating balance requirements. The Agreement contains a provision whereby the commitments willbe reduced by 50% of the proceeds generated from any new equity offering. The average amounts outstanding under our revolving credit agreement were $28.3million in 2003, $25.3 million in 2002 and $46.1 million in 2001 with corresponding effective interest rates, including commitment fees and interest rate swapexpense, of 7.6% in 2003, 8.1% in 2002 and 7.4% in 2001. The carrying value of the amounts borrowed approximates fair market value. At December 31,2003, we had approximately $33 million of available borrowing capacity under this agreement. We have one mortgage with an outstanding balance of $4.2 million at December 31, 2003. The mortgage, which carries an 8.3% interest rate and matureson February 1, 2010, is non-recourse to us and is secured by the Medical Center of Western Connecticut. At December 31, 2003, this mortgage had a fair valueof approximately $4.8 million. Changes in market interest rates on our fixed rate debt impacts the fair value of the debt, but it has no impact on interestincurred or cash flow. Covenants relating to the revolving credit facility require the maintenance of a minimum tangible net worth and specified financial ratios, limit ourability to incur additional debt, limit the aggregate amount of mortgage receivables and limit our ability to increase dividends in excess of 95% of cashavailable for distribution, unless additional distributions are required to comply with the applicable section of the Internal Revenue Code and relatedregulations governing real estate investment trusts. We are in compliance with such covenants at December 31, 2003. 26Table of ContentsThe following represents the scheduled maturities of our contractual obligations as of December 31, 2003: Payments Due by Period (dollars in thousands)Contractual Obligation Total Less than 1 Year 2-3 years 4-5 years After 5 yearsLong-term debt fixed $4,192 $100 $232 $273 $3,587Long-term debt-variable 33,050 33,050 — — — Construction commitments(a) 7,700 7,700 — — — Total contractual cash obligations $44,942 $40,850 $232 $273 $3,587 (a) As of December 31, 2003, we have invested approximately $1 million in Arlington Medical Properties, LLC. We have committed to invest a total of$8.9 million in exchange for a 75% non-controlling interest in the LLC that is constructing and will own and operate the Medical Plaza at Saint Mary’s,a medical office building located in Reno, Nevada. The property is expected to open during the first quarter of 2005. ITEM 7A. Qualitative and Quantitative Disclosures About Market Risk Market Risks Associated with Financial Instruments Our 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 our debt is fixed rate accomplished by entering into interest rate swap agreements. The interest rate swap agreements are contracts that require us topay 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 uponcommencement of the swap agreements. We do not hold or issue derivative instruments for trading purposes and we are not a party to any instruments withleverage features. We are exposed to credit losses in the event of nonperformance by the counterparties to our financial instruments. We have entered into interest rate swap agreements which were designed to reduce the impact of changes in interest rates on our variable rate revolvingcredit notes. At December 31, 2003, we had three outstanding swap agreements having a total notional principal amount of $30 million which mature fromMay, 2004 through November, 2006. These swap agreements effectively fix the interest rate on $30 million of variable rate debt at 7.0% including the revolverspread of 1.00%. The interest rate swap agreements were entered into in anticipation of certain borrowing transactions made by us. Additional interest expenserecorded as a result of our hedging activity, which is included in the effective interest rates shown above, was $1,424,000, $1,332,000 and $680,000 in 2003,2002 and 2001, respectively. We are exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swap agreements. Thesecounterparties are major financial institutions and we do not anticipate nonperformance by the counterparties which are rated A or better by Moody’s InvestorsService. Termination of the interest rate swaps at December 31, 2003 would have resulted in payments to the counterparties of approximately $2,254,000. Thefair value of the interest rate swap agreements at December 31, 2003 reflects the estimated amounts that we would pay to terminate the contracts and are basedon quotes from the counterparties. For the years ended December 31, 2003, 2002 and 2001, we received a weighted average rate of 1.3%, 1.9% and 4.1%,respectively, and paid a weighted average rate on our interest rate swap agreements of 7.0% in 2003, 6.4% in 2002 and 6.5% in 2001 (including the revolverspread of 1.00% in 2003 and 0.50% during 2002 and 2001). The sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their 2003 levels, with all othervariables held constant. A 100 basis point increase in market interest rates would result in a decrease in the fair value of our fixed-rate debt by approximately$212,000. A 100 basis point decrease in market interest rates would result in an increase in the fair value of our fixed-rate debt by approximately $224,000. The table below presents information about our derivative financial instruments and other financial instruments that are sensitive to changes in interestrates, including interest rate swaps as of December 31, 2003. 27Table of ContentsFor debt obligations, the table presents principal cash flows and related weighted-average interest rates by contractual maturity dates. For interest rate swapagreements, the table presents notional amounts by expected maturity date and weighted average interest rates based on rates in effect at December 31, 2003. Maturity Date, Year Ending December 31 (Dollars in thousands) 2004 2005 2006 2007 2008 Thereafter Total Long-term debt: Fixed rate $100 $112 $121 $131 $141 $3,587 $4,192 Average interest rates 8.3% 8.3% 8.3% 8.3% 8.3% 8.3% Variable rate long-term debt $33,050 $33,050 Interest rate swaps: Pay fixed/receive Variable notionalamounts $10,000 $0 $20,000 $0 $0 $0 $30,000 Average pay rate 5.65% 6.02% Fair Value $(226) $(2,028) $(2,254)Average receive rate 3 monthLIBOR 3 monthLIBOR ITEM 8. Financial Statements and Supplementary Data The Trust’s Consolidated Balance Sheets and our Consolidated Statements of Income, Shareholders’ Equity and Cash Flows, together with the report ofKPMG LLP and a previously issued report of Arthur Andersen LLP, independent public accountants, are included elsewhere herein. Reference is made to the“Index to Financial Statements and Schedule.” The report of Arthur Andersen LLP has not been reissued. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There were no disagreements with accountants on accounting and financial disclosures during the last two fiscal years. On June 18, 2002, the Trustdismissed Arthur Andersen LLP as the Trust’s independent public accountant and decided to engage KPMG LLP to serve as the Trust’s independent publicaccountant. The Trust’s decision to change its independent accountants was approved by the Board of Trustees upon recommendation of the AuditCommittee. For more information with respect to this matter, see the Trust’s current report on Form 8-K filed on June 18, 2002. ITEM 9A. Controls and Procedures As of December 31, 2003, under the supervision and with the participation of the Trust’s management, including the Trust’s Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), an evaluation of the effectiveness of the Trust’s disclosure controls and procedures was performed. Based onthis evaluation, the CEO and CFO have concluded that the Trust’s disclosure controls and procedures are effective to ensure that material information isrecorded, processed, summarized and reported by management of the Trust on a timely basis in order to comply with the Trust’s disclosure obligations underthe Securities Exchange Act of 1934 and the SEC rules thereunder. There have been no significant changes in the Trust’s internal controls or in other factors during the fourth quarter of 2003 that have materially effected,or are reasonably likely to materially effect, the Trust’s internal controls. 28Table of ContentsPART III ITEM 10. Directors and Executive Officers of the Registrant There is hereby incorporated by reference the information to appear under the caption “Election of Trustees” in our definitive Proxy Statement to be filedwith the Securities and Exchange Commission within 120 days after December 31, 2003. See also “Executive Officers of the Registrant” appearing in Part Ihereof. ITEM 11. Executive Compensation There is hereby incorporated by reference the information under the caption “Executive Compensation” and “Compensation Pursuant to Plans” in ourdefinitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after December 31, 2003. ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters There is hereby incorporated by reference the information under the caption “Security Ownership of Certain Beneficial Owners and Management” in ourdefinitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after December 31, 2003. ITEM 13. Certain Relationships and Related Transactions There is hereby incorporated by reference the information under the caption “Transactions With Management and Others” in our definitive ProxyStatement to be filed with the Securities and Exchange Commission within 120 days after December 31, 2003. ITEM 14. Principal Accountant Fees and Services There is hereby incorporated by reference the information to appear under the caption “Relationship with Independent Auditor” in our Proxy Statement,to be filed with the Securities and Exchange Commission within 120 days after December 31, 2003. 29Table of ContentsPART IV ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) Financial Statements and Financial Statement Schedules: (1) Independent Auditors’ Report (2) Financial Statements Consolidated Balance Sheets—December 31, 2003 and 2002 Consolidated Statements of Income—Years Ended December 31, 2003, 2002 and 2001 Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2003, 2002 and 2001 Consolidated Statements of Cash Flows—Years Ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements—December 31, 2003 (3) Schedule Schedule III—Real Estate and Accumulated Depreciation—December 31, 2003 Notes to Schedule III—December 31, 2003 (b) Reports on Form 8-K filed during the last quarter of the year ended December 31, 2003: (1) Report on Form 8-K dated October 17, 2003, reported under Item 7, Financial Statements and Exhibits, that the Trust issued a press releaseannouncing the Trust’s financial results for the quarter ended September 30, 2003. (2) Report on Form 8-K dated November 13, 2003, reported under Item 7, Financial Statements and Exhibits, that the Trust issued an updated thirdquarter earnings release reflecting the changes due to the deferral of FASB Statement 150. (c) Exhibits: 3.1 Declaration of Trust, dated as of August 1986, previously filed as Exhibit 4.1 to the Trust’s registration statement on Form S-3 (file No. 333-60638), is incorporated herein by reference. 3.2 Amendment to Declaration of Trust, dated as of June 15, 1993, previously filed as Exhibit 4.2 to the Trust’s registration statement on Form S-3 (fileNo. 333-60638), is incorporated herein by reference. 3.3 Amended and restated bylaws previously filed as Exhibit 4.3 to the Trust’s registration statement on Form S-3 (file No. 333-60638) is incorporatedherein by reference. 10.1 Advisory Agreement, dated as of December 24, 1986, between UHS of Delaware, Inc. and The Trust, previously filed as Exhibit 10.2 to theTrust’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference. 10.2 Agreement effective January 1, 2004, to renew Advisory Agreement dated as of December 24, 1986 between Universal Health Realty Income Trustand UHS of Delaware, Inc. 10.3 Contract of Acquisition, dated as of August 1986, between the Trust and certain subsidiaries of Universal Health Services, Inc., previously filedas Exhibit 10.2 to Amendment No. 3 of the Registration Statement on Form S-11 and S-2 of Universal Health Services, Inc. and the Trust (Registration No.33-7872), is incorporated herein by reference. 30Table of Contents10.4 Form of Leases, including Form of Master Lease Document Leases, between certain subsidiaries of Universal Health Services, Inc. and the Trust,previously filed as Exhibit 10.3 to Amendment No. 3 of the Registration Statement on Form S-11 and Form S-2 of Universal Health Services, Inc. and theTrust (Registration No. 33-7872), is incorporated herein by reference. 10.5 Share Option Agreement, dated as of December 24, 1986, between the Trust and Universal Health Services, Inc., previously filed as Exhibit 10.4to the Trust’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference. 10.6 Corporate Guaranty of Obligations of Subsidiaries Pursuant to Leases and Contract of Acquisition, dated December 1986, issued by UniversalHealth Services, Inc. in favor of the Trust, previously filed as Exhibit 10.5 to the Trust’s Current Report on Form 8-K dated December 24, 1986, isincorporated herein by reference. 10.7 Share Compensation Plan for Outside Trustees, previously filed as Exhibit 10.12 to the Trust’s Annual Report on Form 10-K for the year endedDecember 31, 1991, is incorporated herein by reference. 10.8 Lease dated December 22, 1993, between Universal Health Realty Income Trust and THC-Chicago, Inc. as lessee, previously filed as Exhibit10.14 to the Trust’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference. 10.9 Universal Health Realty Income Trust 1997 Incentive Plan, previously filed as Exhibit 10.1 to the Trust’s Form 10-Q for the quarter endedSeptember 30, 1997, is incorporated herein by reference. 10.10 Amendment No. 1 to Lease, made as of July 31, 1998, between Universal Health Realty Income Trust, a Maryland real estate investment trust(“Lessor”), and Inland Valley Regional Medical Center, Inc., a California Corporation (“Lessee”), previously filed as Exhibit 10.1 to the Trust’s Form 10-Qfor the quarter ended September 30, 1998, is incorporated herein by reference. 10.11 Amendment No. 1 to Lease, made as of July 31, 1998, between Universal Health Realty Income Trust, a Maryland real estate investment trust(“Lessor”), and McAllen Medical Center, L.P. (f/k/a Universal Health Services of McAllen, Inc.), a Texas Limited Partnership (“Lessee”), amends the lease,made as of December 24, 1986, between Lessor and Lessee, previously filed as Exhibit 10.2 to the Trust’s Form 10-Q for the quarter ended September 30,1998, is incorporated herein by reference. 10.12 Revolving Credit Agreement, dated as of May 28, 2003, by and among Universal Health Realty Income Trust, Wachovia Bank, NationalAssociation, as Agent, Fleet National Bank, as Syndication Agent, Wachovia Securities, as Arranger, and the other Banks named therein, previously filed asExhibit 10.1 to the Trust’s Form 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.13 Dividend Reinvestment and Share Purchase Plan is hereby incorporated by reference from Registration Statement Form S-3, Registration No. 333-81763, as filed on June 28, 1999. 10.14 Lease amendment dated as of February 28, 2001 between Universal Health Realty Income Trust and McAllen Hospitals, L.P. previously filed asexhibit 10.16 to the Trust’s Form 10-K for the year ended December 31, 2001 is incorporated herein by reference. 10.15 Lease amendment dated as of July 1, 2002 between Universal Health Realty Income Trust and Universal Health Services of Rancho Springs, Inc. 11 Statement re computation of per share earnings is set forth on page F-5, the Trust’s Consolidated Statements of Income. 31Table of Contents23.1 Independent Auditors’ Consent—KPMG LLP 23.2 Information Regarding Consent of Arthur Andersen LLP 31.1 Certification from the Trust’s Chief Executive Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934. 31.2 Certification from the Trust’s Chief Financial Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934. 32.1 Certification from the Trust’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification from the Trust’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized. UNIVERSAL HEALTH REALTY INCOME TRUSTBy: /S/ ALAN B. MILLER Alan B. Miller,Chairman of the Board,Chief Executive Officer and President Date: March 10, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf ofthe registrant and in the capacities and on the dates indicated. Signatures Title Date/S/ ALAN B. MILLER Alan B. Miller Chairman of the Board, Chief Executive Officerand President March 10, 2004 /S/ JAMES E. DALTON, Jr. James E. Dalton, Jr. Trustee March 10, 2004/S/ MYLES H. TANENBAUM Myles H. Tanenbaum Trustee March 10, 2004/S/ DANIEL M. CAIN Daniel M. Cain Trustee March 10, 2004/S/ MILES L. BERGER Miles L. Berger Trustee March 10, 2004/S/ ELLIOT J. SUSSMAN Elliot J. Sussman, M.D., M.B.A. Trustee March 10, 2004/S/ CHARLES F. BOYLE Charles F. Boyle Vice President, Chief Financial Officer and Controller March 10, 2004/S/ CHERYL K. RAMAGANO Cheryl K. Ramagano Vice President, Treasurer and Secretary March 10, 2004 33Table of ContentsINDEX TO FINANCIAL STATEMENTS AND SCHEDULE PageIndependent Auditors’ Reports on Consolidated Financial Statements and Schedule 35 & 36Consolidated Balance Sheets—December 31, 2003 and December 31, 2002 37Consolidated Statements of Income—Years Ended December 31, 2003, 2002 and 2001 38Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2003,2002 and 2001 39Consolidated Statements of Cash Flows—Years Ended December 31, 2003, 2002 and 2001 40Notes to the Consolidated Financial Statements—December 31, 2003 41Schedule III—Real Estate and Accumulated Depreciation—December 31, 2003 56Notes to Schedule III—December 31, 2003 57 34Table of ContentsINDEPENDENT AUDITORS’ REPORT To the Shareholders and Board of Trustees of Universal Health Realty Income Trust: We have audited the 2003 and 2002 consolidated financial statements of Universal Health Realty Income Trust (a Maryland real estate investment trust)and subsidiaries as listed in the accompanying index. In connection with our audits of the 2003 and 2002 consolidated financial statements, we also haveaudited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statementschedule based on our audits. The accompanying 2001 consolidated financial statements of Universal Health Realty Income Trust were audited by otherauditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements in their report dated January17, 2002. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that weplan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion. In our opinion, the 2003 and 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position ofUniversal Health Realty Income Trust and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for theyears then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, theinformation set forth therein. /s/ KPMG LLP January 20, 2004Philadelphia, Pennsylvania 35Table of ContentsThe following report is a copy of a previously issued Arthur Andersen LLP (“Andersen”) report, and the report has not been reissued by Andersen. TheAndersen report refers to the consolidated balance sheets as of December 31, 2001 and 2000 and the consolidated statements of income, shareholders’ equityand cash flows for the years ended December 31, 2000 and 1999, which are no longer included in the accompanying financial statements. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and Board of Trustees of Universal Health Realty Income Trust: We have audited the accompanying consolidated balance sheets of Universal Health Realty Income Trust and Subsidiaries (a Maryland real estateinvestment trust) as of December 31, 2001 and 2000 and the related consolidated statements of income, shareholders’ equity and cash flows for each of thethree years in the period ended December 31, 2001. These consolidated financial statements and the schedules referred to below are the responsibility of theTrust’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedules based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonablebasis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position ofUniversal Health Realty Income Trust and Subsidiaries, as of December 31, 2001 and 2000 and the consolidated results of their operations and their cashflows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed in theIndex to Financial Statements and Schedules on Page F-1 are presented for the purpose of complying with the Securities and Exchange Commission’s rules andare not part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basicconsolidated financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to thebasic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Philadelphia, PennsylvaniaJanuary 17, 2002 36Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED BALANCE SHEETS(dollar amounts in thousands) December 31,2003 December 31,2002 ASSETS: Real Estate Investments: Buildings and improvements $160,079 $159,767 Accumulated depreciation (52,219) (47,810) 107,860 111,957 Land 22,929 22,929 Net Real Estate Investments 130,789 134,886 Investments in and advances to limited liability companies 61,001 48,314 Other Assets: Cash 628 598 Bonus rent receivable from UHS 1,093 1,101 Rent receivable from non-related parties 107 137 Deferred charges and other assets, net 673 81 Total Assets $194,291 $185,117 LIABILITIES AND SHAREHOLDERS’ EQUITY: Liabilities: Bank borrowings $37,242 $30,493 Accrued interest 310 282 Accrued expenses and other liabilities 1,826 1,761 Fair value of derivative instruments 2,254 3,233 Tenant reserves, escrows, deposits and prepaid rents 461 446 Minority interest — 40 Total Liabilities 42,093 36,255 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: 2003—11,736,395; 2002—11,698,163 117 117 Capital in excess of par value 185,675 184,772 Cumulative net income 221,083 196,658 Cumulative dividends (252,612) (229,652)Accumulated other comprehensive loss (2,065) (3,033) Total Shareholders’ Equity 152,198 148,862 Total Liabilities and Shareholders’ Equity $194,291 $185,117 See the accompanying notes to these consolidated financial statements. 37Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF INCOME(amounts in thousands, except per share amounts) Year ended December 31, 2003 2002 2001 Revenues (Note 1): Base rental—UHS facilities $12,806 $13,011 $13,011 Base rental—Non-related parties 9,114 9,222 9,197 Tenant reimbursements and other—Non-related parties 1,831 2,025 1,896 Bonus rental—UHS facilities 4,562 4,171 3,470 28,313 28,429 27,574 Expenses: Depreciation and amortization 4,536 4,431 4,401 Advisory fees to UHS (Note 2) 1,486 1,388 1,346 Other operating expenses 3,353 3,290 3,209 9,375 9,109 8,956 Income before equity in limited liability companies (“LLCs”) and interest expense 18,938 19,320 18,618 Equity in income of LLCs (including gains on sales of real properties of $2,831 during 2003 and$1,220 during 2002) 7,974 4,923 3,610 Interest expense (2,497) (2,403) (3,896)Gain/(loss) on derivatives 10 (217) 17 Net Income $24,425 $21,623 $18,349 Net Income Per Share—Basic $2.09 $1.85 $1.75 Net Income Per Share—Diluted $2.07 $1.84 $1.74 Weighted average number of shares outstanding—Basic 11,713 11,687 10,492 Weighted average number of share equivalents 66 63 44 Weighted average number of shares and equivalents outstanding—Diluted 11,779 11,750 10,536 See the accompanying notes to these consolidated financial statements. 38Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY For the Years Ended December 31, 2003, 2002 and 2001(amounts in thousands, except per share amounts) Common Shares Capital inexcess ofpar value Cumulativenet income Cumulativedividends Accumulatedothercomprehensiveloss Total Numberof Shares Amount 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 — — 18,349 Cumulative effect of change in accountingprinciple (SFAS No. 133) on othercomprehensive income — — — — — (533) (533)Adjustment for settlement amountsreclassified into income — — — — — 680 680 Unrealized derivative losses on cash flowhedges — — — — — (2,330) (2,330) Total—comprehensive income 16,166 January 1, 2002 11,679 $117 $184,277 $175,035 $(207,212) $(2,183) $150,034 Issuance of shares of beneficial interest 19 — 495 — — — 495 Dividends ($1.92/share) — — — — (22,440) — (22,440)Comprehensive income: Net income — — — 21,623 — — 21,623 Adjustment for settlement amountsreclassified into income — — — — — 1,332 1,332 Unrealized derivative losses on cash flowhedges — — — — — (2,182) (2,182) Total—comprehensive income 20,773 January 1, 2003 11,698 $117 $184,772 $196,658 $(229,652) $(3,033) $148,862 Issuance of shares of beneficial interest 38 — 903 — — — 903 Dividends ($1.96/share) — — — — (22,960) — (22,960)Comprehensive income: Net income — — — 24,425 — — 24,425 Adjustment for settlement amountsreclassified into income — — — — — 1,424 1,424 Unrealized derivative losses on cash flowhedges — — — — — (456) (456) Total—comprehensive income 25,393 December 31, 2003 11,736 $117 $185,675 $221,083 $(252,612) $(2,065) $152,198 See the accompanying notes to these consolidated financial statements. 39Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS(amounts in thousands, unaudited) Year ended December 31, 2003 2002 2001 Cash flows from operating activities: Net income $24,425 $21,623 $18,349 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation & amortization 4,536 4,431 4,401 Loss/(gain) on derivatives (10) 217 (17)Changes in assets and liabilities: Rent receivable 38 (240) 6 Accrued expenses & other liabilities 64 225 158 Tenant escrows, deposits & prepaid rents 15 83 (96)Accrued interest 28 (48) (62)Other, net (19) (5) 39 Net cash provided by operating activities 29,077 26,286 22,778 Cash flows from investing activities: Investments in limited liability companies (“LLCs”) (9,338) (5,322) (8,748)Cash distributions in excess of income from LLCs, excluding gains 671 1,910 1,412 Cash distributions from sale or refinancing proceeds, in excess of gains 9,211 1,860 — Cash (restricted) invested in escrow account—sale proceeds (6,337) — — Advances (made to) received from LLCs, net (6,894) 175 (441)Purchase of minority ownership interest in consolidated entity (54) — — Additions to real estate investments (312) (49) (555) Net cash used in investing activities (13,053) (1,426) (8,332) Cash flows from financing activities: Net borrowings (repayments) on revolving credit facility 6,844 (1,405) (48,606)Fees for new revolving credit facility (540) — — Repayments of mortgage notes payable (95) (88) (80)Repayment of note payable to UHS — (1,446) — Dividends paid (22,960) (22,440) (20,583)Issuance of shares of beneficial interest 757 488 55,158 Net cash used in financing activities (15,994) (24,891) (14,111) Increase (decrease) in cash 30 (31) 335 Cash, beginning of period 598 629 294 Cash, end of period $628 $598 $629 Supplemental disclosures of cash flow information: Interest paid $2,469 $2,451 $3,871 See the accompanying notes to these consolidated financial statements. 40Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUSTNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2003 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations Universal Health Realty Income Trust and subsidiaries (the “Trust”) is organized as a Maryland real estate investment trust. We invest in healthcareand human service related facilities including acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgerycenters, childcare centers and medical office buildings. As of December 31, 2003, we have forty-four real estate investments located in fifteen states consistingof: • eight hospital facilities including four acute care, one behavioral healthcare, two rehabilitation and one sub-acute; • thirty-two medical office buildings, and; • four preschool and childcare centers. Six of our hospital facilities and all or a portion of five medical office buildings are leased to subsidiaries of Universal Health Services, Inc., (“UHS”).Since we have significant investments in hospital facilities, which comprised 70%, 69% and 69% of net revenues in 2003, 2002 and 2001, respectively, weare subject to certain industry risk factors which directly impact the operating results of our lessees. In recent years, an increasing number of legislativeinitiatives have been introduced or proposed in Congress and in state legislatures that would effect major changes in the healthcare system, either nationally orat the state level. In addition, the healthcare industry has been characterized in recent years by increased competition and consolidation. Management is unable to predict the effect, if any, that the industry factors discussed above will have on the operating results of our lessees or on theirability to meet their obligations under the terms of their leases with us. In addition, Management cannot predict whether any of the leases will be renewed ontheir current terms or at all. As a result, management’s estimate of future cash flows from our leased properties could be materially affected in the near term, ifcertain of the leases are not renewed at the end of their lease terms. Revenue Recognition Revenue is recognized on the accrual basis of accounting. Our revenues consist primarily of rentals received from tenants, which are comprised ofminimum rent (base rentals), bonus rentals and reimbursements from tenants for their pro-rata share of expenses such as common area maintenance costs,real estate taxes and utilities. The minimum rent for all hospital facilities is fixed over the initial term or renewal term of the respective leases. Minimum rent for other material leasesis recognized using the straight-line method under which contractual rent increases are recognized evenly over the lease term. Bonus rents are recognized whenearned based upon increases in each facility’s net patient revenue in excess of stipulated amounts. Bonus rentals are determined and paid each quarter basedupon a computation that compares the respective facility’s current quarter’s revenue to the corresponding quarter in the base year. Tenant reimbursements foroperating expenses are accrued as revenue in the same period the related expenses are incurred. Cash and Cash Equivalents We consider all highly liquid investment instruments with original maturities of three months or less to be cash equivalents. As of December 31, 2003and 2002, we had $451,000 and $286,000 in restricted cash accounts held by financial institutions to fund debt services and future capital additions. 41Table of ContentsReal Estate Properties We record acquired real estate at cost and use the straight-line method to calculate depreciation expense for buildings and improvements over theirestimated useful lives of 25 to 45 years. Effective January 1, 2002, we adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedesSFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” and APB Opinion No. 30, “Reportingthe Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions.” The Statement does not change the fundamental provisions of SFAS No. 121; however, it resolves various implementation issues of SFASNo. 121 and establishes a single accounting model for long-lived assets to be disposed of by sale. It retains the requirement of Opinion No. 30 to reportseparately discontinued operations, and extends that reporting for all periods presented to a component of an entity that, subsequent to or on January 1, 2002,either has been disposed of or is classified as held for sale. Additionally, SFAS No. 144 requires that assets and liabilities of components held for sale, ifmaterial, be disclosed separately in the balance sheet. It is our policy to review the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate that the carryingvalue of such assets may not be recoverable. Measurement of the impairment loss is based on the fair value of the asset. Generally, the estimated fair value willbe determined using valuation techniques such as the present value of expected future cash flows. In assessing the carrying value of our real estate investmentsfor possible impairment, management reviews estimates of future cash flows expected from each of our facilities and evaluates the creditworthiness of ourlessees based on their current operating performance and on current industry conditions. Investments in Limited Liability Companies (“LLCs”) Our consolidated financial statements include the consolidated accounts of our controlled investments. In accordance with the American Institute ofCertified 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 CertainApproval or Veto Rights”, we account for our investments in LLCs which we do not control using the equity method of accounting. These investments, whichrepresent 33% to 99% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income,cash contributions and distributions of the investments. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. During December 2003, theFinancial Accounting Standards Board decided to defer to the first quarter of 2004, the implementation date for Interpretation No. 46. This deferral onlyapplies to variable interest entities that existed prior to February 1, 2003 as the interpretation applied immediately to variable interest entities created or obtainedafter January 31, 2003. Pursuant to the provisions of Interpretation No. 46, beginning in the first quarter of 2004, we will begin to consolidate the results ofoperations, assets, liabilities, third-party debt that is non-recourse to us and minority interest liability (to reflect the portion of the LLCs held by other third-party members) of three of our LLC investments that meet the criteria of a variable interest entity of which we are determined to be the primary beneficiary (seeNote 9 to the Consolidated Financial Statements). The 2003 annual revenue for these three LLCs was approximately $6.3 million and the combined totalassets total approximately $39.9 million. On a combined basis, these three LLCs have approximately $22.5 million in third-party debt that is non-recourse tous. There will be no impact on our net income as a result of the consolidation of these LLCs. Rental income recorded at the LLCs relating to leases in excess of one year in length, is recognized using the straight-line method under which contractualrents are recognized evenly over the lease term regardless of 42Table of Contentswhen payments are due. The amount of rental revenue resulting from straight-line rent adjustments is dependent on many factors including the nature andamount of any rental concessions granted to new tenants, scheduled rent increases under existing leases, as well as the acquisition and sales of properties thathave existing in-place leases with terms in excess of one year. As a result, the straight-line adjustments to rental revenue may vary from period-to-period. Federal Income Taxes No provision has been made for federal income tax purposes since we qualify as a real estate investment trust under Sections 856 to 860 of the InternalRevenue Code of 1986, and intend to continue to remain so qualified. As such, we are exempt from Federal Income Taxes and we are required to distribute atleast 90% of our real estate investment taxable income to our shareholders. We are subject to a federal excise tax computed on a calendar year basis. The excise tax equals 4% of the amount by which 85% of our ordinary incomeplus 95% of any capital gain income for the calendar year exceeds cash distributions during the calendar year, as defined. No provision for excise tax hasbeen reflected in the financial statements as no tax was due. Earnings and profits, which determine the taxability of dividends to shareholders, will differ from net income reported for financial reporting purposesdue to the differences for federal tax purposes in the cost basis of assets and in the estimated useful lives used to compute depreciation and the recording ofprovision for investment losses. The aggregate cost basis and net book value of the properties for federal income tax purposes at December 31, 2003 are approximately $168,000,000 and$117,000,000, respectively. Stock-Based Compensation At December 31, 2003, we had two stock-based compensation plans, which are more fully described in Note 8. We account for these plans under therecognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations. No compensationcost is reflected in net income for most stock option grants as all options granted under the plan had an original exercise price equal to the market value of theunderlying shares on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair valuerecognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. We recognize compensation cost related to restricted shareawards over the respective vesting periods. As of December 31, 2003 there were no unvested restricted share awards outstanding. Twelve Months EndedDecember 31, 2003 2002 2001 (in thousands, except per share data) Net income $24,425 $21,623 $18,349 Add: total stock-based compensation expenses included in net income 199 210 192 Deduct: total stock-based employee compensation expenses determined under fair value based methodsfor all awards: (238) (258) (308) Pro forma net income $24,386 $21,575 $18,233 Basic earnings per share, as reported $2.09 $1.85 $1.75 Basic earnings per share, pro forma $2.08 $1.85 $1.74 Diluted earnings per share, as reported $2.07 $1.84 $1.74 Diluted earnings per share, pro forma $2.07 $1.84 $1.73 43Table of ContentsEarnings Per Share Basic earnings per share are based on the weighted average number of shares outstanding during the year. Diluted earnings per share are based on theweighted average number of shares during the year adjusted to give effect to share equivalents. In June, 2001, we issued 2.6 million shares of beneficial interestat a price of $21.57 per share generating $53.9 million of net proceeds which were used to repay borrowings under our revolving credit agreement. The following table sets forth the computation of basic and diluted earnings per share: Twelve Months EndedDecember 31, 2003 2002 2001 (in thousands, except per share data)Basic: Net income $24,425 $21,623 $18,349Weighted average number of common shares 11,713 11,687 10,492 Earnings per common share-basic $2.09 $1.85 $1.75 Diluted: Net income $24,425 $21,623 $18,349Weighted average number of common shares 11,713 11,687 10,492Net effect of dilutive stock options and grants based on the treasury stock method 66 63 44 Weighted average number of common shares and equivalents 11,779 11,750 10,536 Earnings per common share–diluted $2.07 $1.84 $1.74 Fair Value of Financial Instruments The fair value of our interest rate swap agreements are based on quoted market prices. The carrying amounts reported in the balance sheet for cash,receivables, and short-term borrowings approximate their fair values due to the short-term nature of these instruments. Accordingly, these items have beenexcluded from the fair value disclosures included elsewhere in these notes to consolidated financial statements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Accounting for Derivative Instruments and Hedging Activities On January 1, 2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities” and SFAS No. 138,“Accounting for Certain Derivative Instruments and Certain Hedging Activity”, an Amendment of SFAS 133. SFAS Nos. 133 and 138 require that allderivative instruments be recorded on the balance sheet at their respective fair values. In accordance with the transition provisions of SFAS No. 133, we recorded a cumulative-effect adjustment of $533,000 in accumulated othercomprehensive loss to recognize at fair value all derivatives that were designated as cash-flow hedging instruments. We do not have any derivative instrumentsthat are designated as fair value hedging instruments. 44Table of ContentsOn the date a derivative contract is entered into, we designate the derivative as either a hedge of a forecasted transaction or the variability of cash flows tobe paid related to a recognized liability. For all hedging relationships we formally document the hedging relationship and our risk-management objective andstrategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the hedging instrument’s effectiveness inoffsetting the hedged risk will be assessed, and a description of the method of measuring ineffectiveness. This process includes linking all derivatives that aredesignated as cash-flow hedges to specific liabilities on the balance sheet or to specific firm commitments or forecasted transactions. We also formally assess,both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes inthe cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, wediscontinue hedge accounting prospectively. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in othercomprehensive income to the extent that the derivative is effective as a hedge, until earnings are affected by the variability in cash flows of the designatedhedged item. The ineffective portion of the change in fair value of a derivative instrument that qualifies as a cash-flow hedge is reported in earnings. We discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the cash flows ofthe hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is dedesignated as a hedging instrument, because it is unlikely that aforecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designationof the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, we continue to carry the derivative on thebalance sheet at its fair value with subsequent changes in fair value included in earnings, and gains and losses that were accumulated in other comprehensiveincome are recognized immediately in earnings. We manage our ratio of fixed to floating rate debt with the objective of achieving a mix that management believes is appropriate. To manage this mix in acost-effective manner, from time to time, we enter into interest rate swap agreements, in which we agree to exchange various combinations of fixed and/orvariable interest rates based on agreed upon notional amounts. All of our cash flow hedges at December 31, 2003 relate to the payment of variable interest onexisting or forecasted debt. The maximum amount of time over which we are hedging our exposure to the variability in future cash flows for forecastedtransactions is through November 2006. New Accounting Standards In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. During December, 2003, theFinancial Accounting Standards Board decided to defer to the first quarter of 2004, the implementation date for Interpretation No. 46. This deferral onlyapplies to variable interest entities that existed prior to February 1, 2003 as the interpretation applied immediately to variable interest entities created or obtainedafter January 31, 2003. Pursuant to our preliminary analysis of the provisions of Interpretation No. 46, beginning in the first quarter of 2004, we will begin toconsolidate the results of operations, assets, liabilities, third-party debt that is non-recourse to us and minority interest liability of three of our LLCinvestments that meet the criteria of a variable interest entity of which we are determined to be the primary beneficiary (see Note 9 to the Consolidated FinancialStatements). The 2003 annual revenue for these three LLCs was approximately $6.3 million and the combined total assets total approximately $39.9 millionas of December 31, 2003. On a combined basis, these three LLCs have approximately $22.5 million in third-party debt that is non-recourse to us. There willbe no impact on our net income as a result of the consolidation of these LLCs. 45Table of ContentsIn April, 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This Statementamends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts(collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and HedgingActivities”. Most provisions of this are effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June30, 2003. This Statement did not have a material effect on the Trust’s financial statements. In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity (“SFAS 150”). SFAS No. 150 establishes standards for how an issuer classifies and measures in its statementof financial position certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrumentthat is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer. This statementis effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003. Based on a FASB interpretation of SFAS 150 on October 8, 2003, it was determined that SFAS 150 applied to minoritypartner’s/member’s ownership interest in certain consolidated limited life entities. On October 29, 2003, the FASB postponed indefinitely the application ofSFAS 150 to minority partner’s/member’s ownership interest in certain consolidated limited life entities. As of December 31, 2003, we do not have interests inany such entities. (2) RELATIONSHIP WITH UHS AND 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 datedDecember 24, 1986 between the Advisor and us (the “Advisory Agreement”). Under the Advisory Agreement, the Advisor is obligated to present an investmentprogram to us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investmentopportunity to us), to provide administrative services to us and to conduct our day-to-day affairs. In performing its services under the Advisory Agreement,the Advisor may utilize independent professional services, including accounting, legal and other services, for which the Advisor is reimbursed directly by us.The Advisory Agreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Independent Trustees that theAdvisor’s performance has been satisfactory. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor.The Advisory Agreement has been renewed for 2004. 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 our average invested real estate assets, asderived from our consolidated balance sheet from time to time. In addition, the Advisor is entitled to an annual incentive fee of 20% of the amount by whichcash available for distribution to shareholders, as defined in the Advisory Agreement, for each year exceeds 15% of our equity as shown on our balance sheet,determined in accordance with accounting principles generally accepted in the United States, without reduction for return of capital dividends. No incentivefees were paid during 2003, 2002 and 2001. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our audited consolidatedfinancial statements. 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 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 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, exercisableon 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 leaseprior to the expiration of its term for prudent business reasons, UHS is obligated to offer a substitution 46Table of Contentsproperty. If we do not accept the substitution property offered, UHS is obligated to purchase the leased facility back from us at a price equal to the greater of itsthen fair market value or the original purchase price paid by us. As of December 31, 2003, the aggregate fair market value of our facilities leased tosubsidiaries of UHS is not known, however, the aggregate original purchase price paid by us for these properties was $112.5 million. As of December 31, 2003, subsidiaries of UHS leased six of the eight hospital facilities owned by us with terms expiring in 2004 through 2008. For theyears ended December 31, 2003, 2002 and 2001, 61%, 60% and 60%, respectively, of our 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 we have various non-controlling equity interestsranging from 33% to 99%, the UHS leases accounted for 28% in 2003, 29% in 2002 and 31% in 2001 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,which are based upon each facility’s net patient revenue in excess of base amounts, are computed and paid on a quarterly basis based upon a computation thatcompares current quarter revenue to the corresponding quarter in the base year. Our officers are all employees of UHS and as of December 31, 2003, we had no salaried employees. During 2003, 2002 and 2001, Mr. Kirk E. Gorman,former Trustee of the Trust and former President, Chief Financial Officer and Secretary received a $50,000 annual bonus awarded by the Trustees, subject toUHS having agreed to a $50,000 reduction in the advisory fee paid by us. During 2003, Mr. Gorman received $12,000 representing a pro-rated amount of theannual bonus. At December 31, 2003, approximately 6.6% of our outstanding shares of beneficial interest were held by UHS. We have granted UHS theoption to purchase our shares in the future at fair market value to enable UHS to maintain a 5% interest in the Trust. The lease on the Virtue Street Pavilion facility (lessee is a wholly-owned subsidiary of UHS), is scheduled to expire in December 2004. This facility’sratio of earnings before interest, taxes, depreciation, amortization and lease and rental expense (“EBITDAR”) to minimum rent plus additional rent payable tous was approximately 1.9 times for the twelve month period ended December 31, 2003 and approximately 2.2 times for the twelve months ended December 31,2002. The lease on The Bridgeway facility (lessee is a wholly-owned subsidiary of UHS) is also scheduled to expire in December 2004. The ratio of EBITDARto minimum rent plus additional rent payable to us for The Bridgeway was approximately 3.8 times for the twelve month period ended December 31, 2003 and3.6 times for the twelve month period ended December 31, 2002. The lessees on both of these facilities have an option at the end of the lease terms to purchasethe properties at their fair market value or renew the leases at the same terms for another five years. Management cannot predict whether the leases with theseUHS subsidiaries will be renewed at the current rates at the end of their lease terms or if either or both of the lessees will exercise their options to purchase theproperties. If the leases are not renewed at the current rates or if the purchase options are not exercised, we would be required to find other operators for thesefacilities and/or enter into leases on terms potentially less favorable to us than the current leases. During the fourth quarter of 2003, we invested $1.6 million and committed to invest an additional $2.3 million in exchange for a 95% non-controllinginterest in a limited liability company that acquired a 60,000 square foot medical office building on the campus of Spring Valley Hospital in Las Vegas,Nevada, which was opened during the fourth quarter of 2003. The Spring Valley MOB will be 75% master leased for five years by The Valley Health System(“VHS”), a subsidiary of UHS on a triple net basis. The master lease for each suite will terminate at such time that the suite is leased to another tenantacceptable to us and VHS for a minimum term of five years. As of December 31, 2003 letters of intent or lease agreements have been executed on more than75% of the rentable space of this MOB. Commencement of these leases will take place upon completion of the space, which is expected to be during the firstand second quarters of 2004. During the third quarter of 2003 we invested $8.9 million ($3.0 million in equity and a $5.9 million loan) for the purchase of a 98% non-controllingequity interest in a LLC that simultaneously purchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada.These medical office buildings were purchased from a LLC in which UHS holds a 72% ownership interest and has tenants which include subsidiaries ofUHS. 47Table of Contents(3) ACQUISITIONS AND DISPOSITIONS 2003 — We invested a total of $16.3 million in the following (consisting of $9.4 million of investments in LLCs and $6.9 million of net advancesmade to LLCs): • $1.2 million invested for the purchase of a 85% non-controlling equity interest in a LLC that owns a medical office building in Apache Junction,Arizona (the LLC also obtained a $3.0 million third-party mortgage that is non-recourse to us); • $1.6 million invested (and an additional $2.3 million committed) in exchange for a 95% non-controlling interest in a LLC that owns the SpringValley Medical Office Building located in Las Vegas, Nevada (the LLC also obtained a $4.0 million third-party mortgage that is non-recourse tous); • $8.9 million ($3.0 million in equity and a $5.9 million loan which is intended to be reimbursed to us upon securing third-party refinancing whichwill be non-recourse to us) invested for the purchase of a 98% non-controlling equity interest in a LLC that simultaneously purchased three medicaloffice buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada; • $1.0 million net loan funded in connection with a total commitment of $8.9 million by us (consisting of $6.4 million in equity and $2.5 million indebt financing that will be non-recourse to us) in exchange for a 75% non-controlling interest in a LLC that will construct and own the MedicalPlaza at Saint Mary’s located in Reno, Nevada, which is scheduled to be completed and opened in the first quarter of 2005; • $2.0 million funded (remaining commitment of $300,000 after this funding) in connection with the purchase of a 85% non-controlling equityinterest in a LLC that constructed and owns the Rosenberg Children’s Medical Plaza, a medical office building that was opened in February, 2003(the LLC also obtained a $7.5 million third-party mortgage that is non-recourse to us), and; • $1.6 million of additional investments in various LLCs (including prior year commitments) in which we own a non-controlling equity interest. During the fourth quarter of 2003, 23650 Madison and PacPal Investments, two LLCs in which we own 95% non-controlling ownership interests, soldthe real estate assets of Skypark Professional Medical Building and Pacifica Palms Medical Plaza, respectively, both of which are located in Torrance,California. Our share of the combined net sales proceeds resulting from these transactions was $6.3 million. The cash proceeds for both of these sales is beingheld in escrow by a like-kind-exchange agent in anticipation of possibly completing like-kind-exchange transactions during 2004. These transactions resultedin a combined gain of $2.5 million which is included in our 2003 results of operations. Also during 2003, we received $365,000 from Parkvale Properties, aLLC in which we own a 60% non-controlling ownership interest, representing our share of the net sale proceeds from the sale of Palo Verde Medical Center, amedical office building located in Phoenix, Arizona. This sale resulted in a gain of $365,000, which is included in our 2003 results of operations, since thecarrying value of this investment was reduced to zero in a prior year. 2002 — We invested a total of $5.3 million in the following: • $3.1 million invested in a LLC, in which we own a 90% non-controlling equity interest, that constructed the recently opened Deer Valley MedicalOffice II located in Phoenix, Arizona (the LLC also obtained a $7.0 million third-party mortgage that is non-recourse to us); • $200,000 invested (and an additional $2.3 million committed, of which $2.0 million was funded in 2003) for the purchase of a 85% non-controlling equity interest in a LLC that constructed and owns the Rosenberg Children’s Medical Plaza, a medical office building that was openedin February, 2003 (the LLC also obtained a $7.5 million third-party mortgage that is non-recourse to us), and; • $2.0 million of additional investments in various LLCs in which we own a non-controlling equity interest. 48Table of ContentsAlso during 2002, we received $2.6 million of cash for our share of the proceeds generated from the sale of the real estate assets of Samaritan WestValley Medical Center located in Goodyear, Arizona. The transaction resulted in a gain of $1.2 million which is included in our 2002 results of operations.This sale completed the like-kind exchange transaction whereby the LLC in which we own an 89% non-controlling equity interest, acquired the real estateassets during 2001 of Papago Medical Park located in Phoenix, Arizona in exchange for cash and the real estate assets of Samaritan West Valley MedicalCenter located in Goodyear, Arizona. 2001 — We invested a total of $9.2 million in the following (consisting of $8.8 million of investments in LLCs and $400,000 of net advances made toLLCs): • $1.4 million invested to purchase a 75% equity interest in a LLC that owns and operates the Thunderbird Paseo Medical Plaza II located inGlendale, Arizona (the LLC also obtained a $3.1 million third-party mortgage that is non-recourse to us); • $1.9 million invested to purchase a 74% equity interest in a LLC that owns and operates the Mid-Coast Hospital Medical Office Building located inBrunswick, Maine (the LLC also obtained a $8.9 million third-party mortgage that is non-recourse to us); • $2.8 million of cash in a LLC for the purpose of effecting a like-kind exchange which was completed in January, 2002 (as mentioned above); • $45,000 of cash and a commitment to invest a total of $3.4 million in exchange for a 90% non-controlling interest in a limited liability company thatconstructed and owns the Deer Valley Medical Office II located in Phoenix, Arizona which was opened during the third quarter of 2002 (the LLCobtained a $7.0 million third-party mortgage that is non-recourse to us), and; • $3.1 million to purchase an additional equity interest and fund additional investments and loans to various LLCs in which we have various non-controlling equity interests. (4) LEASES All of our leases are classified as operating leases with initial terms ranging from 3 to 20 years with up to five, five-year renewal options. Under theterms of the leases, we earn fixed monthly base rents and pursuant to the leases with subsidiaries of UHS, we may earn periodic bonus rents (see Note 1). Thebonus rents from the subsidiaries of UHS, which are based upon each facility’s net patient revenue in excess of base amounts, are computed and paid on aquarterly basis based upon a computation that compares current quarter revenue to the corresponding quarter in the base year. Minimum future base rents from non-cancelable leases, excluding increases resulting from changes in the consumer price index and bonus rents, are asfollows (000s): 2004 $21,5482005 17,9222006 17,2192007 5,6402008 3,947Later Years 5,751 Total Minimum Base Rents $72,027 Under the terms of the hospital leases, the lessees are required to pay all operating costs of the properties including property insurance and real estatetaxes. Tenants of the medical office buildings generally are required to pay their pro-rata share of the property’s operating costs. 49Table of Contents(5) DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES We use variable-rate debt to finance a portion of our operations and investments. These variable-rate debt obligations expose us to variability in interestpayments due to changes in interest rates. Management believes that it is prudent to limit the variability of a portion of our interest payments. To meet thisobjective, management enters into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These swaps change thevariable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest rate swaps, we receive variable interest ratepayments and makes fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. At December 31, 2003, we had three outstanding swap agreements for notional principal amounts of $30 million which mature from May 2004 throughNovember 2006. These swap agreements effectively fix the interest rate on $30 million of variable rate debt at 7.0% including the revolver spread of 1.00%. Weare exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swap agreements. These counterparties are major financialinstitutions and we do not anticipate nonperformance by the counterparties which are rated A or better by Moody’s Investors Service. Termination of theinterest rate swaps at December 31, 2003 would have resulted in payments to the counterparties of approximately $2,254,000. The fair value of the interest rateswap agreements at December 31, 2003 reflects the estimated amounts that we would pay to terminate the contracts and are based on quotes from thecounterparties. Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability of cash flows associated withvariable-rate debt obligations are reported in accumulated other comprehensive income. These amounts subsequently are reclassified into interest expense in thesame period in which the underlying hedged item affects earnings. For the years ended December 31, 2003, 2002 and 2001, we recorded additional interestexpense of $1,424,000, $1,332,000, and $680,000, respectively, as a result of our hedging activity. Operating results for the years ended December 31, 2003, 2002 and 2001 include net (gains)/losses of ($10,000), $217,000 and ($17,000), respectively,representing cash flow hedge ineffectiveness arising from differences between the critical terms of the interest rate swap and the hedged debt obligation when itaffects earnings. As of December 31, 2003, $1,230,000 of deferred losses on derivative instruments in other accumulated comprehensive loss are expected to bereclassified to earnings during the next 12 months. There were no cash flow hedges discontinued during 2003, 2002 or 2001. (6) DEBT We have an unsecured $80 million revolving credit agreement (the “Agreement”) which expires on May 27, 2007. We have a one time option, which canbe exercised at any time, to increase the amount by $20 million for a total commitment of $100 million. The Agreement provides for interest at our option, atthe Eurodollar rate plus 1.00% to 1.40% or the prime rate plus zero to .40%. A fee of .25% to .35% is paid on the unused portion of this commitment. Themargins over the Eurodollar rate, prime rate and the commitment fee are based upon our debt to total capital ratio as defined by the Agreement. At December 31,2003, the applicable margin over the Eurodollar rate was 1.00% and the commitment fee was .25%. At December 31, 2003, we had $13.9 million of letters ofcredit outstanding against the Agreement. There are no compensating balance requirements. The Agreement contains a provision whereby the commitments willbe reduced by 50% of the proceeds generated from any new equity offering. The average amounts outstanding under our revolving credit agreement were $28.3million in 2003, $25.3 million in 2002 and $46.1 million in 2001 with corresponding effective interest rates, including commitment fees and interest rate swapexpense, of 7.6% in 2003, 8.1% in 2002 and 7.4% in 2001. The carrying value of the amounts borrowed approximates fair market value. At December 31,2003, we had approximately $33 million of available borrowing capacity under this agreement. The carrying value of this instrument approximates fair value. 50Table of ContentsCovenants relating to the revolving credit facility require the maintenance of a minimum tangible net worth and specified financial ratios, limit ourability to incur additional debt, limit the aggregate amount of mortgage receivables and limit our ability to increase dividends in excess of 95% of cashavailable for distribution, unless additional distributions are required to comply with the applicable section of the Internal Revenue Code and relatedregulations governing real estate investment trusts. We are in compliance with all their covenants at December 31, 2003. We have one mortgage with an outstanding balance of $4.2 million at December 31, 2003. The mortgage, which carries an 8.3% interest rate and matureson February 1, 2010, is non-recourse to us and is secured by the Medical Center of Western Connecticut. This mortgage has a fair value of approximately$4.8 million as of December 31, 2003. We expect to repay an average of approximately $125,000 in principal per year, with a balloon payment of $3.4 millionin 2010. (7) DIVIDENDS Dividends of $1.960 per share were declared and paid in 2003, of which $1.820 per share was ordinary income, $.137 per share was a capital gaindistribution and $.003 per share was a return of capital distribution. Dividends of $1.92 per share were declared and paid in 2002, of which $1.86 per sharewas ordinary income and $.06 per share was a return of capital distribution. Dividends of $1.875 per share were declared and paid in 2001, of which $1.81per share was ordinary income and $.06 per share was a return of capital distribution. (8) INCENTIVE PLANS During 1997, our Board of Trustees approved the Universal Health Realty Income Trust 1997 Incentive Plan (“The Plan”), a stock option anddividend equivalents rights plan for employees of the Trust, including officers and trustees. A combined total of 400,000 shares and dividend equivalent rightshave been reserved for issuance under The Plan. From inception through December 31, 2003, there have been 118,000 stock options with dividend equivalentrights granted to eligible individuals, including officers and trustees. All stock options were granted with an exercise price equal to the fair market value on thedate of the grant. The options granted vest ratably at 25% per year beginning one year after the date of grant, and expire in ten years. Dividend equivalentrights effectively reduce the exercise price of the 1997 Incentive Plan options by an amount equal to the cash or stock dividends distributed subsequent to thedate of grant. We recorded expenses relating to the dividend equivalent rights of $199,000 in 2003, $197,000 in 2002 and $188,000 in 2001. As of December31, 2003, there were 77,750 options exercisable under The Plan with an average exercise price of $17.98 per share (average exercise price, adjusted to giveeffect to the dividend equivalent rights is $7.32 per share). In 1991, the Trustees adopted a share compensation plan for Trustees who are neither employees nor officers of the Trust (“Outside Trustees”). Thereare 40,000 shares reserved for issuance under this plan. Pursuant to the plan, each Outside Trustee may elect to receive, in lieu of all or a portion of thequarterly cash compensation for services as a Trustee, shares of the Trust based on the closing price of the shares on the date of issuance. As of December 31,2003 no shares have been issued under the terms of this plan. As discussed in Note 1, we account for stock-based compensation using the intrinsic value method in APB No. 25, as permitted under SFAS No. 123.The fair value of each option grant was estimated on the date of grant using the Black Scholes option-pricing model with the following range of assumptionsused for the four option grants that occurred in 2003 and 2002. No options were granted during 2001, therefore the following table is not applicable (“N/A”) forthat year: Year Ended December 31, 2003 2002 2001Volatility 15% 15% N/AInterest rate 3% 4%-5% N/AExpected life (years) 8.2 8.1 N/AForfeiture rate 0% 0% N/ADividend yield 6.5% 7.5% N/A 51Table of ContentsStock options to purchase shares of beneficial interest have been granted to eligible individuals, including our officers and trustees, under various plans.Information with respect to these options, before adjustment to the option price to give effect to the dividend equivalent rights, is summarized as follows: Outstanding Options Numberof Shares ExerciseWeighted-Average Price Grant PriceRange(High-Low)Balance, January 1, 2001 158,024 $17.38 $ 21.44 / $ 14.75Exercised (58,024) $16.77 $ 16.88 / $ 16.13 Balance, January 1, 2002 100,000 $17.74 $ 21.44 / $ 14.75Granted 6,000 $27.39 $ 27.65 / $ 26.09 Balance, January 1, 2003 106,000 $18.29 $ 27.65 / $ 14.75Granted 7,000 $27.62 $ 29.44 / $ 26.25Exercised (17,500) $18.55 $18.625 / $18.375 Balance, December 31, 2003 95,500 $18.92 $ 29.44 / $ 14.75 Outstanding Options at December 31, 2003: Number of Shares Average Option Price Range(High-Low) ContractualLife25,000 $14.7500 $14.7500-$14.7500 6.255,000 $18.6705 $19.6250-$18.6250 3.57,500 $24.6245 $26.2500-$21.4375 7.68,000 $28.3213 $29.4400-$27.6500 9.1 95,500 (9) SUMMARIZED FINANCIAL INFORMATION OF EQUITY AFFILIATES Our consolidated financial statements include the accounts of our controlled investments. In accordance with the American Institute of Certified PublicAccountants’ Statement of Position 78-9 “Accounting for Investments in Real Estate Ventures” and Emerging Issues Task Force Issue 96-16, “Investor’sAccounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval orVeto Rights”, we account for our investments in LLCs which we do not control using the equity method of accounting. These investments, which represent33% to 99% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income, cashcontributions and distributions of the investments. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. During December, 2003, theFinancial Accounting Standards Board decided to defer to the first quarter of 2004, the implementation date for Interpretation No. 46. This deferral onlyapplies to variable interest entities that existed prior to February 1, 2003 as the interpretation applied immediately to variable interest entities created or obtainedafter January 31, 2003. Pursuant to our preliminary analysis of the provisions of Interpretation No. 46, beginning in the first quarter of 2004, we will begin toconsolidate the results of operations, assets, liabilities, third-party debt that is non-recourse to us and minority interest liability (to reflect the portion of theLLCs held by other third-party members) of three of our LLC investments that meet the criteria of a variable interest entity of which we are determined to bethe primary beneficiary. The 2003 annual revenue for these three LLCs was approximately $6.3 million and the combined total assets total approximately$39.9 million as of December 31, 2003. On a combined basis, these three LLCs have approximately $22.5 million in third-party debt that is non-recourse tous. There will be no impact on our net income as a result of consolidating these LLCs. 52Table of ContentsRental income recorded at the LLCs relating to leases in excess of one year in length, is recognized using the straight-line method under which contractualrents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting from straight-line rent adjustmentsis dependent on many factors including the nature and amount of any rental concessions granted to new tenants, scheduled rent increases under existingleases, as well as the acquisition and sales of properties that have existing in-place leases with terms in excess of one year. As a result, the straight-lineadjustments to rental revenue may vary from period-to-period. Since January 1, 1995 through December 31, 2003, we have invested $67.8 million of cash (including $6.9 million of advances to various LLCs) inLLCs in which we own various non-controlling equity interests ranging from 33% to 99%, before reductions for cash distributions received from the LLCs. As of December 31, 2003, we had investments in twenty-four limited liability companies (“LLCs”) accounted for by the equity method. The followingtable represents summarized unaudited financial information related to these LLCs: Name of LLC Ownership Property Owned by LLCDSMB Properties 76% Desert Samaritan Hospital MOBsDVMC Properties 95% Desert Valley Medical CenterParkvale Properties 60% Maryvale Hospital MOBsSuburban Properties 33% Suburban Medical Plaza IILitchvan Investments 89% Papago Medical ParkPaseo Medical Properties II 75% Thunderbird Paseo Medical Plaza I & IIWilletta Medical Properties 94% Edwards Medical PlazaDesMed(a.) 99% Desert Springs Medical PlazaPacPal Investments 95% (b.)RioMed Investments 80% Rio Rancho Medical CenterWest Highland Holdings 48% St. Jude Heritage Health ComplexSanta Fe Scottsdale 94% Santa Fe Professional PlazaBayway Properties 73% East Mesa Medical Center653 Town Center Drive(a.) 98% Summerlin Hospital MOB575 Hardy Investors 73% Centinela Medical Building Complex653 Town Center Phase II(a.) 98% Summerlin Hospital MOB II23560 Madison 95% (b.)Brunswick Associates 74% Mid Coast Hospital MOBDeerval Properties 90% Deer Valley Medical Office IIPCH Medical Properties 85% Rosenberg Children’s Medical PlazaGold Shadow Properties(a.) 98% 700 Shadow Lane & Goldring MOBsArlington Medical Properties(c.) 75% Saint Mary’s Professional Office BuildingApaMed Properties 85% Apache Junction Medical PlazaSpring Valley Medical Properties(a.) 95% Spring Valley Medical Office Building(a.) Tenants of this medical office building include subsidiaries of UHS.(b.) During the fourth quarter of 2003, 23650 Madison and PacPal Investments sold the real estate assets of Skypark Professional Medical Building andPacifica Palms Medical Plaza, respectively, both of which are located in Torrance, California. Our share of the combined net sales proceeds resultingfrom these transactions was $6.3 million. The cash proceeds for both of these sales is being held in escrow by a like-kind-exchange agent in anticipationof possibly completing like-kind-exchange transactions during 2004. These transactions resulted in a combined gain of $2.5 million which is includedin our 2003 results of operations.(c.) We have committed to invest a total of $8.9 million ($6.4 million in equity and $2.5 million in debt financing) in exchange for a 75% non-controllinginterest in this LLC that will construct and own a professional office building located in Reno, Nevada. The office building is scheduled to be completedand opened in the first quarter of 2005. As of December 31, 2003, we had advanced $959,000 in connection with this project. 53Table of Contents December 31, 2003 2002 (amounts in thousands)Net property $180,398 $169,636Other assets 12,341 13,266Restricted cash for potential like-kind-exchange transactions 7,087 — Liabilities 5,079 5,129Mortgage notes payable, non-recourse to us 132,681 128,658Notes payable to us 6,894 — Equity 55,172 49,115UHT’s share of equity and notes receivable from LLCs 61,001 48,314 For the Year EndedDecember 31, 2003 2002 2001 (amounts in thousands)Revenues $33,495 $30,281 $26,451Operating expenses 13,248 11,605 9,760Depreciation & amortization 5,585 5,152 4,741Interest, net 9,354 8,923 8,001 Net income before gains on divestitures 5,308 4,601 3,949Gains on divestitures 3,691 1,346 — Net income $8,999 $5,947 $3,949 Our share of net income before gains on divestitures $5,143 $3,703 $3,610Our share of gains on divestitures 2,831 1,220 — Our share of net income $7,974 $4,923 $3,610 As of December 31, 2003, aggregate maturities of mortgage notes payable by LLCs, which are non-recourse to us, are as follows (000s): 2004 $8,1972005 2,7322006 21,7612007 12,3152008 14,146Later 73,530 Total $132,681 (10) SEGMENT REPORTING Our primary segment is leasing of healthcare and human service facilities, and all revenues from external customers relate to the same segment.Additionally, we may, from time to time, loan funds to external parties. Operating results and assessment of performance are reviewed by the chief operatingdecision-maker on a company-wide basis and no discrete financial information is available or produced on any one component of the business. Accordingly,the disclosure requirements of SFAS 131 are not applicable to us. 54Table of Contents(11) QUARTERLY RESULTS (unaudited) 2003 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $7,193 $7,018 $7,043 $7,059 $28,313Net Income $5,670 $5,315 $5,347 $8,093 $24,425Earnings Per Share-Basic $0.48 $0.45 $0.46 $0.69 $2.09Earnings Per Share-Diluted $0.48 $0.45 $0.45 $0.69 $2.07 Included in the net income for the first quarter of 2003 is a gain of $365,000, or $.03 per diluted share, resulting from the sale of Palo Verde MedicalCenter in Phoenix, Arizona. Included in the net income for the fourth quarter of 2003 are gains totaling $2.5 million, or $.21 per diluted share, resulting fromthe sales of Skypark Professional Medical Building and Pacifica Palms Medical Plaza, both of which are located in Torrance, California. 2002 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $7,126 $7,164 $7,077 $7,062 $28,429Net Income $6,278 $5,179 $5,104 $5,062 $21,623Earnings Per Share-Basic $0.54 $0.44 $0.44 $0.43 $1.85Earnings Per Share-Diluted $0.53 $0.44 $0.43 $0.43 $1.84 Included in the net income for the first quarter of 2002 is a gain of $1.2 million, or $.10 per diluted share, recorded on the sale of Samaritan West ValleyMedical Center in Goodyear, Arizona. 55Table of ContentsSCHEDULE IIIUNIVERSAL HEALTH REALTY INCOME TRUSTREAL ESTATE AND ACCUMULATED DEPRECIATION—DECEMBER 31, 2003(amounts in thousands) Initial Cost toUniversal HealthRealty IncomeTrust Net costcapitalized/divestedsubsequentto acquisition Gross amount atwhich carriedat close of period AccumulatedDepreciationas of Dec. 31,2003 Date ofconstructionor mostrecentsignificantexpansion orrenovation DateAcquired AverageDepreciableLifeDescription Land Building&Improv. Land &Improv. Land Building &Improvements Total Virtue Street Pavilion $1,825 $9,445 — $1,770 $9,445 $11,215 $4,594 1975 1986 35 YearsChalmette Medical Center 2,000 7,473 $3,148 2,000 10,621 12,621 3,847 1999 1988 34 YearsChalmette, Louisiana Inland Valley Regional Medical Center Wildomar, California 2,050 10,701 2,868 2,050 13,569 15,619 4,745 1986 1986 43 YearsMcAllen Medical Center McAllen, Texas 4,720 31,442 10,188 6,281 40,069 46,350 13,989 1994 1986 42 YearsWellington Regional Medical Center West Palm Beach, Florida 1,190 14,652 4,822 1,663 19,001 20,664 6,598 1986 1986 42 YearsThe Bridgeway North Little Rock, Arkansas 150 5,395 499 150 5,894 6,044 2,849 1983 1986 35 YearsTri-State Rehabilitation Hospital Evansville, Indiana 500 6,945 1,062 500 8,007 8,507 2,834 1993 1989 40 YearsKindred Hospital Chicago Central Chicago, Illinois 158 6,404 1,837 158 8,241 8,399 5,263 1993 1986 25 YearsFresno-Herndon Medical Plaza Fresno, California 1,073 5,266 35 1,073 5,301 6,374 1,070 1992 1994 45 YearsFamily Doctor’s Medical Office Building Shreveport, Louisiana 54 1,526 494 54 2,020 2,074 380 1991 1995 45 YearsKelsey-Seybold Clinic at King’s Crossing 439 1,618 73 439 1,691 2,130 304 1995 1995 45 YearsProfessional Center at King’s Crossing 439 1,837 78 439 1,915 2,354 339 1995 1995 45 YearsKingwood, Texas Chesterbrook Academy Audubon, Pennsylvania 307 996 — 307 996 1,303 170 1996 1996 45 YearsChesterbrook Academy New Britain, Pennsylvania 250 744 — 250 744 994 127 1991 1996 45 YearsChesterbrook Academy Uwchlan, Pennsylvania 180 815 — 180 815 995 138 1992 1996 45 YearsChesterbrook Academy Newtown, Pennsylvania 195 749 — 195 749 944 128 1992 1996 45 YearsThe Southern Crescent Center 1,130 5,092 69 1,130 5,161 6,291 869 1994 1996 45 YearsThe Southern Crescent Center II — — 5,479 806 4,673 5,479 501 2000 1998 35 YearsRiverdale, Georgia The Cypresswood Professional Center Spring, Texas 573 3,842 187 573 4,029 4,602 750 1997 1997 35 YearsOrthopaedic Specialists of Nevada Building Las Vegas, Nevada — 1,579 — — 1,579 1,579 268 1999 1999 25 YearsSheffield Medical Building Atlanta, Georgia 1,760 9,766 563 1,760 10,329 12,089 1,755 1999 1999 25 YearsMedical Center of Western Connecticut—Bldg. 73(a.) Danbury, Connecticut 1,151 5,176 54 1,151 5,230 6,381 701 2000 2000 30 Years TOTALS $20,144 $131,463 $31,456 $22,929 $160,079 $183,008 $52,219 a. At December 31, 2003 this property had an outstanding mortgage balance of $4.2 million. The mortgage carries an 8.3% interest rate and matures on February 1, 2010. The mortgage is non-recourse to us and issecured by the Medical Center of Western Connecticut. 56Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST NOTES TO SCHEDULE IIIDECEMBER 31, 2003(amount in thousands) (1) RECONCILIATION OF REAL ESTATE PROPERTIES The following table reconciles the Real Estate Properties from January 1, 2001 to December 31, 2003: 2003 2002 2001Balance at January 1, $182,696 $182,647 $182,172Additions and acquisitions 312 49 475 Balance at December 31, $183,008 $182,696 $182,647 (2) RECONCILIATION OF ACCUMULATED DEPRECIATION The following table reconciles the Accumulated Depreciation from January 1, 2001 to December 31, 2003: 2003 2002 2001Balance at January 1, $47,810 $43,432 $39,080Current year depreciation expense 4,409 4,378 4,352 Balance at December 31, $52,219 $47,810 $43,432 57EXHIBIT 10.2December 31, 2003 Mr. Alan B. MillerPresidentUHS of Delaware, Inc.367 South Gulph RoadKing of Prussia, PA 19406 Dear Alan: The Board of Trustees of Universal Health Realty Income Trust, at their December 1, 2003 meeting, authorized the renewal of the current AdvisoryAgreement 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, 2004, upon the same terms and conditions. Please acknowledge UHSof Delaware’s acceptance of this offer by signing in the space provided below and returning one copy of this letter to me. Sincerely, Charles F. BoyleVice President,Chief Financial Officer andController cc: Warren J. Nimetz, Esq. Cheryl K. Ramagano Agreed to and Accepted: UHS OF DELAWARE, INC. By: Alan B. Miller, President EXHIBIT 23.1 INDEPENDENT AUDITORS’ CONSENT To the Board of Trustees and Shareholders of Universal Health Realty Income Trust: We consent to the incorporation by reference in the Registration Statements (File Nos. 033-56843 and 333-57815) on Form S-8 and the Registration Statements(File Nos. 333-81763 and 333-60638) on Form S-3 of Universal Health Realty Income Trust of our report dated January 20, 2004, with respect to theconsolidated balance sheets of Universal Health Realty Income Trust as of December 31, 2003 and 2002, and the related consolidated statements of income,shareholders’ equity and cash flows for the years then ended, and the related financial statement schedule, which report appears in the December 31, 2003annual report on Form 10-K of Universal Health Realty Income Trust. /s/ KPMG LLP KPMG LLP Philadelphia, PennsylvaniaMarch 12, 2004Exhibit 31.1 CERTIFICATION—Chief Executive Officer I, Alan B. Miller, certify that: 1. I have reviewed this annual report on Form 10-K of Universal Health Realty Income Trust; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annualreport; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly duringthe period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’s internal control over financial reporting; and 5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting. Date: March 12, 2004 /s/ ALAN B. MILLER President and ChiefExecutive OfficerExhibit 31.2 CERTIFICATION—Chief Financial Officer I, Charles F. Boyle, certify that: 1. I have reviewed this annual report on Form 10-K of Universal Health Realty Income Trust; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annualreport; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) for the registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly duringthe period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this annual report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report, based on such evaluation; and c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscalquarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant’s internal control over financial reporting; and 5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant’s ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control overfinancial reporting. Date: March 12, 2004 /s/ CHARLES F. BOYLE Vice President andChief Financial OfficerEXHIBIT 32.1 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Universal Health Realty Income Trust (the “Trust”) on Form 10-K for the year ended December 31, 2003 as filed withthe Securities and Exchange Commission on the date hereof (the “Report”), I, Alan B. Miller, President and Chief Executive Officer of the Trust, herebycertify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (i) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Trust at the end of,and for the period covered by the Report. /s/ Alan B. Miller President and Chief Executive OfficerMarch 12, 2004 A signed original of this written statement required by Section 906 has been provided to the Trust and will be retained and furnished to the Securities andExchange Commission or its staff upon request.EXHIBIT 32.2 CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Universal Health Realty Income Trust (the “Trust”) on Form 10-K for the year ended December 31, 2003, as filedwith the Securities and Exchange Commission on the date hereof (the “Report”), I, Charles F. Boyle, Vice President and Chief Financial Officer of the Trust,hereby certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge: (i) the Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (ii) the information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Trust at the end of,and for the period covered by the Report. /s/ Charles F. Boyle Vice President andChief Financial OfficerMarch 12, 2004 A signed original of this written statement required by Section 906 has been provided to the Trust and will be retained and furnished to the Securities andExchange Commission or its staff upon request.

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