Universal Health Realty Income Trust Annual Report 2004

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 FORM 10-K xx ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACTOF 1934 For the fiscal year ended December 31, 2004 OR ¨¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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 Center367 South Gulph RoadP.O. Box 61558King of Prussia, Pennsylvania(Address of principal executive offices) 19406-0958(Zip Code) Registrant’s telephone number, including area code: (610) 265-0688 Securities registered pursuant to Section 12(b) of the Act: Title of each ClassShares of beneficial interest, $.01 par value Name of each exchange on which registeredNew 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 xx 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 this Form10-K. ¨ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes xx No ¨¨ Aggregate market value of voting shares held by non-affiliates as of June 30, 2004: $335,612,978. Number of shares of beneficial interest outstanding ofregistrant as of January 31, 2005: 11,756,072 DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant’s definitive proxy statement for our 2005 Annual Meeting of Shareholders, which will be filed with the Securities and ExchangeCommission within 120 days after December 31, 2004 (incorporated by reference under Part III). Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST2004 FORM 10-K ANNUAL REPORTTABLE OF CONTENTS PART IItem 1 Business 4Item 2 Properties 12Item 3 Legal Proceedings 16Item 4 Submission of Matters to a Vote of Security Holders 16PART IIItem 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 30Item 8 Financial Statements and Supplementary Data 31Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 32Item 9A Controls and Procedures 32PART IIIItem 10 Directors and Executive Officers of the Registrant 34Item 11 Executive Compensation 34Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 34Item 13 Certain Relationships and Related Transactions 34Item 14 Principal Accountant Fees and Services 34PART IVItem 15 Exhibits, Financial Statement Schedules and Reports on Form 8-K 35SIGNATURES 38 Table of ContentsThis Annual Report on Form 10-K is for the year ended December 31, 2004. 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 the information contained in this Annual Report, and should particularly consider any risk factors that we set forth in thisAnnual 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 events and ofour 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 other comparable words.You should be aware that those statements are only our predictions. Actual events or results may differ materially. In evaluating those statements, you shouldspecifically consider various factors, including the risks outlined below. Those factors may cause our actual results to differ materially from any of ourforward-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 98%. We currently account for our share of the income/loss from these investments by theequity method (see Note 9). As of December 31, 2004, we had investments or commitments in twenty-two limited liability companies (“LLCs”), nineteen ofwhich are accounted for by the equity method and three that are consolidated in the results of operations as of April 1, 2004. Effective March 31, 2004, weadopted FASB Interpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. As a result of our relatedparty relationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and various properties owned by threeLLCs in which we own a 98% or 99% non-controlling ownership interest, these LLCs are considered to be variable interest entities. In addition, we are theprimary beneficiary of these LLC investments as a result of our level of investment in the entities. Consequently, we began consolidating the results ofoperations of these three LLC investments. There was no impact on our net income as a result of the consolidation of these LLCs. The remaining LLCs are notvariable interest entities and therefore are not subject to the consolidation requirements of FIN 46R. 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 continues to undergo change and is subject to possible changes inthe levels and terms of reimbursement from third-party payors and government reimbursement programs, including Medicare and Medicaid; • we cannot predict whether leases on our properties, including leases on the properties leased to subsidiaries of UHS, which have options topurchase the respective leased facilities at the end of the lease renewal terms at the appraised fair market value, will be renewed at their currentrates at the end of the lease terms. If the leases are not renewed, we may be required to find other operators for these facilities and/or enter into leaseswith less favorable terms. If the UHS facilities are purchased by the lessees at the end of the lease term, the economic return earned by us on thesale proceeds may be less favorable than the rental revenue currently earned on the facilities; • our ability to finance our growth on favorable terms; 2Table of Contents • 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 as well as an increasein the development of medical office condominiums in certain markets; • the operators of our facilities, including UHS, are confronted with other issues such as: industry capacity; demographic changes; existing lawsand government regulations and changes in or failure to comply with laws and governmental regulations; the ability to enter into managed careprovider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of patientaccounts; competition by other healthcare providers, including physician owned facilities in certain markets, including McAllen, Texas, the siteof our largest facility; decreasing inpatient admission trends; the loss of significant customers; technological and pharmaceutical improvementsthat increase the cost 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 expense (including earthquakeinsurance in California) and general and professional liability insurance expense and as a result, certain operators have assumed a greater portionof their liability risk and there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted againstthe operators of our facilities, 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 order to qualify as a real estate investment trust (“REIT”) we must comply with certain highly technical and complex requirements. Although weintend to remain so qualified, there may be facts and circumstances beyond our control that may affect our ability to qualify as a REIT. Failure to qualify as aREIT may subject us to income tax liabilities, including federal income tax at regular corporate rates. The additional income tax incurred may significantlyreduce the cash flow available for distribution to shareholders and for debt service. In addition, if disqualified, we might be barred from qualification as aREIT for four years following disqualification. Although we believe we have been qualified as a REIT since our inception, there can be no assurance that wehave 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(“MOB”s). As of December 31, 2004 we have forty-three real estate investments or commitments located in fifteen states consisting of: (i) seven hospitalfacilities including four acute care, one behavioral healthcare, one rehabilitation and one sub-acute; (ii) thirty-two medical office buildings, and; (iii) fourpreschool 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 web site. 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 Officers and charters for each of the Audit Committee, CompensationCommittee and Nominating and Corporate Governance Committee of the board of trustees. These documents are also available on the Trust’s Internet website.We intend to satisfy the disclosure requirement under Item 10 of Form 8-K relating to amendments to or waivers from any provision of our Code of Ethics forSenior Officers by posting this information on our Internet website. Our website address is listed above. The information posted on our website is notincorporated into this Annual Report. As of December 31, 2004, we have investments or commitments in forty-three facilities 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.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% —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(G) 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(I) Mesa, AZ MOB 73% —Summerlin Hospital MOB(G) 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(G) Las Vegas, NV MOB 98% — 4Table of ContentsFacility Name Location Type of Facility Ownership GuarantorMedical 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 St. Mary’s Center for Health(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% —Sierra San Antonio Medical Plaza(H) Fontana, CA 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. HealthSouth does not expect to file its restated historical financial statements for periods ended on or before December 31, 2003 with the SEC until they have completed thereconstruction of their financial records and their audit is completed. HealthSouth currently estimates that such financial statements will not be completed until the first quarter of 2005. The lessee on the Tri-Statefacility is HealthSouth/Deaconess L.L.C., a joint venture between HealthSouth Properties Corporation and Deaconess Hospital, Inc. During 2004, 2003 and 2002, Tri-State had reported information to us thatindicated that the ratio of earnings before interest, taxes, depreciation, amortization and lease and rental expense was many times its annual lease payments to us. However, there can be no assurance that the financialcondition 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 to expire in June 2004, however, during 2004 the lesseeextended the lease for another five-year period to June of 2009. The renewal rate, which was based on the five-year Treasury rate immediately preceding the commencement of the lease renewal, resulted in areduction in annual base rental on this facility of $321,000.(F)We have committed to invest up to $10.5 million ($8.0 million in equity and $2.5 million in debt financing) in exchange for a 75% non-controlling interest in a LLC that constructed and owns the St. Mary’sCenter for Health located in Reno, Nevada. As of December 31, 2004, we have advanced $1.8 million in connection with this project, and the LLC has borrowed $18.3 million in construction loans from a $26million total construction loan commitment. This medical office building was opened in March of 2005.(G)Tenants of these medical office buildings include subsidiaries of UHS. Effective March 31, 2004, we adopted FIN 46R and as a result of our related party relationship with UHS, and certain master lease, leaseassurance or lease guarantee arrangements between UHS and these properties in which we own a 98% or 99% non-controlling ownership interest, these LLCs are considered to be variable interest entities. In addition,we are the primary beneficiary as a result of our level of investment in these three LLCs. Consequently, the December 31, 2004 Consolidated Balance Sheet includes the assets, liabilities, minority interest and third-party borrowings, which are non-recourse to us, of these LLCs. Beginning on April 1, 2004, pursuant to the provisions of FIN 46R, we began to consolidate the results of operations of these LLCs on ourConsolidated Statements of Income. There was no impact on our net income as a result of the consolidation of these LLCs.(H)We have committed to invest up to a total of $3.5 million in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own and operate the Sierra San Antonio Medical Plaza located inFontana, California. This LLC has a $7.5 million third-party construction loan commitment.(I)During the first quarter of 2005, Bayway Properties, a LLC in which we owned a 73% non-controlling ownership interest, sold the real estate assets of the East Mesa Medical Center, which is located in Mesa, Arizona.Our share of the net sale proceeds resulting from this transaction was $2.9 million. The transaction resulted in a gain of approximately $1.1 million which will be included in our results of operations for the threemonth period ended March 31, 2005. Included in our portfolio are seven hospital facilities with an aggregate investment of $118.2 million, excluding Virtue Street, which was sold onDecember 31, 2004 (see below). The leases with respect to the seven remaining hospital facilities comprised approximately 58%, 69% and 68% of ourrevenues in 2004, 2003 and 2002, respectively, and as of December 31, 2004, these leases have fixed terms with an average of 3.1 years remaining and includerenewal options ranging from two to five, five-year terms. We believe a facility’s earnings before interest, taxes, depreciation, amortization and lease rental expense (“EBITDAR”) and a facility’s EBITDARdivided by the sum of minimum rent plus additional rent payable to us (“Coverage Ratio”), which are non-GAAP financial measures, are helpful to us andour investors as a measure of the operating performance of a hospital facility. EBITDAR, which is used as an indicator of a facility’s estimated cash flowgenerated from operations (before rent expense, capital additions and debt service), is used by us in evaluating a facility’s financial viability and its ability topay rent. 5Table of ContentsFor the seven hospital facilities owned by us, the combined Coverage Ratio was approximately 7.8 (ranging from 3.1 to 14.9) during 2004, 9.1 (rangingfrom 3.8 to 17.1) during 2003 and 8.4 (ranging from 3.3 to 16.8) during 2002 (see “Relationship to Universal Health Services, Inc.”). The coverage ratio forindividual facilities varies. Pursuant to the terms of the leases with the seven hospital facilities, including subsidiaries of UHS, each individual hospital (the “lessee”) is responsiblefor building operations, maintenance and renovations. We, or the LLCs in which we have invested, are responsible for the building operations, maintenanceand renovations of the preschool and childcare centers and the multi-tenant medical office buildings, however, a portion of the expenses associated with themedical office buildings are passed on directly to the tenants. Cash reserves have been established to fund required building maintenance and renovations atthe multi-tenant medical office buildings. Lessees are required to maintain all risk, replacement cost and commercial property insurance policies on the leasedproperties and we, or the LLC in which we have invested, are also named insureds on these policies. In addition, we, or the LLCs in which we have invested,maintain property insurance on all properties. Although we believe that generally our properties are adequately insured, five medical office buildings (includingone currently under construction) and Inland Valley Regional Medical Center, an acute care hospital leased by a wholly-owned subsidiary of UHS, are notcovered under commercial earthquake policies since insurance is not available at rates which are economically beneficial in relation to the risks covered.However, pursuant to the terms of the lease, the wholly-owned subsidiary of UHS is responsible for property replacement cost for Inland Valley RegionalMedical Center, a portion of which is commercially insured. Relationship to Universal Health Services, Inc. Leases: As of December 31, 2004, subsidiaries of UHS leased five of the seven hospital facilities owned by us with terms expiring through 2009. Theleases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another. Pursuant to the terms of our leases withsubsidiaries of UHS, we earn fixed monthly base rents plus bonus rents based upon each facility’s net revenue in excess of base amounts. The bonus rentsare computed and paid on a quarterly basis upon a computation that compares current quarter revenue to the corresponding quarter in the base year. Theseleases contain remaining renewal options ranging from two to five, five-year periods. Excluding the lease on the Virtue Street facility which was sold to UHS inDecember, 2004 (reflected as discontinued operations on the Consolidated Statements of Income), the combined revenues generated from the leases on the fiveUHS hospital facilities accounted for approximately 58% of our total revenue for the five years ended December 31, 2004 (approximately 51% for the yearended December 31, 2004). Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controlling equity interestsranging from 33% to 98%, the leases on the five UHS hospital facilities accounted for approximately 29% of the combined consolidated and unconsolidatedrevenue for the five years ended December 31, 2004 (approximately 27% for the year ended December 31, 2004). For the five hospital facilities owned by usand leased to subsidiaries of UHS, the combined Coverage Ratio was approximately 8.1, 9.8 and 8.9 for the years ended December 31, 2004, 2003 and 2002,respectively. The Coverage Ratio for individual facilities vary and range from 4.0 to 14.9 in 2004, 5.1 to 17.1 in 2003 and 3.3 to 16.8 in 2002. On December 31, 2004, we completed the sale of the real estate assets of Virtue Street Pavilion, located in Chalmette, Louisiana, to the former lessee ofthe facility, a wholly-owned subsidiary of UHS. Pursuant to the terms of the lease on the facility, the lessee exercised its option to purchase the facility at itsfair market value upon the December, 2004 lease expiration. Accordingly, pursuant to the terms of the lease, independent appraisals were obtained by us andthe lessee, which indicated that the fair market value of the property, and therefore the sale price, was $7,320,000. The sale resulted in a gain of $833,000which is reflected as “Income from discontinued operations, net” in the Consolidated Statements of Income for the year ended December 31, 2004. The annualminimum rent payable to us under the Virtue Street Pavilion lease with UHS was $1,261,000 and no bonus rent was earned on this facility during 2004, 2003or 2002. As a result of the sale of the Virtue Street Pavilion, our future funds from operations and results of operations will likely be adversely affected since atinterest rates as currently projected, the reduction in annual interest expense resulting from repayment of borrowings using the sale proceeds is likely to beapproximately $1 million less than the annual rental payments previously earned by us pursuant to this lease. 6Table of ContentsDuring the third quarter of 2004, the lease on The Bridgeway facility (lessee is a wholly-owned subsidiary of UHS), which was scheduled to expire inDecember, 2004, was renewed for a five-year period through December, 2009, at the same lease terms. During the third quarter of 2004, Wellington Regional Medical Center, our 121-bed acute care facility located in West Palm Beach, Florida, sustainedstorm damage caused by a hurricane. This facility is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease, UHS is responsiblefor maintaining replacement cost property insurance for the facility, a substantial portion of which is insured by a commercial carrier. Although the facilityhas not experienced significant business interruption, our Consolidated Statements of Income for the year ended December 31, 2004, includes a property write-down charge of $1.9 million representing the estimated net book value of the damaged assets. This property charge is offset by an equal amount recoverablefrom UHS. We expect the ultimate replacement cost of the damaged property to exceed the net book value and the excess cost will also be recoverable fromUHS. As of December 31, 2004, UHS spent approximately $1.9 million to replace the damaged property and this amount is reflected as construction inprogress on our Consolidated Balance Sheet as of that date. During the first quarter of 2004, the lessee of this facility completed and financed an $8.5 millionexpansion to the facility in order to meet patient demand. Accordingly, since the bonus rent calculation on this facility is based on net revenues, the lease wasamended to exclude from the bonus rent calculation the estimated net revenues generated from the UHS-owned real estate assets (as calculated pursuant to apercentage based allocation determined at the time of expansion). During the fourth quarter of 2003, we invested $1.6 million, and during 2004 we invested an additional $2.1 million (and have committed to invest anadditional $200,000), in exchange for a 95% non-controlling interest in a limited liability company that acquired the Spring Valley Medical Office Building, amedical office building on the campus of Spring Valley Hospital in Las Vegas, Nevada. This MOB will be 75% master leased for five years by Valley HealthSystem (“VHS”), a majority-owned subsidiary of UHS, on a triple net basis. The master lease for each suite was extinguished at such time that the suite wasleased to another tenant acceptable to us and VHS, for a minimum term of five years. As of December 31, 2004, letters of intent or lease agreements have beenexecuted on more than 82% of the rentable space of this MOB and therefore the master lease arrangement has been extinguished. During the third quarter of 2003, we invested $8.9 million plus an additional $600,000 during the fourth quarter of 2004 ($3.0 million in equity and$6.5 million of debt financing, which was repaid to us during the first quarter of 2005), for the purchase of a 98% non-controlling equity interest in a limitedliability company that simultaneously purchased the 700 Shadow Lane & Goldring MOBs, consisting of three medical office buildings on the campus ofValley Hospital Medical Center in Las Vegas, Nevada. These medical office buildings were purchased from VHS and have tenants which are subsidiaries ofUHS. During the third quarter of 2002, the lessee of Chalmette Medical Center, a wholly-owned subsidiary of UHS, gave us the required notice to exercise itsrenewal option and extended the lease on this facility for a five-year term to 2008. The renewal rate was based upon the then five-year Treasury rate plus aspread. As a result, beginning at the end of March, 2003, the annual base rental on this facility was reduced by $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 7Table of Contentsare no longer separable, the lease was amended during 2002 to exclude from the bonus rent calculation, the estimated net revenues generated at the RanchoSprings campus. No assurance can be given as to the effect, if any, the consolidation of the two facilities as mentioned above, had on the underlying value ofInland Valley. 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, UHS has the option to purchase the respective leased facilities at the end of the lease terms or any renewalterms at the appraised market value. In addition, UHS has the rights of first refusal to: (i) purchase the respective leased facilities during, and for 180 daysafter, 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, andfor 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer. The terms of the leases also provide that in the event UHSdiscontinues 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, 2004, 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 $101.3 million (excluding Virtue Street Pavilion). As noted below, transactions with UHS must be approved by a majority of the Trustees whoare unaffiliated with UHS (the “Independent Trustees”). The purchase options and rights of first refusal granted to the respective lessees to purchase or leasethe 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 potentialconflict of interest between us and UHS since the price and terms offered by a third-party are likely to be dependent, in part, upon the financial performanceof the facility during the final years of 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, tax 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 2005. 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 8Table of Contentsas shown on our consolidated balance sheet, determined in accordance with generally accepted accounting principles without reduction for return of capitaldividends. No incentive fees were paid during 2004, 2003 and 2002. The advisory fee is payable quarterly, subject to adjustment at year end, based upon ouraudited financial statements. Our officers are all employees of UHS and as of December 31, 2004, we had no salaried employees. 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, 2004, UHS owned 6.7% of the outstanding shares of beneficial interest. Competition 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, the site of our largest facility, competition from other healthcare providers, includingphysician owned facilities, has increased and additional inpatient capacity at a physician owned hospital opened in late 2004. A continuation of the increasedprovider competition in the markets in which our hospital facilities operate, including McAllen, Texas, 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 and may potentiallyhave a negative impact on the underlying value of the properties. 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 2004, 2003 and 2002, 48%, 52% and 51%, 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 (excluding managed Medicare and Medicaid programs). 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; 9Table of Contents(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. There 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 reduce the amount of payments for outpatient services, bad debt expense and capital costs. In federal fiscal year 2004, hospitals were receivingfull market basket inflation adjustment for services paid under the inpatient PPS (inpatient PPS update of the market basket is 3.4% in fiscal year 2004),although CMS estimates that for the same time period, Medicare payment rates under OPPS were to increase, for each service, by an average of 4.5%. Underthe Medicare Modernization Act of 2003, which was signed into law in November 2003, the update was restored to the full market basket for fiscal year 2004;however, for fiscal years 2005 through 2007, operating updates equal to the market basket will be granted only to those hospitals that submit data on the tenquality indicators established by CMS. The operators of our acute care hospital facilities intend to submit the required quality data to CMS. For federal fiscalyear 2005, CMS will increase the inpatient Medicare unadjusted standard base rate by a full market basket increase of 3.3%, absent any legislative action byCongress. However, this Medicare payment increase will be mitigated by changes in other factors that directly impact a hospital’s DRG payment including,but not limited to, annual Medicare wage index updates, expansion of the DRG transfer payment policy and the annual recalibration of DRG relative paymentweights. 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 believe that their policies, procedures and practices comply with governmental regulations, noassurance can be given that they will not be subjected to governmental inquiries or actions, or that they would not be faced with sanctions, fines or penalties ifso subjected. Even if they were to ultimately prevail, a significant governmental inquiry or action under one of the above laws, regulations or rules could havea material adverse 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. 10Table of ContentsExecutive Officers of the Registrant Name Age PositionAlan B. Miller 67 Chairman of the Board, Chief Executive Officer and PresidentCharles F. Boyle 45 Vice President and Chief Financial OfficerCheryl K. Ramagano 42 Vice President, Treasurer and SecretaryTimothy J. Fowler 49 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 Trust until March, 1990. Mr. Miller has been Chairman of the Board, President and ChiefExecutive Officer of UHS since its inception in 1978. Mr. Miller also serves as a Director of Penn Mutual Life Insurance Company and Broadlane, Inc. (an e-commerce marketplace 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, 2004, 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. Lease Term Numberofavailablebeds @12/31/04 Average Occupancy(1) Minimumrent End ofinitialorrenewedterm Renewalterm(years)Hospital Facility Name and Location Type offacility 2004 2003 2002 2001 2000 Chalmette Medical CenterChalmette, Louisiana Acute Care 138 68% 71% 68% 60% 55% $960,000 2008 10Southwest Healthcare System:Inland Valley Campus(2)Wildomar, California Acute Care 80 78% 74% 71% 80% 76% 1,857,000 2006 25McAllen Medical Center(3)McAllen, Texas Acute Care 612 68% 72% 73% 69% 76% 5,485,000 2006 25Wellington Regional MedicalCenter(4)West Palm Beach, Florida Acute Care 121 72% 68% 58% 52% 45% 2,495,000 2006 25The BridgewayNorth Little Rock, Arkansas BehavioralHealth 98 98% 98% 97% 91% 82% 683,000 2009 20Tri-State Rehabilitation HospitalEvansville, Indiana Rehabilitation 80 74% 75% 74% 71% 73% 885,000 2009 15Kindred Hospital Chicago CentralChicago, Illinois Sub-Acute Care 87 47% 71% 78% 64% 50% 1,246,000 2006 20 12Table of ContentsITEM 2.Properties (continued) Lease Term Type offacility Average Occupancy(1) Minimumrent End ofinitialorrenewedterm(5) Renewalterm(years)Facility Name and Location 2004 2003 2002 2001 2000 Fresno Herndon Medical PlazaFresno, California MOB 67% 73% 92% 95% 99% $515,000 2007-2008 variousKelsey-Seybold Clinic atKings CrossingKingwood, Texas MOB 100% 100% 100% 100% 100% 319,000 2008 noneProfessional Bldgs. at KingsCrossingKingwood, Texas MOB 91% 82% 83% 88% 96% 277,000 2005-2011 variousSouthern Crescent CenterRiverdale, Georgia MOB 64% 70% 77% 77% 77% 422,000 2005-2007 variousCypresswood ProfessionalCenterSpring, Texas MOB 100% 97% 96% 100% 100% 628,000 2005-2008 variousDesert Springs MedicalPlaza(6)Las Vegas, Nevada MOB 100% 100% 100% 100% 99% 1,276,000 2005-2009 variousOrthopaedic Specialists ofNevada BuildingLas Vegas, Nevada MOB 100% 100% 100% 100% 100% 208,000 2009 20Summerlin Hospital MOB(6)Las Vegas, Nevada MOB 100% 100% 100% 100% 100% 1,188,000 2005-2014 variousSummerlin Hospital MOB II(6)Las Vegas, Nevada MOB 100% 100% 100% 100% 100% 1,306,000 2005-2012 variousSheffield Medical BuildingAtlanta, Georgia MOB 88% 99% 98% 99% 95% 1,315,000 2005-2012 variousSouthern Crescent Center, IIRiverdale, Georgia MOB 98% 98% 88% 88% 88% 1,006,000 2010 10Medical Center of WesternConnecticutDanbury, Connecticut MOB 100% 94% 94% 95% 100% 808,000 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(6)Las Vegas, Nevada MOB 99% 99% — — — 1,765,000 2005-2013 variousN/A- Not Applicable(1)Average occupancy rate for the hospital facilities is based on the average number of available beds occupied during each of the five years endedDecember 31, 2004. Average available beds is the number of beds which are actually in service at any given time for immediate patient use with thenecessary equipment and 13Table of Contents 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 ofdemand, incomplete construction and anticipation of future needs. The average occupancy rate of a hospital is affected by a number of factors,including the number of physicians using the hospital, changes in the number of beds, the composition and size of the population of the community inwhich the hospital is located, general and local economic conditions, variations in local medical and surgical practices and the degree of outpatient use ofthe hospital services. Average occupancy rate for the multi-tenant medical office buildings is based on the occupied square footage of each building,including any applicable master leases.(2)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 include therevenues of both Inland Valley and Rancho Springs. Although we do not own the real estate assets of the Rancho Springs facility, Southwest Healthcarebecame the lessee on the lease relating to the real estate assets of the Inland Valley facility. Since the bonus rent calculation for the Inland Valley campusis based on net revenues and the financial results of the two facilities are no longer separable, the lease was amended during 2002 to exclude from thebonus rent calculation the estimated net revenues generated at the Rancho Springs campus (as calculated pursuant to a percentage based allocationdetermined at the time of the merger).The average occupancy rates shown for this facility in 2004, 2003 and 2002 were based on the combined number of beds occupied at the Inland Valleyand Rancho Springs campuses. The average occupancy rates shown for the years 2000 and 2001 were based on the average number of beds occupied atthe Inland Valley campus.(3)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 propertyof which is not owned by us. Accordingly, since the bonus rent calculation for McAllen Medical Center is based on net revenues and the financialresults of the two facilities are no longer separable, the McAllen Medical Center lease was amended during 2001 to exclude from the bonus rentcalculation, the estimated net revenues generated at the Heart Hospital (as calculated pursuant to a percentage based allocation determined at the time ofthe merger). Base rental commitments and the guarantee by UHS under the original lease continue for the remainder of the lease terms. During 2000,UHS purchased a non-acute care facility located in McAllen, Texas that had been closed. The license for this facility was merged with the license forMcAllen Medical Center and this non-acute facility, the real property of which is not owned by us, was re-opened during 2001. There was noamendment 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 2004, 2003, 2002 and 2001 were based on the combined number of beds at McAllen MedicalCenter and the McAllen Heart Hospital. The average occupancy rates shown for the year 2000 was based on the average number of beds occupied at theMcAllen Medical Center.(4)During the first quarter of 2004, UHS completed and financed an $8.5 million expansion to the physical capacity of Wellington Regional MedicalCenter in order to meet patient demand. Accordingly, since the bonus rent calculation on this facility is based on net revenues, the lease was amended toexclude from the bonus rent calculation the estimated net revenues generated from the portion of the facility owned by UHS (as calculated pursuant to apercentage based allocation determined at the time of the expansion).(5)Properties are multi-tenant MOBs which have various lease maturity dates.(6)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 (does not include the two MOBs under construction as of December 31, 2004): AvailableforLeaseJan. 1,2005 Percentage of RSF with lease expirations Total RSF 2005 2006 2007 2008 2009 2010andlater Hospital Investments McAllen Medical Center 532,403 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%Wellington Regional Medical Center 121,015 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%Kindred Hospital Chicago Central 115,554 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%Chalmette Medical Center 93,751 0.0% 0.0% 0.0% 0.0% 100.0% 0.0% 0.0%Southwest Healthcare System—Inland Valley Campus 84,515 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%Tri-State Regional Rehabilitation Hospital 77,440 0.0% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0%The Bridgeway 57,901 0.0% 0.0% 0.0% 0.0% 0.0% 100.0% 0.0% Sub-total Hospitals 1,082,579 0.0% 0.0% 78.8% 0.0% 8.7% 12.5% 0.0% Other Investments Medical Office Buildings: Desert Samaritan Hospital MOBs 200,669 3.8% 21.0% 20.6% 33.9% 13.2% 2.4% 5.1%Edwards Medical Plaza 141,583 9.8% 22.0% 23.0% 22.2% 6.7% 3.3% 13.0%700 Shadow Lane & Goldring MOBs 112,786 2.4% 19.3% 12.3% 20.7% 18.1% 2.2% 25.0%Desert Springs Medical Plaza 106,830 0.0% 23.5% 49.7% 7.6% 5.6% 13.6% 0.0%Centinela Medical Building Complex 102,898 1.5% 9.9% 35.4% 4.1% 4.1% 37.9% 7.1%Suburban Medical Plaza II 99,497 1.4% 6.0% 18.5% 28.9% 2.1% 8.2% 34.9%Thunderbird Paseo Medical Plaza I & II 96,569 4.3% 1.9% 14.8% 18.3% 41.9% 3.8% 15.0%Summerlin Hospital Medical OfficeBuilding II 92,313 0.0% 0.0% 20.2% 16.9% 6.4% 3.8% 52.7%Summerlin Hospital Medical OfficeBuilding I 88,900 0.0% 21.2% 32.5% 23.2% 5.5% 14.2% 3.4%Papago Medical Park 79,251 4.9% 16.7% 30.7% 0.0% 25.9% 18.5% 3.3%Deer Valley Medical Office II 77,264 0.0% 0.9% 0.0% 4.2% 0.0% 5.6% 89.3%Mid Coast Hospital Medical Office Building 73,762 0.0% 0.0% 19.8% 0.0% 7.3% 0.0% 72.9%Sheffield Medical Building 71,944 12.3% 14.5% 11.9% 15.7% 10.3% 9.4% 25.9%Rosenberg Children’s Medical Plaza 66,231 8.3% 0.0% 0.0% 0.0% 21.3% 0.0% 70.4%Spring Valley Medical Office Building 57,828 17.1% 8.2% 0.0% 0.0% 0.0% 41.3% 33.4%Southern Crescent Center II 57,180 0.0% 0.0% 0.0% 0.0% 0.0% 7.0% 93.0%East Mesa Medical Center 56,348 3.8% 24.0% 34.8% 18.2% 3.3% 8.0% 7.9%Desert Valley Medical Plaza 53,625 1.7% 28.1% 37.9% 17.5% 12.5% 2.3% 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 43.2% 17.1% 33.9% 5.8% 0.0% 0.0% 0.0%Cypresswood Professional Center 40,082 0.0% 9.2% 11.6% 46.5% 32.7% 0.0% 0.0%Medical Center of Western Connecticut 37,522 0.0% 5.7% 4.9% 19.0% 4.4% 15.1% 50.9%Fresno-Herndon Medical Plaza 36,417 33.3% 0.0% 0.0% 46.7% 20.0% 0.0% 0.0%Apache Junction Medical Plaza 26,901 0.0% 0.0% 5.9% 38.9% 20% 0.0% 35.2%Santa Fe Professional Plaza 25,294 0.0% 4.5% 18.1% 22% 50.4% 5.0% 0.0%Rio Rancho Medical Center 22,956 0.0% 0.0% 100.0% 0.0% 0.0% 0.0% 0.0%Professional Buildings at Kings Crossing 21,677 9.5% 33.9% 0.0% 20.4% 13.7% 0.0% 22.5%Kelsey-Seybold Clinic at Kings Crossing 20,470 0.0% 0.0% 100.0% 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% Preschool and Childcare Centers: 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% Sub-total Other Investments 2,002,764 4.7% 11.8% 20.7% 15.9% 10.9% 10.1% 25.9% Total 3,085,343 3.8% 7.0% 25.3% 10.5% 10.4% 12.2% 30.8% 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, 2004 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, 2004 and 2003 are summarized below: 2004 2003 HighPrice LowPrice HighPrice LowPriceFirst Quarter $33.70 $29.61 $26.93 $25.30Second Quarter $34.00 $24.82 $27.75 $25.95Third Quarter $30.85 $27.99 $28.00 $26.54Fourth Quarter $34.50 $30.14 $30.55 $27.46 As of January 31, 2005, there were approximately 621 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: 2004 2003 2002 2001 2000First Quarter $.495 $.485 $.475 $.465 $.455Second Quarter .500 .490 .480 .465 .460Third Quarter .500 .490 .480 .470 .460Fourth Quarter .505 .495 .485 .475 .465 $2.000 $1.960 $1.920 $1.875 $1.840 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) 2004(1) 2003(1) 2002(1) 2001 2000 Operating Results: Total revenue $31,777 $27,052 $27,168 $26,313 $26,054 Income from continuing operations 21,712 23,433 20,631 17,357 15,264 Income from discontinued operations, net (including gain on sale of realproperty of $833 during 2004) 1,959 992 992 992 992 Net income $23,671 $24,425 $21,623 $18,349 $16,256 Balance Sheet Data: Real estate investments, net of accumulated depreciation $158,062 $130,789 $134,886 $139,215 $143,092 Investments in LLCs(2) 40,523 61,001 48,314 46,939 39,164 Total assets(2) 204,583 194,291 185,117 187,904 183,658 Total indebtedness(2)(3) 46,210 37,242 30,493 33,432 82,031 Other Data: Funds from operations(4) $31,199 $30,149 $28,572 $25,985 $21,739 Cash provided by (used in): Operating activities 26,987 26,246 25,066 22,778 19,970 Investing activities 11,885 (10,222) (206) (8,332) (8,913)Financing activities (36,387) (15,994) (24,891) (14,111) (11,615)Per Share Data: Basic earnings per share: From continuing operations $1.85 $2.00 $1.77 $1.65 $1.70 From discontinued operations 0.17 0.09 0.08 0.10 0.11 Total basic earnings per share $2.02 $2.09 $1.85 $1.75 $1.81 Diluted earnings per share: From continuing operations $1.84 $1.99 $1.76 $1.65 $1.70 From discontinued operations 0.16 0.08 0.08 0.09 0.11 Total diluted earnings per share $2.00 $2.07 $1.84 $1.74 $1.81 Dividends per share $2.000 $1.960 $1.920 $1.875 $1.840 Other Information (in thousands) Weighted average number of shares outstanding—basic 11,744 11,713 11,687 10,492 8,981 Weighted average number of shares and share equivalents outstanding—diluted 11,813 11,779 11,750 10,536 9,003 (1)See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”(2)Effective March 31, 2004, we began consolidating the assets, liabilities, third-party borrowings, which are non-recourse to us, and minority interests ofthree LLC investments. As a consequence, as of December 31, 2004, our Investments in LLCs decreased by $16.4 million, our Total Assets increasedby $22.6 million and our Total Indebtedness increased by $22.1 million.(3)Excludes $124.8 million of third-party debt that is non-recourse to us, incurred by unconsolidated LLCs in which we hold various non-controllingequity interests as of December 31, 2004 (see Note 9 to the Consolidated Financial Statements).(4)Funds from operations, 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 17Table of Contents Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO in accordance with theNAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. To facilitate a clear understanding of ourhistorical operating results, FFO should be examined in conjunction with net income determined in accordance with GAAP. FFO does not represent cashgenerated 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 analternative to cash flow from operating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) nor is FFO an indicator offunds available for our cash needs, including our ability to make cash distributions to shareholders. A reconciliation of our reported net income to FFOis shown below. 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 to us. Theseproceeds were used to repay outstanding borrowings under our revolving credit facility thereby decreasing interest expense and increasing FFO. FFO shownabove is calculated as follows: (000s) 2004 2003 2002 2001 2000 Net income $23,671 $24,425 $21,623 $18,349 $16,256 Depreciation expense: Consolidated investments 5,088 4,409 4,378 4,352 4,414 Unconsolidated affiliates 4,282 4,146 3,791 3,284 2,964 Gain on sale of real property Consolidated investments — — — — (1,895)Unconsolidated affiliates (1,009) (2,831) (1,220) — — Discontinued operations (833) — — — — FFO $31,199 $30,149 $28,572 $25,985 $21,739 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, 2004, we have forty-three real estate investments or commitments located in fifteen states consisting of: • seven hospital facilities including four acute care, one behavioral healthcare, one 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. 18Table of ContentsSuch 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 continues to undergo change and is subject to possible changes inthe levels and terms of reimbursement from third-party payors and government reimbursement programs, including Medicare and Medicaid; • we cannot predict whether the leases on our properties, including the leases on the properties leased to subsidiaries of UHS, which have options topurchase the respective leased facilities at the end of the lease or renewal terms at the appraised fair market value, will be renewed at their currentrates at the end of the lease terms. If the leases are not renewed, we may be required to find other operators for these facilities and/or enter into leaseswith less favorable terms. If the UHS facilities are purchased by the lessees at the end of the lease term, the economic return earned by us on thesale proceeds may be less favorable than the rental revenue currently earned on the facilities; • 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, as well as anincrease in the development of medical office condominiums in certain markets; • the operators of our facilities, including UHS, are confronted with other issues such as: industry capacity; demographic changes; existing lawsand government regulations and changes in or failure to comply with laws and governmental regulations; the ability to enter into managed careprovider agreements on acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of patientaccounts; competition by other healthcare providers, including physician owned facilities; decreasing inpatient admission trends; the loss ofsignificant customers; technological and pharmaceutical improvements that increase the cost 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 expense (including earthquakeinsurance in California) and general and professional liability insurance expense and as a result, certain operators have assumed a greater portionof their liability risk and there can be no assurance that a continuation of these unfavorable trends, or a sharp increase in claims asserted againstthe operators of our facilities, 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 certain markets, including McAllen, Texas, the site of our largest facility, competition from other healthcare providers, includingphysician owned facilities, has increased and additional inpatient capacity at a physician owned hospital opened in late 2004. A continuation of the increasedprovider competition in the markets in which our hospital facilities operate, including McAllen, Texas, 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 and may potentiallyhave a negative impact on the underlying value of the properties. 19Table of ContentsIn order to qualify as a real estate investment trust (“REIT”) we must comply with certain highly technical and complex Internal Revenue Servicerequirements. Although we intend to remain so qualified, there may be facts and circumstances beyond our control that may affect our ability to qualify as aREIT. Failure to qualify as a REIT may subject us to income tax liabilities, including federal income tax at regular corporate rates. The additional income taxincurred may significantly reduce the cash flow available for distribution to shareholders and for debt service. In addition, if disqualified, we might be barredfrom qualification as a REIT for four years following disqualification. Although we believe we have been qualified as a REIT since our inception, there can beno assurance 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 U.S. generally accepted accounting principles requires us to make estimates andassumptions 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 and reimbursements from tenants for their pro-rata share of expenses such as commonarea 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 regardless of when payments aredue. Bonus rents are recognized when earned based upon increases in each facility’s net revenue in excess of stipulated amounts. Bonus rentals are determinedand paid each quarter based upon a computation that compares the respective facility’s current quarter’s revenue to the corresponding quarter in the base year.Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred. Investments in Limited Liability Companies (“LLCs”) — Our consolidated financial statements include the consolidated accounts of ourcontrolled investments and those investments that meet the criteria of a variable interest entity where we are the primary beneficiary as a result of our level ofinvestment in the entity. In accordance with the American Institute of Certified Public Accountants’ Statement of Position 78-9 “Accounting for Investments inReal Estate Ventures” and Emerging Issues Task Force Issue 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the VotingInterest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights”, we account for our unconsolidated investments in LLCs whichwe do not control using the equity method of accounting. These investments, which represent 33% to 98% non-controlling ownership interests, are recordedinitially at our cost and subsequently adjusted for our net equity in the net income, cash contributions to and distributions from the investments. Rental income recorded by the LLCs relating to leases in excess of one year in length, is recognized using the straight-line method under whichcontractual rents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting from straight-line rentadjustments is dependent 20Table of Contentson many factors including the nature and amount of any rental concessions granted to new tenants, scheduled rent increases under existing leases, as well asthe acquisitions and sales of properties that have existing in-place leases with terms in excess of one year. As a result, the straight-line adjustments to rentalrevenue may vary from period-to-period. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation, as revised (“FIN 46R”), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. EffectiveMarch 31, 2004, we adopted FIN 46R. As a result of our related party relationship with UHS, and certain master lease, lease assurance or lease guaranteearrangements between UHS and various properties owned by three LLCs in which we own a 98% or 99% non-controlling ownership interest, these LLCs areconsidered to be variable interest entities (see Note 9 to the Consolidated Financial Statements). In addition, we are the primary beneficiary of these LLCinvestments as a result of our level of investment in the entities. Consequently, we began consolidating the results of operations of these three LLC investments.Included on our December 31, 2004 Consolidated Balance Sheet are the: (i) assets; (ii) liabilities; (iii) third-party borrowings, which are non-recourse to us,and; (iv) minority interests, of these three LLC investments. Also as a consequence of FIN 46R, beginning on April 1, 2004, we began consolidating theresults of operations of these LLC investments on our Consolidated Statements of Income. There was no impact on our net income as a result of theconsolidation of these LLCs. The remaining LLCs are not variable interest entities and therefore are not subject to the consolidation requirements of FIN 46R. Federal Income Taxes — No provision has been made for federal income tax purposes since we qualify as a 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 weare required to distribute at least 90% of our real estate investment taxable income to our shareholders. We are subject to a federal excise tax computed on a calendar year basis. The excise tax equals 4% of the amount by which 85% of our ordinary 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. 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, tax and other services, for which the Advisor is reimbursed directly by us. TheAdvisory 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 2005. All transactions with UHS must be approved by the Independent Trustees. Our officers are all employeesof UHS and as of December 31, 2004, we had no salaried employees. Excluding the lease on the Virtue Street facility, which was sold to UHS in December, 2004, the leases on the five remaining UHS wholly-ownedhospital facilities comprised approximately 51%, 60% and 59% of our 21Table of Contentsrevenues for the years ended December 31, 2004, 2003 and 2002, respectively. Including 100% of the revenues generated at the unconsolidated LLCs in whichwe have various non-controlling equity interests ranging from 33% to 98%, the leases with wholly-owned UHS hospital facilities accounted for 27% in each2004, 2003 and 2002 of the combined consolidated and unconsolidated revenues. The leases to the hospital facilities of UHS are guaranteed by UHS andcross-defaulted with one another. See Note 2 to the Consolidated Financial Statements for additional disclosure. Results of Operations Year ended December 31, 2004 as compared to the year ended December 31, 2003: Income from continuing operations decreased $1.7 million to $21.7 million or $1.84 per diluted share during 2004 as compared to $23.4 million or$1.99 per diluted share during 2003. Net income decreased $754,000 to $23.7 million or $2.00 per diluted share during 2004 as compared to $24.4 million or$2.07 per diluted share during 2003. The $1.7 million decrease in income from continuing operations during 2004, as compared to 2003, was primarily due toa $1.8 million decrease in gains from sales of real properties by certain LLCs ($1.0 million or $.09 per diluted share of gains during 2004 as compared to$2.8 million or $.24 per diluted share during 2003). The $754,000 decrease in net income during 2004, as compared to 2003, was primarily due to the $1.8million decrease in gains mentioned above, partially offset by a $833,000 gain recorded during 2004 resulting from the sale of the Virtue Street Pavilion(reflected as discontinued operations in the Consolidated Statements of Income). Total revenues increased by $4.7 million to $31.8 million in 2004 as compared to $27.1 million in 2003, resulting primarily from: (i) a favorable $4.8million increase in base rentals due to the consolidation of the results of operations of the three LLCs, as discussed below, and; (ii) $100,000 of other netunfavorable changes due primarily to approximately $200,000 of base rental decreases resulting from lease renewals during 2003 and 2004 which were basedon Treasury rates at the time of renewal, partially offset by $106,000 increase in bonus rental revenue from UHS facilities. Interest expense increased by $870,000 in 2004, as compared to 2003, due to: (i) an increase of $1.3 million resulting from the consolidation of the threeLLCs, as discussed below, and; (ii) a decrease of $422,000 due to the expiration of an interest rate swap agreement which reduced our effective borrowing rate,and a decrease in our average outstanding borrowings. Also contributing to the reduction in interest expense were gains of $124,000 during 2004, as comparedto $10,000 during 2003, stemming from the ineffective portion of cash flow hedges on derivatives pursuant to the provisions of SFAS No. 133. Depreciation and amortization increased $910,000 during 2004, as compared to 2003, due primarily to the consolidation of the LLCs, as discussedbelow. Other operating expenses increased $1.6 million during 2004, as compared to 2003, also due primarily to the consolidation of the results of operationsof the three LLCs, as discussed below. Included in our other operating expenses were expenses related to the consolidated medical office buildings, whichtotaled $4.3 million in 2004 and $2.6 million in 2003. The $1.7 million increase in operating expense related to our medical office buildings is also due to theconsolidation of the LLCs, as discussed below. A portion of the expenses associated with the medical office buildings are passed on directly to the tenants andare included as revenues in our statements of income. Approximately $3.3 million or 75% in 2004 and, $1.6 million or 60% in 2003, of the operating expensesrelated to the medical office buildings were passed on directly to the tenants. Building expenses allocated to tenants for reimbursement are dependent on variousfactors such as overall building occupancy levels and terms of individual leases. Included in our financial results was $4.0 million in 2004 (before $1.0 million gain on sale of real property) and $5.1 million in 2003 (before $2.8million of gains on sales of real properties) of operating income generated from our ownership of equity interests in limited liability companies which ownmedical office buildings in Arizona, California, Kentucky, New Mexico, Nevada and Maine (see Note 9 to the Consolidated Financial 22Table of ContentsStatements). The decrease during 2004, as compared to 2003, is due primarily to the consolidation of the three LLCs, as discussed below. As of December 31, 2004, we have investments or commitments in twenty-two limited liability companies (“LLCs”), nineteen of which are accountedfor by the equity method and three that are consolidated in the results of operations as of April 1, 2004. Effective March 31, 2004, we adopted FASBInterpretation No. 46R (“FIN 46R”), “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. As a result of our related party relationshipwith UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and various properties owned by three LLCs in which weown a 98% or 99% non-controlling ownership interest, these LLCs are considered to be variable interest entities. In addition, we are the primary beneficiary ofthese LLC investments as a result of our level of investment in the entities. Consequently, we began consolidating the results of operations of these three LLCinvestments. There was no impact on our net income as a result of the consolidation of these three LLCs. The remaining LLCs are not variable interest entitiesand therefore are not subject to the consolidation requirements of FIN 46R. The following table presents the effect on our Consolidated Statement of Income for the year ended December 31, 2004 resulting from the consolidation ofthe three LLCs considered variable interest entities (amounts in thousands): Year Ended December 31, 2004 Consolidated Statementof Income beforeconsolidation of LLCsconsidered variableinterest entities CombinedStatementsof Incomefor LLCs(a) As reportedConsolidatedStatement ofIncome Revenues: Base rental - UHS facilities $11,478 $1,622 $13,100 Base rental - Non-related parties 8,975 1,681 10,656 Bonus rental - UHS facilities 4,668 — 4,668 Tenant reimbursements and other - Non-related parties 1,826 841 2,667 Tenant reimbursements and other - UHS facilities — 686 686 26,947 4,830 31,777 Expenses: Depreciation and amortization 4,304 873 5,177 Advisory fee to UHS 1,498 — 1,498 Other operating expenses 3,318 1,682 5,000 Property write-down - hurricane damage 1,863 — 1,863 Property damage recoverable from UHS (1,863) — (1,863) 9,120 2,555 11,675 Income before equity in limited liability companies (“LLCs”) and interest expense 17,827 2,275 20,102 Equity in income of unconsolidated LLCs (including gain on sale of real propertyof $1,009) 5,950 (983) 4,967 Interest expense (2,065) (1,292) (3,357) Income from continuing operations 21,712 — 21,712 Income from discontinued operations, net (including gain on sale of real property of$833) 1,959 — 1,959 Net Income $23,671 — $23,671 (a)As discussed above, the operating results of the three variable interest entities were accounted for under the equity method for the three month periodended March 31, 2004 and consolidated in our financial results for the period of April 1, 2004 through December 31, 2004 (information presented abovefor LLCs is for the nine month period of April through December 2004). 23Table of ContentsOn December 31, 2004, we completed the sale of the real estate assets of Virtue Street Pavilion, located in Chalmette, Louisiana, to the former lessee ofthe facility, a wholly-owned subsidiary of UHS, for cash proceeds of $7.3 million. The sale resulted in a gain of $833,000 which is reflected as “Income fromdiscontinued operations, net” in the Consolidated Statements of Income for the year ended December 31, 2004. The operating results of this facility are alsoreflected as “Income from discontinued operations, net” in the Condensed Consolidated Statements of Income for the years ended December 31, 2004, 2003 and2002. The following table shows the results of operations for the Virtue Street Pavilion during 2004, 2003 and 2002 (in thousands): Year Ended December 31, 2004 2003 2002 Revenues $1,261 $1,261 $1,261 Depreciation expense (135) (269) (269) Income from operations 1,126 992 992 Gain on sale 833 — — Income from discontinued operations, net $1,959 $992 $992 During the third quarter of 2004, Wellington Regional Medical Center, our 121-bed acute care facility located in West Palm Beach, Florida, sustainedstorm damage caused by a hurricane. This facility is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease, UHS is responsiblefor maintaining replacement cost property insurance for the facility, a substantial portion of which is insured by a commercial carrier. Although the facilityhas not experienced significant business interruption, our Consolidated Statements of Income for the year ended December 31, 2004, includes a property write-down charge of $1.9 million representing the estimated net book value of the damaged assets. This property charge is offset by an equal amount recoverablefrom UHS. We expect the ultimate replacement cost of the damaged property to exceed the net book value and the excess cost will also be recoverable fromUHS. During the second quarter of 2004, Parkvale Properties sold the real property of the Parkvale Medical Building which is located in Phoenix, Arizona.Our share of the net sale proceeds resulting from this transaction was $950,000 which is included as a gain on sale of real property in our results of operationsfor 2004, since the carrying value of this investment was reduced to zero in a prior year. During the fourth quarter of 2003, 23650 Madison and PacPal Investments, two LLCs in which we owned 95% non-controlling ownership interests,sold the 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. These transactions resulted 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 Parkvale Properties, a LLC in which we owna 60% non-controlling ownership interest, representing our share of the net sale proceeds from the sale of Palo Verde Medical Center, a medical office buildinglocated in Phoenix, Arizona. Since the carrying value of this investment was reduced to zero in a prior year, this sale resulted in a gain of $365,000, which isincluded in our 2003 results of operations. Funds from operations, 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 represent cashgenerated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income determined in accordance withGAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordance with GAAP; (ii) as an alternative tocash flow from 24Table of Contentsoperating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) nor is FFO an indicator of funds available for our cashneeds, including our ability to make cash distributions to shareholders. Our FFO increased $1.1 million or 3.5% to $31.2 million during 2004 as compared to $30.1 million during 2003. Below is a reconciliation of ourreported net income to FFO (amounts in thousands). Year EndedDecember 31, 2004 2003 Funds From Operations: Net income $23,671 $24,425 Plus: Depreciation and amortization: Consolidated investments 5,088 4,409 Unconsolidated affiliates 4,282 4,146 Less: Gain on LLC’s sale of real property (1,009) (2,831) Gain on sale of real property-discontinued operations (833) — Funds From Operations $31,199 $30,149 Year ended December 31, 2003 as compared to year ended December 31, 2002: Income from continuing operations increased $2.8 million to $23.4 million or $1.99 per diluted share during 2003 as compared to $20.6 million or$1.76 per diluted share during 2002. Net income increased $2.8 million to $24.4 million or $2.07 per diluted share during 2003 as compared to $21.6 millionor $1.84 per diluted share during 2002. The $2.8 million increase in income from continuing operations and net income during 2003, as compared to 2002,was primarily attributable to a $3.0 million increase in equity in income of unconsolidated LLCs. The increased income from LLCs during 2003, as comparedto 2002, resulted from: (i) a $1.6 million increase in gains from sales of real properties by certain LLCs ($2.8 million or $.24 per diluted share of gainsduring 2003 as compared to $1.2 million or $.10 per diluted share during 2002), and; (ii) $1.4 million of additional income from our investments in variousLLCs. Included in the income from the LLCs is rental income relating to leases in excess of one year in length, which is recognized using the straight-linemethod under which contractual rents are recognized evenly over the lease term regardless of when payments are due. Also contributing to the increase wasincome generated from the LLCs in which we initially invested during 2002 or 2003. Total revenues decreased $116,000 to $27.1 million during 2003, as compared to $27.2 million during 2002, resulting primarily from: (i) anunfavorable $205,000 or 2% decrease in base rentals from UHS facilities, resulting from the lease renewal at Chalmette Medical Center which was renewed inMarch, 2003 at a lower annual base rental rate which was based upon Treasury rates; (ii) an unfavorable $302,000 or 3% decrease in base rental and tenantreimbursements from non-related parties, caused primarily by an increased vacancy rate at three medical office buildings located in Fresno, California,Riverdale, Georgia and Kingwood, Texas, and; (iii) a favorable $391,000 or 9% increase in bonus rental revenue from UHS facilities. Interest expense decreased $133,000 in 2003, as compared to 2002, due primarily to a loss of $217,000 recorded during 2002 (as compared to $10,000gain during 2003) stemming from the ineffective portion of cash flow hedges on derivatives pursuant to the provisions of SFAS No. 133. Other operating expenses increased 2% or $63,000 in 2003, as compared to 2002. Included in our other operating expenses were expenses related to themedical office buildings, in which we have a controlling ownership interest, which totaled $2.6 million in 2003 and $2.5 million in 2002. A portion of theexpenses associated with the medical office buildings are passed on directly to the tenants and are included as revenues in our statements of income.Approximately $1.6 million or 60% in 2003 and $1.7 million or 70% in 2002, of the operating expenses related to the medical office buildings were passed ondirectly to the tenants. Building 25Table of Contentsexpenses allocated to tenants 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. Included in our financial results was $5.1 million in 2003 (before $2.8 million gains on sales of real properties) and $3.7 million in 2002 (before $1.2million gain on sale of property), of operating income generated from our ownership of equity interests in limited liability companies which own medical officebuildings in Arizona, California, Kentucky, New Mexico, Nevada and Maine (see Note 9 to the Consolidated Financial Statements). During 2003, asdiscussed above, we recorded $2.8 million of combined gains related to the sales of Skypark Professional Medical Building, Pacifica Palms Medical Plazaand Palo Verde Medical Center, as discussed above. During 2002, we received $2.6 million of cash for our share of the proceeds generated from the sale of thereal estate assets of Samaritan West Valley Medical Center located in Goodyear, Arizona. The transaction resulted in a gain of $1.2 million which is includedin our 2002 results of operations. Our FFO increased $1.5 million or 5.5% to $30.1 million during 2003 as compared to $28.6 million during 2002. Below is a reconciliation of ourreported net income to FFO (amounts in thousands). Year EndedDecember 31, 2003 2002 Funds From Operations: Net income $24,425 $21,623 Plus: Depreciation and amortization: Consolidated investments 4,409 4,378 Unconsolidated affiliates 4,146 3,791 Less: Gain on LLC’s sale of real property (2,831) (1,220) Funds From Operations $30,149 $28,572 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, most of our medicaloffice building leases require the tenant to pay an allocable share of operating expenses, including common area maintenance costs, insurance and real estatetaxes over a base year amount. These provisions may reduce our exposure to increases in operating costs resulting from inflation. To the extent that 26Table of Contentssome leases do not contain such provisions, our future operating results may be adversely impacted by the effects of inflation. Liquidity and Capital Resources Liquidity Year ended December 31, 2004 as compared to December 31, 2003: Net cash provided by operating activities Net cash provided by operating activities increased to $27.0 million during 2004 as compared to $26.2 million during 2003. The $741,000 net favorablechange during 2004, as compared to 2003, was primarily attributable to: (i) a $1.0 million favorable change in net income plus or minus the adjustments toreconcile net income to net cash provided by operating activities (depreciation and amortization and gains on sales of real properties); (ii) a $129,000unfavorable change in accrued interest, and; (iii) $141,000 of other net unfavorable changes. The $1.0 million favorable change mentioned above was dueprimarily to the add-back of approximately $900,000 of depreciation and amortization expense incurred by three LLCs that we began including in ourfinancial statements, on a consolidated basis, during 2004 in connection with the adoption of FIN 46R. Net cash provided by/(used in) investing activities Net cash provided by/(used in) investing activities was $11.9 million during 2004 as compared to ($10.2 million) during 2003. During 2004, we received $7.3 million of cash in connection with the sale of the real assets of Virtue Street Pavilion, located in Chalmette, Louisiana, tothe former lessee of the facility, a wholly-owned subsidiary of UHS. Also during 2004, we received $6.4 million of cash in connection with the 2003 sale bytwo LLCs that owned the real estate assets of Skypark Professional Medical Office Building and Pacifica Palms Medical Plaza. The sale proceeds were held ina cash escrow account by a like-kind-exchange agent in anticipation of potentially completing a like-kind-exchange transaction during 2004. Since the like-kind-exchange transaction did not occur, these proceeds were distributed to us during 2004. We received $1.0 million during 2004 and $365,000 during 2003($6.7 million of cash distributions from sales of properties by LLCs during 2003 less $6.3 million held in an escrow account, as mentioned above), of cashdistributions in connection with the sales of real properties by LLCs. We also received distributions from refinancing proceeds of $800,000 during 2004, and$5.0 million during 2003, in connection with our investments in LLCs. During 2004, we invested a total of $4.2 million in the following (consisting of $2.8 million of investments in LLCs and $1.4 million of net advancesmade to LLCs): • $2.1 million funded in connection with the purchase of a 95% non-controlling equity interest in a LLC that owns the Spring Valley MedicalOffice Building located in Las Vegas, Nevada (the LLC also obtained a $4.0 million third-party mortgage that is non-recourse to us); • $830,000 additional net loan funded in connection with a total commitment of up to $10.5 million by us (consisting of $8.0 million in equity and$2.5 million in debt financing) in exchange for a 75% non-controlling equity interest in a LLC that is constructing and owns the St. Mary’sCenter for Health located in Reno, Nevada, which was opened in the first quarter of 2005 (the LLC also obtained a $26 million third-partymortgage that is non-recourse to us); • $600,000 additional net loan funded in connection with the purchase of a 98% non-controlling equity interest in a LLC that simultaneouslypurchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada, and; • $700,000 of additional investments in various LLCs in which we own a non-controlling equity interest. 27Table of ContentsDuring 2003, we invested a total of $16.2 million in the following (consisting of $9.3 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, of which $2.1 million was funded during 2004) in exchange for a 95% non-controlling interest in a LLC that owns the Spring Valley Medical Office Building located in Las Vegas, Nevada (the LLC also obtained a $4.0million third-party mortgage that is non-recourse to us); • $8.9 million during 2003, consisting of $3.0 million in equity and a $6.5 million loan (this loan was fully repaid to us during the first quarter of2005), invested for the purchase of a 98% non-controlling equity interest in a LLC that simultaneously purchased three medical office buildingson the campus of Valley Hospital Medical Center in Las Vegas, Nevada; • $1.0 million net loan funded in connection with a total commitment of up to $10.5 million by us (consisting of $8.0 million in equity and $2.5million in debt financing) in exchange for a 75% non-controlling interest in a LLC that will construct and own the St. Mary’s Center for Healthlocated in Reno, Nevada; • $2.0 million funded in connection with the purchase of a 85% non-controlling equity interest in a LLC that constructed and owns the RosenbergChildren’s Medical Plaza, a medical office building that was opened in February, 2003 (the LLC also obtained a $7.5 million third-party mortgagethat is non-recourse to us), and; • $1.5 million of additional investments in various LLCs in which we own a non-controlling equity interest. Net cash used in financing activities Net cash used in financing activities was $36.4 million during 2004 and $16.0 million during 2003. We paid dividends of $23.5 million during 2004 as compared to $23.0 million during 2003. We repaid $13.0 million during 2004, and borrowed $6.8million during 2003, under the terms of our revolving credit facility. We repaid $435,000 of mortgage notes payable during 2004 (including $333,000 ofmortgage notes payable related to three LLCs that were consolidated into our results of operations during 2004 as a result of FIN 46R) as compared to $95,000during 2003. We received $593,000 during 2004 and $757,000 during 2003, of proceeds from the issuance of shares of beneficial interest. During 2003, wepaid $540,000 in fees in connection with the commencement of our revolving credit agreement. Year ended December 31, 2003 as compared to December 31, 2002: Net cash provided by operating activities Net cash provided by operating activities increased to $26.2 million during 2003 as compared to $25.1 million in 2002. The $1.1 million increaseduring 2003, as compared to 2002, resulted primarily from $1.4 million of increases in net income (excluding gains) due primarily to increased earnings fromthe LLCs in which we own various non-controlling ownership interests. Contributing to the increased earnings from the LLCs was increased rental incomerecorded at the LLCs relating to leases in excess of one year in length which is recognized using the straight-line method. Also contributing to the increase wasincome generated from the LLCs in which we initially invested during 2002 or 2003. Cash used in investing activities Net cash used in investing activities was $10.2 million during 2003, as discussed above, as compared to $200,000 during 2002. 28Table of ContentsDuring 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 Deer Valley Medical Office II locatedin Phoenix, Arizona (the LLC also obtained a $7.0 million third-party mortgage that is non-recourse to us); • $200,000 invested (of the $2.6 million commitment) for the purchase of a 85% non-controlling equity interest in a LLC that constructed andowns the Rosenberg Children’s Medical Plaza, a medical office building that was opened in February, 2003 (the LLC also obtained a $7.5 millionthird-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. During 2002, we received $2.6 million of cash distributions from sale proceeds in connection with the sale of real property by an LLC. Also during2002, we received $525,000 of distributions from refinancing proceeds, in connection with our investments in LLCs. Net cash used in financing activities Net cash used in financing activities was $16.0 million during 2003, as discussed above, and $24.9 million during 2002. We paid dividends of $22.4 million during 2002 and repaid $1.4 million of borrowings under the terms of our revolving credit agreement. Also during2002, we repaid a $1.5 million note payable to UHS and generated $488,000 from the issuance of shares of beneficial interest. 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, subject to bank approval, to increase the amount by $20 million for a total commitment of $100 million. The Agreement provides forinterest at our option, at the 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 ofthis commitment. The margins over the Eurodollar rate, prime rate and the commitment fee are based upon our debt to total capital ratio as defined by theAgreement. At December 31, 2004, the applicable margin over the Eurodollar rate was 1.00% and the commitment fee was .25%. At December 31, 2004, wehad $15.3 million of letters of credit outstanding against the Agreement. There are no compensating balance requirements. The Agreement contains a provisionwhereby the commitments will be reduced by 50% of the proceeds generated from any new equity offering. The average amounts outstanding under ourrevolving credit agreement were $26.4 million in 2004, $28.3 million in 2003 and $25.3 million in 2002 with corresponding effective interest rates, includingcommitment fees and interest rate swap expense, of 7.0% in 2004, 7.6% in 2003 and 8.1% in 2002. The carrying value of the amounts borrowed approximatesfair market value. At December 31, 2004, we had approximately $44.7 million of available borrowing capacity under this agreement. 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, 2004. We have four mortgages, which are non-recourse to us, included on our Consolidated Balance Sheet as of December 31, 2004 with a combinedoutstanding balance of $26.2 million. These mortgages carry various 29Table of Contentsinterest rates ranging from 7.0% to 8.3% and have maturity dates ranging from 2006 through 2010. The mortgages are secured by the real property of thebuildings as well as property leases and rents. At December 31, 2004, these mortgages had a combined fair value of approximately $28.5 million. Changes inmarket interest rates on our fixed rate debt impacts the fair value of the debt, but it has no impact on interest incurred or cash flow. We are scheduled to repayan average of approximately $660,000 in principal per year through 2006, with a balloon payment in the amount of $5.1 million occurring in 2006; anaverage of approximately $550,000 in principal per year from 2007 through 2009, with a balloon payment in the amount of $6.5 million occurring in 2009;during 2010, we are scheduled to repay approximately $250,000 in principal, with two balloon payments totaling of $11.4 million in 2010. The following represents the scheduled maturities of our contractual obligations as of December 31, 2004: 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(a) $26,210 $660 $6,246 $7,641 $11,663Long-term debt-variable 20,000 — 20,000 — — Construction commitments(b)(c) 9,900 9,900 — — — Total contractual cash obligations $56,110 $10,560 $26,246 $7,641 $11,663 (a)Excludes $124.8 million of third-party debt that is non-recourse to us, incurred by unconsolidated LLCs in which we hold various non-controllingequity interests as of December 31, 2004 (see Note 9 to the Consolidated Financial Statements).(b)As of December 31, 2004, we have invested approximately $1.8 million in Arlington Medical Properties, LLC. We have committed to invest a total of upto $10.5 million in exchange for a 75% non-controlling interest in the LLC that is constructing and will own and operate the St. Mary’s Center forHealth, a medical office building located in Reno, Nevada. The property opened during the first quarter of 2005.(c)As of December 31, 2004, we have committed to invest up to $3.5 million (none of which was funded as of December 31, 2004) in exchange for a 95%non-controlling interest in Sierra Medical Properties, LLC. This LLC also has a $7.5 million construction loan commitment. Off Balance Sheet Arrangements As of December 31, 2004, we are party to certain off balance sheet arrangements consisting of standby letters of credit and construction commitments.Our outstanding letters of credit at December 31, 2004 totaled $15.3 million consisting of: (i) $1.3 million related to 653 Town Center, Phase II; (ii) $9.7million related to Arlington Medical Properties, (iii) $1.5 million related to Spring Valley Medical Properties, and; (iv) $2.8 million related to Sierra MedicalProperties. The $9.7 million letter of credit for Arlington Medical Properties is related to our construction commitment to Arlington Medical Properties, ofwhich $1.8 million has been funded. The $2.8 million letter of credit for Sierra Medical Properties is related to our construction commitment to Sierra MedicalProperties, none of which has been funded. ITEM 7A.Quantitative and Qualitative 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. 30Table of ContentsWe 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, 2004, we had two outstanding swap agreements having a total notional principal amount of $20 million which mature from July,2006 through November, 2006. These swap agreements effectively fix the interest rate on $20 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 $1,106,000, $1,424,000 and $1,332,000 in2004, 2003 and 2002, respectively. We are exposed to credit loss in the event of nonperformance by the counterparties to the interest rate swap agreements.These counterparties are major financial institutions and we do not anticipate nonperformance by the counterparties which are rated A or better by Moody’sInvestors Service. Termination of the interest rate swaps at December 31, 2004 would have resulted in payments to the counterparties of approximately$1,059,000. The fair value of the interest rate swap agreements at December 31, 2004 reflects the estimated amounts that we would pay to terminate thecontracts and are based on quotes from the counterparties. For the years ended December 31, 2004, 2003 and 2002, we received a weighted average rate of1.4%, 1.3% and 1.9% respectively, and paid a weighted average rate on our interest rate swap agreements of 7.0% in 2004 and 2003 and 6.4% in 2002(including the revolver spread of 1.00% in 2004 and 2003 and 0.50% during 2002). The sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their 2004 levels, with all othervariables held constant. A 100 basis point increase in market interest rates would result in an decrease in the fair value of our fixed-rate debt by approximately$814,000. 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 $1.3 million. 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, 2004. For debt obligations, the table presents principal cash flows and related weighted-average interestrates by contractual maturity dates. For interest rate swap agreements, the table presents notional amounts by expected maturity date and weighted averageinterest rates based on rates in effect at December 31, 2004. Maturity Date, Year Ending December 31 (Dollars in thousands) 2005 2006 2007 2008 2009 Thereafter Total Long-term debt: Fixed rate $660 $5,701 $545 $589 $7,052 $11,663 $26,210 Average interest rates 7.9% 7.8% 7.9% 7.9% 8.3% 8.3% Variable rate long-term debt $20,000 $20,000 Interest rate swaps: Pay fixed/receive Variable notional amounts $0 $20,000 $0 $0 $0 $0 $20,000 Average pay rate 6.02% Fair Value $(1,059) $(1,059)Average receive rate 3monthLIBOR 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, independent public accountants, are included elsewhere herein. Reference is made to the “Index to Financial Statements and Schedule.” 31Table of ContentsITEM 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. ITEM 9A.Controls and Procedures. As of December 31, 2004, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) andChief Financial Officer (“CFO”), an evaluation of the effectiveness of our disclosure controls and procedures was performed. Based on this evaluation, theCEO and CFO have concluded that our disclosure controls and procedures are effective to ensure that material information is recorded, processed,summarized and reported by management on a timely basis in order to comply with our disclosure obligations under the Securities and Exchange Act of 1934and the SEC rules thereunder. Management’s Report on Internal Control Over Financial Reporting – Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting for the Trust. In order toevaluate the effectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted anassessment, including testing, using the criteria in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO). The Trust’s system of internal control over financial reporting is designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with U.S. generallyaccepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness of internal control over financial reporting to future periods are subject to the risk that controls may becomeinadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Based on its assessment, management has concluded that the Trust maintained effective internal control over financial reporting as of December 31,2004, based on criteria in Internal Control – Integrated Framework, issued by the COSO. Management’s assessment of the effectiveness of the Trust’sinternal control over financial reporting as of December 31, 2004, has been audited by KPMG LLP, an independent registered public accounting firm, asstated in their report which is included herein. 32Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Shareholders and Board of TrusteesUniversal Health Realty Income Trust: We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, thatUniversal Health Realty Income Trust maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Universal HealthRealty Income Trust’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectivenessof internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances.We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluationof effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate. In our opinion, management’s assessment that Universal Health Realty Income Trust maintained effective internal control over financial reporting as ofDecember 31, 2004, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Universal Health Realty Income Trust maintained, in all materialrespects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – IntegratedFramework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balancesheets of Universal Health Realty Income Trust and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2004, and our report dated March 11, 2005, expressedan unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Philadelphia, PennsylvaniaMarch 11, 2005 33Table 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, 2004. 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, 2004. 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, 2004. 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, 2004. 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, 2004. 34Table of ContentsPART IV ITEM 15.Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)Financial Statements and Financial Statement Schedules: (1)Report of Independent Registered Public Accounting Firm (2)Financial Statements Consolidated Balance Sheets—December 31, 2004 and 2003 Consolidated Statements of Income—Years Ended December 31, 2004, 2003 and 2002 Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2004, 2003 and 2002 Consolidated Statements of Cash Flows—Years Ended December 31, 2004, 2003 and 2002 Notes to Consolidated Financial Statements—December 31, 2004 (3)Schedule Schedule III—Real Estate and Accumulated Depreciation—December 31, 2004 Notes to Schedule III—December 31, 2004 (b)Reports on Form 8-K filed during the last quarter of the year ended December 31, 2004: (1)Report on Form 8-K dated January 4, 2005, reported under Item 2.01, Completion of Acquisition or Disposition of Assets, that the Trustcompleted its sale of the land and buildings comprising the Virtue Street Pavilion, located in Chalmette, Louisiana to a wholly owned subsidiaryof Universal Health Services, Inc. for $7.3 million. (2)Report on Form 8-K dated October 21, 2004, reported under Item 2.02, Results of Operations and Financial Condition, that the Trust issued apress release announcing the Trust’s financial results for the quarter ended September 30, 2004. (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(File No. 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, 2005, 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 (File No. 33-7872),is incorporated herein by reference. 35Table 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 (File 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 the Trust and THC-Chicago, Inc., as lessee, previously filed as Exhibit 10.14 to the Trust’s AnnualReport 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 the Trust and Inland Valley Regional Medical Center, Inc., previously filed asExhibit 10.1 to the Trust’s Form 10-Q for 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 the Trust and McAllen Medical Center, L.P., previously filed as Exhibit 10.2 tothe 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 the Trust, Wachovia Bank, National Association, as Agent, FleetNational Bank, as Syndication Agent, Wachovia Securities, as Arranger, and the other Banks named therein, previously filed as Exhibit 10.1 to the Trust’sForm 10-Q for the quarter ended June 30, 2003, is incorporated herein by reference. 10.13 Dividend Reinvestment and Share Purchase Plan included in the Trust’s Registration Statement Form S-3 (Registration No. 333-81763) filed onJune 28, 1999, is incorporated herein by reference. 10.14 Lease amendment dated as of February 28, 2001 between the Trust and McAllen Hospitals, L.P., previously filed as Exhibit 10.16 to the Trust’sForm 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 the Trust and Universal Health Services of Rancho Springs, Inc., previously filed as Exhibit10.16 to the Trust’s Annual Report on Form 10-K for the year ended December 31, 2002, is incorporated herein by reference. 11 Statement re computation of per share earnings is set forth on page 48, the Trust’s Consolidated Statements of Income. 23.1 Consent of Independent Registered Public Accounting Firm—KPMG LLP 36Table of Contents31.1 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. 37Table 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 11, 2005 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 Officer andPresident March 11, 2005/s/ JAMES E. DALTON, JR. James E. Dalton, Jr. Trustee March 11, 2005/s/ MYLES H. TANENBAUM Myles H. Tanenbaum Trustee March 11, 2005/s/ DANIEL M. CAIN Daniel M. Cain Trustee March 11, 2005/s/ MILES L. BERGER Miles L. Berger Trustee March 11, 2005/s/ ELLIOT J. SUSSMAN Elliot J. Sussman, M.D., M.B.A. Trustee March 11, 2005/s/ CHARLES F. BOYLE Charles F. Boyle Vice President and Chief Financial Officer March 11, 2005/s/ CHERYL K. RAMAGANO Cheryl K. Ramagano Vice President, Treasurer and Secretary March 11, 2005 38Table of ContentsINDEX TO FINANCIAL STATEMENTS AND SCHEDULE PageReport of Independent Registered Public Accounting Firm on Consolidated Financial Statements and Schedule 40Consolidated Balance Sheets—December 31, 2004 and December 31, 2003 41Consolidated Statements of Income—Years Ended December 31, 2004, 2003 and 2002 42Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2004, 2003 and 2002 43Consolidated Statements of Cash Flows—Years Ended December 31, 2004, 2003 and 2002 44Notes to the Consolidated Financial Statements—December 31, 2004 45Schedule III—Real Estate and Accumulated Depreciation—December 31, 2004 63Notes to Schedule III—December 31, 2004 64 39Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Shareholders and Board of TrusteesUniversal Health Realty Income Trust: We have audited the consolidated financial statements of Universal Health Realty Income Trust and subsidiaries as listed in the accompanying index. Inconnection with our audits of the consolidated financial statements, we also have audited the financial statement schedule listed in the accompanying index.These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to expressan opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Universal HealthRealty Income Trust and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financialstatement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for the consolidation of variable interestentities effective March 31, 2004 to adopt the provisions of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness ofUniversal Health Realty Income Trust’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 11, 2005,expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP Philadelphia, PennsylvaniaMarch 11, 2005 40Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED BALANCE SHEETS(dollar amounts in thousands) December 31,2004 December 31,2003 ASSETS: Real Estate Investments: Buildings and improvements $189,859 $160,079 Accumulated depreciation (56,803) (52,219) 133,056 107,860 Land 23,143 22,929 Construction in progress 1,863 — Net Real Estate Investments 158,062 130,789 Investments in and advances to limited liability companies 40,523 61,001 Other Assets: Cash 3,588 628 Bonus rent receivable from UHS 1,128 1,093 Rent receivable-other 392 107 Deferred charges and other assets, net 890 673 Total Assets $204,583 $194,291 LIABILITIES AND SHAREHOLDERS’ EQUITY: Liabilities: Line of credit borrowings $20,000 $33,057 Mortgage note payable, non-recourse to us 4,083 4,185 Mortgage notes payable of consolidated LLCs, non-recourse to us 22,127 — Accrued interest 417 310 Accrued expenses and other liabilities 1,902 1,826 Fair value of derivative instruments 1,059 2,254 Tenant reserves, escrows, deposits and prepaid rents 703 461 Total Liabilities 50,291 42,093 Minority interest 239 — 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: 2004—11,755,670;2003—11,736,395 118 117 Capital in excess of par value 186,275 185,675 Cumulative net income 244,754 221,083 Accumulated other comprehensive loss (994) (2,065)Cumulative dividends (276,100) (252,612) Total Shareholders’ Equity 154,053 152,198 Total Liabilities and Shareholders’ Equity $204,583 $194,291 See the accompanying notes to these consolidated financial statements. 41Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF INCOME(amounts in thousands, except per share amounts) Year ended December 31, 2004 2003 2002 Revenues (Note 1): Base rental—UHS facilities $13,100 $11,545 $11,750 Base rental—Non-related parties 10,656 9,114 9,222 Bonus rental—UHS facilities 4,668 4,562 4,171 Tenant reimbursements and other—Non-related parties 2,667 1,831 2,025 Tenant reimbursements and other—UHS facilities 686 — — 31,777 27,052 27,168 Expenses: Depreciation and amortization 5,177 4,267 4,162 Advisory fees to UHS (Note 2) 1,498 1,486 1,388 Other operating expenses 5,000 3,353 3,290 Property write-down—hurricane damage 1,863 — — Property damage recoverable from UHS (1,863) — — 11,675 9,106 8,840 Income before equity in limited liability companies (“LLCs”) and interest expense 20,102 17,946 18,328 Equity in income of unconsolidated LLCs (including gains on sales of real property of $1,009, $2,831 and$1,220 during 2004, 2003 and 2002, respectively) 4,967 7,974 4,923 Interest expense (3,357) (2,487) (2,620) Income from continuing operations 21,712 23,433 20,631 Income from discontinued operations, net (including gain on sale of real property of $833 during 2004) 1,959 992 992 Net Income $23,671 $24,425 $21,623 Basic earnings per share: From continuing operations $1.85 $2.00 $1.77 From discontinued operations $0.17 $0.09 $0.08 Total basic earnings per share $2.02 $2.09 $1.85 Diluted earnings per share: From continuing operations $1.84 $1.99 $1.76 From discontinued operations $0.16 $0.08 $0.08 Total diluted earnings per share $2.00 $2.07 $1.84 Weighted average number of shares outstanding—Basic 11,744 11,713 11,687 Weighted average number of share equivalents 69 66 63 Weighted average number of shares and equivalents outstanding—Diluted 11,813 11,779 11,750 See the accompanying notes to these consolidated financial statements. 42Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY For the Years Ended December 31, 2004, 2003 and 2002(amounts in thousands, except per share amounts) Common Shares Capital inexcess ofpar value Cumulativenet income Cumulativedividends Accumulatedothercomprehensive(loss)/income Total Numberof Shares Amount 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 amounts reclassified intoincome — — — — — 1,332 1,332 Unrealized derivative losses on cash flow hedges — — — — — (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 amounts reclassified intoincome — — — — — 1,424 1,424 Unrealized derivative losses on cash flow hedges — — — — — (456) (456) Total—comprehensive income 25,393 January 1, 2004 11,736 $117 $185,675 $221,083 ($252,612) ($2,065) $152,198 Issuance of shares of beneficial interest 20 1 600 — — — 601 Dividends ($2.00/share) — — — — (23,488) — (23,488)Comprehensive income: Net income — — — 23,671 — — 23,671 Adjustment for settlement amounts reclassified intoincome — — — — — 1,106 1,106 Unrealized derivative losses on cash flow hedges — — — — — (35) (35) Total—comprehensive income 24,742 December 31, 2004 11,756 $118 $186,275 $244,754 ($276,100) ($994) $154,053 See the accompanying notes to these consolidated financial statements. 43Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS(amounts in thousands) Year ended December 31, 2004 2003 2002 Cash flows from operating activities: Net income $23,671 $24,425 $21,623 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,312 4,536 4,431 Gains on sales of properties by LLCs (1,009) (2,831) (1,220)Gain on sale of real property (833) — — Changes in assets and liabilities: Rent receivable (31) 38 (240)Accrued expenses and other liabilities 90 54 442 Tenant escrows, deposits and prepaid rents 22 15 83 Accrued interest (101) 28 (48)Other, net (134) (19) (5) Net cash provided by operating activities 26,987 26,246 25,066 Cash flows from investing activities: Investments in limited liability companies (“LLCs”) (2,764) (9,338) (5,322)Advances (made to) received from LLCs, net (1,375) (6,894) 175 Cash distributions in excess of income from LLCs 1,038 1,036 1,910 Cash distributions from sale of property by LLC 1,009 6,702 2,555 Cash escrow account distributions/(deposits) from LLC sale proceeds 6,405 (6,337) — Cash distributions from refinancing proceeds 800 4,975 525 Purchase of minority ownership interest in consolidated entity — (54) — Cash received from sale of real property 7,320 — — Additions to real estate investments (548) (312) (49) Net cash provided by (used in) investing activities 11,885 (10,222) (206) Cash flows from financing activities: Net (repayments) borrowings on line of credit (13,057) 6,844 (1,405)Repayments of mortgage notes payable of consolidated LLCs (333) — — Repayments of mortgage notes payable (102) (95) (88)Fees for new revolving credit facility — (540) — Repayment of note payable to UHS — — (1,446)Dividends paid (23,488) (22,960) (22,440)Issuance of shares of beneficial interest 593 757 488 Net cash used in financing activities (36,387) (15,994) (24,891) Increase (decrease) in cash 2,485 30 (31)Cash due to the initial consolidation of variable interest entities 475 — — Cash, beginning of period 628 598 629 Cash, end of period $3,588 $628 $598 Supplemental disclosures of cash flow information: Interest paid $3,582 $2,469 $2,451 See the accompanying notes to these consolidated financial statements. 44Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUSTNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2004 (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, 2004, we have forty-three real estate investments or commitments located in fifteenstates consisting of: • seven hospital facilities including four acute care, one behavioral healthcare, one rehabilitation and one sub-acute; • thirty-two medical office buildings, and; • four preschool and childcare centers. Since we have significant investments in seven hospital facilities, which comprised 58%, 69% and 68% of net revenues in 2004, 2003, and 2002,respectively, we are subject to certain industry risk factors which directly impact the operating results of our lessees. In recent years, an increasing number oflegislative initiatives have been introduced or proposed in Congress and in state legislatures that would effect major changes in the healthcare system, eithernationally or at the state level. In addition, the healthcare industry has been characterized in recent years by increased competition and consolidation. Five ofour seven hospital facilities and all or a portion of five medical office buildings are leased to subsidiaries of Universal Health Services, Inc., (“UHS”). 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, we cannot predict whether any of the leases will be renewed on their currentterms 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, if certain of theleases 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 regardless of when payments aredue. Bonus rents are recognized when earned based upon increases in each facility’s net revenue in excess of stipulated amounts. Bonus rentals are determinedand paid each quarter based upon a computation that compares the respective facility’s current quarter’s revenue to the corresponding quarter in the base year.Tenant reimbursements for operating expenses are accrued as revenue in the same period the related expenses are incurred. 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, 2004and 2003, we had $290,000 and $451,000 in restricted cash accounts held by financial institutions to fund debt services and future capital additions. 45Table 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 and those investments that meet the criteria of avariable interest entity where we are the primary beneficiary as a result of our level of investment in the entity. 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 unconsolidated investments in LLCs which we do not control using the equity method of accounting. Theseinvestments, which represent 33% to 98% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity inthe net income, cash contributions to and distributions from the investments. In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation, as revised (“FIN 46R”), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. EffectiveMarch 31, 2004, we adopted FIN 46R. As a result of our related party relationship with UHS, and certain master lease, lease assurance or lease guaranteearrangements between UHS and various properties owned by three LLCs in which we own a 98% or 99% non-controlling ownership interest, these LLCs areconsidered to be variable interest entities (see Note 9 to the Consolidated Financial Statements). In addition, we are the primary beneficiary of these LLCinvestments as a result of our level of investment in the entities. Consequently, we began consolidating the results of operations of these three LLC investments.Included on our December 31, 2004 Consolidated Balance Sheet are the: (i) assets; (ii) liabilities; (iii) third-party borrowings, which are non-recourse to us,and; (iv) minority interests, of these three LLC investments. Also as a consequence of FIN 46R, beginning on April 1, 2004, we began consolidating theresults of operations of these LLC investments on our Consolidated Statements of Income. There was no impact on our net income as a result of theconsolidation of these LLCs. The remaining LLCs are not variable interest entities and therefore are not subject to the consolidation requirements of FIN 46R. 46Table 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. 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, 2004 are approximately $200 million and$139 million, respectively. Stock-Based Compensation At December 31, 2004, 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. In December, 2004, the FASB issued SFAS 123R, “Share-Based Payment” which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. Statement 123R replaces FASB Statement No. 123, “Accounting for Stock-BasedCompensation”, which was originally issued in 1995, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS 123R iseffective for interim periods beginning after June 15, 2005. Retroactive application of the requirements of SFAS 123 (not SFAS 123R) to the beginning of thefiscal year that includes the effective date or for all periods presented would be permitted, but not required. We will be required to apply SFAS 123R beginningon July 1, 2005, which will be reflected in our financial statements for the quarter ending September 30, 2005. SFAS 123R is not expected to have a materialeffect on our consolidated financial statements. Had we adopted SFAS 123, the additional stock-based compensation expense determined under a fair valuemethod would have been $11,000 and $39,000 for the years ended December 31, 2004 and 2003, respectively. Upon applying SFAS 123R on July 1, 2005,our reported net income will be reduced by approximately $3,000 for the six months ending December 31, 2005 based on options outstanding as of December31, 2004. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS 123,“Accounting for Stock-Based Compensation”. We recognize 47Table of Contentscompensation cost related to restricted share awards over the respective vesting periods. As of December 31, 2004, there were no unvested restricted shareawards outstanding. Twelve Months EndedDecember 31, 2004 2003 2002 (in thousands, exceptper share data) Income from continuing operations $21,712 $23,433 $20,631 Income from discontinued operations, net (including gain on sale during 2004) 1,959 992 992 Net income $23,671 $24,425 $21,623 Income from continuing operations $21,712 $23,433 $20,631 Add: total stock-based compensation expenses included in net income 192 199 210 Deduct: total stock-based employee compensation expenses determined under fair value based methods for allawards: (203) (238) (258) Pro forma net income from continuing operations $21,701 $23,394 $20,583 Income from discontinued operations, net (including gain on sale during 2004) 1,959 992 992 Total pro forma net income $23,660 $24,386 $21,575 Basic earnings per share, as reported: From continuing operations $1.85 $2.00 $1.77 From discontinued operations 0.17 0.09 0.08 Total basic earnings per share, as reported $2.02 $2.09 $1.85 Basic earnings per share, pro forma: From continuing operations $1.84 $1.99 $1.77 From discontinued operations 0.17 0.09 0.08 Total basic earnings per share, pro forma $2.01 $2.08 $1.85 Diluted earnings per share, as reported: From continuing operations $1.84 $1.99 $1.76 From discontinued operations 0.16 0.08 0.08 Total diluted earnings per share, as reported $2.00 $2.07 $1.84 Diluted earnings per share, pro forma: From continuing operations $1.84 $1.99 $1.76 From discontinued operations 0.16 0.08 0.08 Diluted earnings per share $2.00 $2.07 $1.84 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. 48Table of ContentsReclassifications Certain prior period amounts have been reclassified to conform to the current year presentation. Accounting for Derivative Instruments and Hedging Activities SFAS No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities” and SFAS No. 138, “Accounting for Certain DerivativeInstruments and Certain Hedging Activity”, an Amendment of SFAS 133, require that all derivative instruments be recorded on the balance sheet at theirrespective fair values. On 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 or terminated, the derivative is dedesignated as a hedging instrument because it is unlikely that a forecastedtransaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of thederivative 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, 2004 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. (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 49Table of ContentsAgreement”). Under the Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investmentssuitable for such program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and toconduct our day-to-day affairs. In performing its services under the Advisory Agreement, the Advisor may utilize independent professional services, includingaccounting, legal, tax and other services, for which the Advisor is reimbursed directly by us. The Advisory Agreement expires on December 31 of each year;however, it is renewable by us, subject to a determination by the Independent Trustees that the Advisor’s performance has been satisfactory. The AdvisoryAgreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreement has been renewed for 2005. Alltransactions 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 of America, without reduction for return of capital dividends. Noincentive fees were payable during 2004, 2003 and 2002. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our auditedconsolidated financial statements. Pursuant to the terms of the leases with UHS, UHS has the option to purchase the respective leased facilities at the end of the lease terms or any renewalterms at the appraised market value. In addition, UHS has the rights of first refusal to: (i) purchase the respective leased facilities during and for 180 daysafter 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, andfor 180 days after, the lease term at the same terms and conditions pursuant to any third-party offer. The terms of the leases also provide that in the event UHSdiscontinues 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, 2004, 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 $101.3 million (excluding Virtue Street Pavilion, as mentioned below). The purchase options and rights of first refusal granted to the respectivelessees 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, andmay present a potential conflict of interest between us and UHS since the price and terms offered by a third-party are likely to be dependent, in part, upon thefinancial performance of the facility during the final years of 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. As of December 31, 2004, subsidiaries of UHS leased five of the seven hospital facilities owned by us with terms expiring through 2009. For the yearsended December 31, 2004, 2003 and 2002, 51%, 60% and 59%, respectively, of our revenues were earned under the terms of the leases with wholly-ownedhospital facilities of UHS. Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controlling equity interestsranging from 33% to 98%, the leases with wholly-owned subsidiaries of UHS accounted for 27% during each of the years 2004, 2003 and 2002. 50Table of ContentsThe leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another. Pursuant to the terms of ourleases with subsidiaries of UHS, we earn fixed monthly base rents plus bonus rents based upon each facility’s net revenue in excess of base amounts. Thebonus rents are computed and paid on a quarterly basis upon a computation that compares current quarter revenue to the corresponding quarter in the baseyear. Our officers are all employees of UHS and as of December 31, 2004, we had no salaried employees. At December 31, 2004, approximately 6.7% of ouroutstanding shares of beneficial interest were held by UHS. We have granted UHS the option to purchase our shares in the future at fair market value to enableUHS to maintain a 5% interest in the Trust. On December 31, 2004, we completed the sale of the real estate assets of Virtue Street Pavilion, located in Chalmette, Louisiana, to the former lessee ofthe facility, a wholly-owned subsidiary of UHS. Pursuant to the terms of the lease on the facility, the lessee exercised its option to purchase the facility at itsfair market value upon the December, 2004 lease expiration. Accordingly, pursuant to the terms of the lease, independent appraisals were obtained by us andthe lessee, which indicated that the fair market value of the property, and therefore the sale price, was $7,320,000. The sale resulted in a gain of $833,000which is reflected as “Income from discontinued operations, net” in the Consolidated Statements of Income for the year ended December 31, 2004. The annualminimum rent payable to us under the Virtue Street Pavilion lease with UHS was $1,261,000 and no bonus rent was earned on this facility during 2004, 2003or 2002. As a result of the sale of the Virtue Street Pavilion, our future results of operations will likely be adversely affected since at interest rates as currentlyprojected, the reduction in annual interest expense resulting from repayment of borrowings using the sale proceeds is likely to be approximately $1 million lessthan the annual rental payments previously earned by us pursuant to this lease. The following table summarizes the results of operations for the Virtue Street Pavilion during 2004, 2003 and 2002 (in thousands): Year Ended December 31, 2004 2003 2002 Revenues $1,261 $1,261 $1,261 Depreciation expense (135) (269) (269) Income from operations 1,126 992 992 Gain on sale 833 — — Income from discontinued operations, net $1,959 $992 $992 During the third quarter of 2004, the lease on The Bridgeway facility (lessee is a wholly-owned subsidiary of UHS), which was scheduled to expire inDecember, 2004, was renewed for a five-year period through December, 2009, at the same lease terms. During the third quarter of 2004, Wellington Regional Medical Center, our 121-bed acute care facility located in West Palm Beach, Florida, sustainedstorm damage caused by a hurricane. This facility is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease, UHS is responsiblefor maintaining replacement cost property insurance for the facility, a substantial portion of which is insured by a commercial carrier. Although the facilityhas not experienced significant business interruption, our Consolidated Statements of Income for the year ended December 31, 2004, includes a property write-down charge of $1.9 million representing the estimated net book value of the damaged assets. This property charge is offset by an equal amount recoverablefrom UHS. We expect the ultimate replacement cost of the damaged property to exceed the net book value and the excess cost will also be recoverable fromUHS. As of December 31, 2004, UHS spent 51Table of Contentsapproximately $1.9 million to replace the damaged property and this amount is reflected as construction in progress on our Consolidated Balance Sheet as ofthat date. During the first quarter of 2004, the lessee of this facility completed and financed an $8.5 million expansion to the facility in order to meet patientdemand. Accordingly, since the bonus rent calculation on this facility is based on net revenues, pursuant to the terms of the lease, the lease was amended toexclude from the bonus rent calculation the estimated net revenues generated from the UHS-owned real estate assets (as calculated pursuant to a percentagebased allocation determined at the time of expansion). During the fourth quarter of 2003, we invested $1.6 million, and during 2004 we invested an additional $2.1 million and are committed to invest anadditional $200,000, in exchange for a 95% non-controlling interest in a limited liability company that acquired the Spring Valley Medical Office Building, a60,000 square foot medical office building on the campus of Spring Valley Hospital in Las Vegas, Nevada. This MOB will be 75% master leased for fiveyears by Valley Health System (“VHS”), a majority owned subsidiary of UHS, on a triple net basis. The master lease for each suite was extinguished at suchtime that the suite was leased to another tenant acceptable to us and VHS, for a minimum term of five years. As of December 31, 2004 letters of intent or leaseagreements have been executed on more than 82% of the rentable space of this MOB, therefore the master lease arrangement has been extinguished. During the third quarter of 2003 we invested $8.9 million and an additional $600,000 during the fourth quarter of 2004 (combined totals $3.0 million inequity and a $6.5 million of debt financing, which was repaid to us during the first quarter of 2005) for the purchase of a 98% non-controlling equity interestin a limited liability company that simultaneously purchased the 700 Shadow Lane & Goldring MOBs, consisting of three medical office buildings on thecampus of Valley Hospital Medical Center in Las Vegas, Nevada. These medical office buildings were purchased from VHS and have tenants which aresubsidiaries of UHS. 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 $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. No assurance can be given as to the effect, if any, the consolidation of the two facilities as mentionedabove, had on the underlying value of Inland Valley. (3)ACQUISITIONS AND DISPOSITIONS 2005 — During the first quarter of 2005, Bayway Properties, a LLC in which we owned a 73% non- controlling ownership interest, sold the real estateassets of the East Mesa Medical Center, which is located in Mesa, Arizona. Our share of the net sale proceeds resulting from this transaction was $2.9million. The transaction resulted in a gain of approximately $1.1 million which will be included in our results of operations for the three month period endedMarch 31, 2005. 52Table of Contents2004 — We invested a total of $4.2 million in the following (consisting of $2.8 million of investments in LLCs and $1.4 million of net advances madeto LLCs): • $2.1 million funded in connection with the purchase of a 95% non-controlling equity interest in a LLC that owns the Spring Valley MedicalOffice Building located in Las Vegas, Nevada (the LLC also obtained a $4.0 million third-party mortgage that is non-recourse to us); • $830,000 additional net loan funded in connection with a total commitment of up to $10.5 million by us (consisting of $8.0 million in equity and$2.5 million in debt financing) in exchange for a 75% non-controlling equity interest in a LLC that is constructing and owns the the St. Mary’sCenter for Health located in Reno, Nevada, which opened in the first quarter of 2005 (the LLC also obtained a $26 million third-party mortgagethat is non-recourse to us); • $600,000 additional net loan funded in connection with the purchase of a 98% non-controlling equity interest in a LLC that simultaneouslypurchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada, and; • $700,000 of additional investments in various LLCs in which we own a non-controlling equity interest. During the fourth quarter of 2004, we committed to invest a total of up to $3.5 million (none of which was funded as of December 31, 2004) in exchangefor a 95% non-controlling interest in a LLC that will develop, construct, own and operate the Sierra San Antonio Medical Plaza located in Fontana, California.This LLC, which is expected to open in late 2005, also has a $7.5 million third-party construction loan commitment. On December 31, 2004, we completed the sale of the real estate assets of Virtue Street Pavilion, located in Chalmette, Louisiana, to the former lessee ofthe facility, a wholly-owned subsidiary of UHS. Pursuant to the terms of the lease on the facility, the lessee exercised its option to purchase the facility at itsfair market value upon the December, 2004 lease expiration. Accordingly, pursuant to the terms of the lease, independent appraisals were obtained by us andthe lessee, which indicated that the fair market value of the property, and therefore the sale price, was $7,320,000. The sale resulted in a gain of $833,000which is reflected as “Income from discontinued operations, net” in the Consolidated Statements of Income for the twelve months ended December 31, 2004. During the second quarter of 2004, Parkvale Properties sold the real property of Parkvale Medical Building which is located in Phoenix, Arizona. Ourshare of the net sale proceeds resulting from this transaction was $950,000 which is included as a gain on sale of real property in our results of operations for2004, since the carrying value of this investment was reduced to zero in a prior year. 2003 — We invested a total of $16.2 million in the following (consisting of $9.3 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, of which $2.1 million was funded during 2004) in exchange for a 95% non-controlling interest in a LLC that owns the Spring Valley Medical Office Building located in Las Vegas, Nevada (the LLC also obtained a $4.0million third-party mortgage that is non-recourse to us); • $8.9 million during 2003 (and an additional $600,000 funded during 2004) consisting of $3.0 million in equity and a $6.5 million loan (this loanwas fully repaid to us during the first quarter of 2005), invested for the purchase of a 98% non-controlling equity interest in a LLC thatsimultaneously purchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada; 53Table of Contents • $1.0 million net loan funded in connection with a total commitment of up to $10.5 million by us (consisting of $8.0 million in equity and $2.5million in debt financing) in exchange for a 75% non-controlling interest in a LLC that will construct and own the St. Mary’s Center for Healthlocated in Reno, Nevada; • $2.0 million funded in connection with the purchase of a 85% non-controlling equity interest in a LLC that constructed and owns the RosenbergChildren’s Medical Plaza, a medical office building that was opened in February, 2003 (the LLC also obtained a $7.5 million third-party mortgagethat is non-recourse to us), and; • $1.5 million of additional investments in various LLCs 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 owned 95% non-controlling ownership interests,sold the 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 washeld in escrow by a like-kind-exchange agent in anticipation of possibly completing like-kind-exchange transactions during 2004. During the second quarter of2004, we received the restricted proceeds totaling $6.4 million, as the like-kind-exchange transaction did not occur. These transactions resulted in a combinedgain of $2.5 million which is included in our 2003 results of operations. Also during 2003, we received $365,000 from Parkvale Properties, a LLC in whichwe own a 60% non-controlling ownership interest, representing our share of the net sale proceeds from the sale of Palo Verde Medical Center, a medical officebuilding located in Phoenix, Arizona. This sale resulted in a gain of $365,000, which is included in our 2003 results of operations, since the carrying value ofthis 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 Deer Valley Medical Office II locatedin Phoenix, Arizona (the LLC also obtained a $7.0 million third-party mortgage that is non-recourse to us); • $200,000 invested (of the $2.6 million commitment) for the purchase of a 85% non-controlling equity interest in a LLC that constructed andowns the Rosenberg Children’s Medical Plaza, a medical office building that was opened in February, 2003 (the LLC also obtained a $7.5 millionthird-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. Also 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. (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 revenue in excess of base amounts, are computed and paid on a quarterlybasis based upon a computation that compares current quarter revenue to the corresponding quarter in the base year. Minimum rent for other material leases isrecognized using the straight-line method under which contractual rent increases are recognized evenly over the lease term regardless of when payments are due. 54Table of ContentsMinimum future base rents from non-cancelable leases, excluding increases resulting from changes in the consumer price index and bonus rents, are asfollows (amounts in thousands): 2005 $23,7132006 22,5532007 9,5362008 7,1182009 5,123Later Years 5,073 Total Minimum Base Rents $73,116 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. (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 make fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. At December 31, 2004, we had two outstanding swap agreements for notional principal amounts of $20 million which mature from July 2006 throughNovember 2006. These swap agreements effectively fix the interest rate on $20 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, 2004 would have resulted in payments to the counterparties of approximately $1,059,000. The fair value of the interest rateswap agreements at December 31, 2004 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, 2004, 2003 and 2002, we recorded additional interestexpense of $1,106,000, $1,424,000 and $1,332,000, respectively, as a result of our hedging activity. Operating results for the years ended December 31, 2004, 2003 and 2002 include net (gains)/losses of ($124,000), ($10,000) and $217,000, 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, 2004, $649,000 of deferred losses on derivative instruments in other accumulated comprehensive loss are expected to be reclassifiedto earnings during the next 12 months. There was one $10 million cash flow hedge discontinued during 2004 and none discontinued in 2003 or 2002. 55Table of Contents(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, subject to bank approval, to increase the amount by $20 million for a total commitment of $100 million. The Agreement provides forinterest at our option, at the 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 ofthis commitment. The margins over the Eurodollar rate, prime rate and the commitment fee are based upon our debt to total capital ratio as defined by theAgreement. At December 31, 2004, the applicable margin over the Eurodollar rate was 1.00% and the commitment fee was .25%. At December 31, 2004, wehad $15.3 million of letters of credit outstanding against the Agreement. There are no compensating balance requirements. The Agreement contains a provisionwhereby the commitments will be reduced by 50% of the proceeds generated from any new equity offering. The average amounts outstanding under ourrevolving credit agreement were $26.4 million in 2004, $28.3 million in 2003 and $25.3 million in 2002 with corresponding effective interest rates, includingcommitment fees and interest rate swap expense, of 7.0% in 2004, 7.6% in 2003 and 8.1% in 2002. The carrying value of the amounts borrowed approximatesfair market value. At December 31, 2004, we had approximately $44.7 million of available borrowing capacity under this agreement. 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 all their covenants at December 31, 2004. The carrying value of this instrumentapproximates fair value. We have four mortgages, which are non-recourse to us, included on our Consolidated Balance Sheet as of December 31, 2004, with a combinedoutstanding balance of $26.2 million. The mortgages carry various interest rates ranging from 7.0% to 8.3% and have maturity dates ranging from 2006through 2010. The mortgages are secured by the real property of the buildings as well as property leases and rents. These mortgages have a combined fairvalue of approximately $28.5 million as of December 31, 2004. As of December 31, 2003, we had one mortgage, which is non-recourse to us, included in ourConsolidated Balance Sheet with an outstanding balance of $4.2 million. This mortgage had a fair value of $4.8 million as of December 31, 2003. Changes inmarket rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow. We are scheduled to repay an averageof approximately $660,000 in principal per year through 2006, with a balloon payment in the amount of $5.1 million occurring in 2006; an average ofapproximately $550,000 in principal per year from 2007 through 2009, with a balloon payment in the amount of $6.5 million occurring in 2009; during2010, we are scheduled to repay approximately $250,000 in principal, with two balloon payments totaling of $11.4 million in 2010. The following table summarizes these outstanding mortgages at December 31, 2004 (amounts in thousands): Facility Name / Secured by OutstandingBalance(in thousands) InterestRate MaturityDateMedical Center of Western Connecticut $4,083 8.3% 2010Desert Springs Medical Plaza 5,390 7.9% 2006Summerlin Hospital MOB 7,493 7.0% 2009Summerlin Hospital MOB II 9,244 8.3% 2010 Total $26,210 56Table of Contents(7)DIVIDENDS Dividends of $2.00 per share were declared and paid in 2004, of which $1.753 per share was ordinary income and $.247 per share was a capital gaindistribution. Dividends of $1.96 per share were declared and paid during 2003, of which $1.82 per share was ordinary income, $.137 per share was acapital gain distribution 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 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, 2004, there have been 123,000 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 $192,000 in 2004, $199,000 in 2003 and $197,000 in 2002. As of December31, 2004, there were 87,250 options exercisable under The Plan with an average exercise price of $18.11 per share (average exercise price, adjusted to giveeffect to the dividend equivalent rights is $5.99 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 31,2004, 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 123. Thefair value of each option grant was estimated on the date of grant using the Black Scholes option-pricing model with the following range of assumptions usedfor the five option grants that occurred in 2004, 2003 and 2002: Year Ended December 31, 2004 2003 2002 Volatility 18% 15% 15% Interest rate 3% 3% 4%-5%Expected life (years) 9.2 8.2 8.1 Forfeiture rate 0% 0% 0% Dividend yield 6.5% 6.5% 7.5% 57Table 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, 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, January 1, 2004 95,500 $18.92 $29.44/$14.75Granted 5,000 $34.07 $34.07/$34.07 Balance, December 31, 2004 100,500 $19.67 $34.07/$14.75 Outstanding Options at December 31, 2004: Number of Shares Average Option Price Range (High-Low) Contractual Life (years)25,000 $14.7500 $14.7500-$14.7500 5.255,000 $18.6705 $19.6250-$18.6250 2.57,500 $24.6245 $26.2500-$21.4375 6.58,000 $28.3213 $29.4400-$27.6500 8.15,000 $34.0700 $34.0700-$34.0700 9.9 100,500 (9)Summarized Financial Information of Equity Affiliates Our consolidated financial statements include the consolidated accounts of our controlled investments and those investments that meet the criteria of avariable interest entity where we are the primary beneficiary as a result of our level of investment in the entity. 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 98% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our net equity in the net income,cash contributions to and distributions from the investments. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities”, an Interpretation of ARB No. 51. ThisInterpretation, as revised (“FIN 46R”), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. EffectiveMarch 31, 2004, we adopted FIN 46R. As a result of our related party relationship with UHS, and certain master lease, lease assurance or lease guaranteearrangements between UHS and various properties owned by three LLCs in which we own a 98% or 99% non-controlling ownership interest, these LLCs areconsidered to be variable interest entities. In addition, we are the primary beneficiary of these LLC investments as a result of our level of investment in theentities. Consequently, we began consolidating the results of operations of these three LLC investments. Included on our December 31, 2004 ConsolidatedBalance Sheet are the: (i) assets; (ii) liabilities; (iii) third-party borrowings, which are non-recourse to us, and; (iv) minority interests, of these three LLCinvestments. Also as a consequence of FIN 46R, beginning on April 1, 2004, we began consolidating the results of operations of these LLC investments on ourConsolidated Statements of Income. There was no impact on our net income as a result of the consolidation of these LLCs. The remaining LLCs are notvariable interest entities and therefore are not subject to the consolidation requirements of FIN 46R. 58Table 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, 2004, we have invested $65.5 million of cash (including advances to various LLCs) in LLCs in whichwe own various non-controlling equity interests ranging from 33% to 99% (consolidated and unconsolidated), before reductions for cash distributions receivedfrom the LLCs. As of December 31, 2004, short-term unsecured advances aggregated $8.4 million from two LLCs, $6.5 million of which was repaid to us inMarch, 2005. As of December 31, 2004, we had investments or commitments in nineteen limited liability companies (“LLCs”) which are accounted for by the equitymethod and three that were consolidated in the results of operations as of April 1, 2004. The following table represents summarized unaudited financialinformation related to the LLCs which were accounted for under the equity method: Name of LLC Ownership Property Owned by LLCDSMB Properties 76% Desert Samaritan Hospital MOBsDVMC Properties 95% Desert Valley Medical CenterSuburban 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 PlazaRioMed Investments 80% Rio Rancho Medical CenterWest Highland Holdings 48% St. Jude Heritage Health ComplexSanta Fe Scottsdale 94% Santa Fe Professional PlazaBayway Properties(a.) 73% East Mesa Medical Center575 Hardy Investors 73% Centinela Medical Building ComplexBrunswick Associates 74% Mid Coast Hospital MOBDeerval Properties 90% Deer Valley Medical Office IIPCH Medical Properties 85% Rosenberg Children’s Medical PlazaGold Shadow Properties(b.) 98% 700 Shadow Lane & Goldring MOBsArlington Medical Properties(c.) 75% The Saint Mary’s Center for HealthApaMed Properties 85% Apache Junction Medical PlazaSpring Valley Medical Properties(b.) 95% Spring Valley Medical Office BuildingSierra Medical Properties(d.) 95% Sierra San Antonio Medical Plaza(a.)During the first quarter of 2005, Bayway Properties, a LLC in which we owned a 73% non-controlling ownership interest, sold the real estate assets ofthe East Mesa Medical Center, which is located in Mesa, Arizona. Our share of the net sale proceeds resulting from this transaction was $2.9 million.The transaction resulted in a gain of approximately $1.1 million which will be included in our results of operations for the three month period endedMarch 31, 2005(b.)Tenants of this medical office building include subsidiaries of UHS.(c.)We have committed to invest a total of up to $10.5 million ($8.0 million in equity and $2.5 million in debt financing) in exchange for a 75% non-controlling interest in a LLC that constructed and owns the Saint Mary’s Center for Health located in Reno, Nevada. As of December 31, 2004, we haveadvanced $1.8 million in connection with this project, and the LLC has borrowed $18.3 million in construction loans from a $26 million totalconstruction loan commitment. This medical office building opened in March of 2005. 59Table of Contents (d.) We have committed to invest a total of up to $3.5 million in equity in exchange for a 95% non-controlling interest in a LLC that will develop,construct, own and operate the Sierra San Antonio Medical Plaza located in Fontana, California. As of December 31, 2004, we have not invested anyequity in connection with this project. The LLC has a $7.5 million total construction loan commitment. This project is scheduled to be completed andopened during the fourth quarter of 2005. Below are the combined statements of income for the LLCs accounted for under the equity method: For the Year Ended December 31, 2004 2003 2002 (amounts in thousands)Revenues $28,961 $33,495 $30,281Operating expenses 12,069 13,248 11,605Depreciation and amortization 5,006 5,585 5,152Interest, net 7,600 9,354 8,923 Net income before gain 4,286 5,308 4,601Gains on sales 1,192 3,691 1,346 Net income $5,478 $8,999 $5,947 Our share of net income before gains on sales $3,958 $5,143 $3,703Our share of gains on sales 1,009 2,831 1,220 Our share of net income $4,967 $7,974 $4,923 Included in the information presented above for the three months ended March 31, 2004 and the years ended December 31, 2003 and 2002 was thecombined income statement information for three LLCs that we began including in our consolidated statements of income on April 1, 2004, pursuant to theprovisions of FIN 46R. For the nine month period from April 1, 2004 to December 31, 2004, these three LLCs had combined revenues of $4.8 million,operating expenses of $1.7 million, depreciation and amortization expense of $900,000 and interest expense of $1.3 million. There was no impact on our netincome as a result of the consolidation of these LLCs. Below are the combined balance sheets for the LLCs accounted for under the equity method: December 31, 2004 2003 (amounts in thousands)Net property, including CIP $156,332 $180,398Other assets 12,486 12,341Restricted cash for potential like-kind-exchange transactions — 7,087 Total assets $168,818 $199,826 Liabilities $3,909 $5,079Mortgage notes payable, non-recourse to us 124,814 132,681Notes payable to us 8,446 6,894Equity 31,649 55,172 Total liabilities and equity $168,818 $199,826 Our share of equity and notes receivable from LLCs $40,523 $61,001 Included in the information presented above as of December 31, 2003 was the combined balance sheet information for three LLCs that we beganincluding in our consolidated balance sheet as of March 31, 2004, 60Table of Contentspursuant to the provisions of FIN 46R. As of December 31, 2004, these three LLCs had combined total assets of $39.0 million, third-party mortgage notespayable, which are non-recourse to us, of $22.1 million and other liabilities of $500,000. As of December 31, 2004, aggregate maturities of mortgage notes payable by unconsolidated LLCs, which are accounted for under the equity methodand are non-recourse to us, are as follows (amounts in thousands): 2005 $18,1902006 16,4042007 18,1472008 13,6892009 8,207Later 50,177 Total $124,814 Pursuant to the operating agreements of the LLCs, the third-party members and the Trust, at any time, have the right to make an offer (“OfferingMember”) to the other member(s) (“Non-Offering Member”) in which it either agrees to: (i) sell the entire ownership interest of the Offering Member to the Non-Offering Member (“Offer to Sell”) at a price as determined by the Offering Member (“Transfer Price”), or; (ii) purchase the entire ownership interest of theNon-Offering Member (“Offer to Purchase”) at the equivalent proportionate Transfer Price. The Non-Offering Member has 60 days to either: (i) purchase theentire ownership interest of the Offering-Member at the Transfer Price, or; (ii) sell its entire ownership interest to the Offering Member at the equivalentproportionate Transfer Price. The closing of the transfer must occur within 60 days of the acceptance by the Non-Offering Member. (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. (11)QUARTERLY RESULTS (unaudited) 2004 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $6,842 $8,366 $8,353 $8,216 $31,777Income from continuing operations $4,800 $6,171 $5,298 $5,443 $21,712Income from discontinued operations 248 248 248 1,215 1,959 Net Income $5,048 $6,419 $5,546 $6,658 $23,671 Earnings per Share-Basic: From continuing operations $0.41 $0.53 $0.45 $0.46 $1.85From discontinued operations 0.02 0.02 0.02 0.11 0.17 Total basic earnings per share $0.43 $0.55 $0.47 $0.57 $2.02 Earnings per Share-Diluted: From continuing operations $0.41 $0.52 $0.45 $0.46 $1.84From discontinued operations 0.02 0.02 0.02 0.10 0.16 Total diluted earnings per share $0.43 $0.54 $0.47 $0.56 $2.00 61Table of ContentsIncluded in income from continuing operations and net income during the second quarter of 2004 is a gain on the sale of real property by a LLC of $1.0million, of $.09 per diluted share. Included in income from discontinued operations and net income during the fourth quarter of 2004 is a gain on the sale ofreal property of $833,000, or $.07 per diluted share, resulting from the sale of Virtue Street Pavilion. 2003 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $6,878 $6,703 $6,727 $6,744 $27,052Income from continuing operations $5,422 $5,067 $5,099 $7,845 $23,433Income from discontinued operations 248 248 248 248 992 Net Income $5,670 $5,315 $5,347 $8,093 $24,425 Earnings per Share-Basic: From continuing operations $0.46 $0.43 $0.44 $0.67 $2.00From discontinued operations 0.02 0.02 0.02 0.02 0.09 Total basic earnings per share $0.48 $0.45 $0.46 $0.69 $2.09 Earnings per Share-Diluted: From continuing operations $0.46 $0.43 $0.43 $0.67 $1.99From discontinued operations 0.02 0.02 0.02 0.02 0.08 Total diluted earnings per share $0.48 $0.45 $0.45 $0.69 $2.07 Included in income from continuing operations and net income during the first quarter of 2003 is a gain of $365,000, or $.03 per diluted share, resultingfrom the sale of Palo Verde Medical Center. Included in income from continuing operations and net income for the fourth quarter of 2003 are gains totaling $2.5million, or $.21 per diluted share, resulting from the sales of Skypark Professional Medical Building and Pacifica Palms Medical Plaza. 62Table of ContentsSCHEDULE IIIUNIVERSAL HEALTH REALTY INCOME TRUSTREAL ESTATE AND ACCUMULATED DEPRECIATION—DECEMBER 31, 2004(amounts in thousands) Initial Cost toUniversal HealthRealty IncomeTrust Net costcapitalized/divestedsubsequentto acquisition Gross amount atwhich carriedat close of period AccumulatedDepreciationas of Dec. 31,2004 Date ofconstruction,acquisitionor mostrecentsignificantexpansion orrenovation DateAcquired AverageDepreciableLifeDescription Land Building&Improv. Amount Land Building &Improvements CIP Total Chalmette Medical CenterChalmette, Louisiana $2,000 $7,473 $3,148 $2,000 $10,621 $12,621 $4,156 1999 1988 34 YearsInland Valley Regional Medical CenterWildomar, California 2,050 10,701 2,868 2,050 13,569 15,619 5,064 1986 1986 43 YearsMcAllen Medical CenterMcAllen, Texas 4,720 31,442 10,188 6,281 40,069 46,350 14,933 1994 1986 42 YearsWellington Regional Medical CenterWest Palm Beach, Florida 1,190 14,652 3,754(a.) 1,663 16,070 1,863 19,596 5,963 1986 1986 42 YearsThe BridgewayNorth Little Rock, Arkansas 150 5,395 499 150 5,894 6,044 3,019 1983 1986 35 YearsTri-State Rehabilitation HospitalEvansville, Indiana 500 6,945 1,062 500 8,007 8,507 3,037 1993 1989 40 YearsKindred Hospital Chicago CentralChicago, Illinois 158 6,404 1,837 158 8,241 8,399 5,612 1993 1986 25 YearsFresno-Herndon Medical PlazaFresno, California 1,073 5,266 66 1,073 5,332 6,405 1,191 1992 1994 45 YearsFamily Doctor’s Medical Office BuildingShreveport, Louisiana 54 1,526 494 54 2,020 2,074 426 1991 1995 45 YearsKelsey-Seybold Clinic at King’s Crossing 439 1,618 93 439 1,711 2,150 354 1995 1995 45 YearsProfessional Center at King’s CrossingKingwood, Texas 439 1,837 86 439 1,923 2,362 385 1995 1995 45 Years Chesterbrook AcademyAudubon, Pennsylvania 307 996 — 307 996 1,303 192 1996 1996 45 YearsChesterbrook AcademyNew Britain, Pennsylvania 250 744 — 250 744 994 143 1991 1996 45 YearsChesterbrook AcademyUwchlan, Pennsylvania 180 815 — 180 815 995 157 1992 1996 45 YearsChesterbrook AcademyNewtown, Pennsylvania 195 749 — 195 749 944 144 1992 1996 45 YearsThe Southern Crescent Center 1,130 5,092 74 1,130 5,166 6,296 988 1994 1996 45 YearsThe Southern Crescent Center IIRiverdale, Georgia — — 5,479 806 4,673 5,479 653 2000 1998 35 Years The Cypresswood Professional CenterSpring, Texas 573 3,842 187 573 4,029 4,602 866 1997 1997 35 YearsOrthopaedic Specialists of Nevada BuildingLas Vegas, Nevada — 1,579 — — 1,579 1,579 331 1999 1999 25 YearsSheffield Medical BuildingAtlanta, Georgia 1,760 9,766 633 1,760 10,399 12,159 2,199 1999 1999 25 YearsMedical Center of Western Connecticut—Bldg. 73 (b.)Danbury, Connecticut 1,151 5,176 126 1,151 5,302 6,453 875 2000 2000 30 YearsDesert Springs Medical Plaza (c.)Las Vegas, Nevada 1,630 14,981 189 1,630 15,170 16,800 2,534 1998 1998 40 YearsSummerlin Hospital MOB (d.)Las Vegas, Nevada 196 13,553 26 196 13,579 13,775 2,291 1999 1999 36 YearsSummerlin Hospital MOB II (e.)Las Vegas, Nevada 158 13,073 128 158 13,201 13,359 1,290 2000 2000 40 Years TOTALS $20,303 $163,625 $30,937 $23,143 $189,859 $1,863 $214,865 $56,803 a.Includes property write-down and replacement costs, as of December 31, 2004, related to hurricane damage.b.At December 31, 2004 this property had an outstanding mortgage balance of $4.1 million. The mortgage carries a 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.c.At December 31, 2004 this property had an outstanding mortgage balance of $5.3 million. The mortgage carries a 7.9% interest rate and matures on November 1, 2006. The mortgage is non-recourse to us and issecured by the Desert Springs Medical Plaza.d.At December 31, 2004 this property had an outstanding mortgage balance of $7.5 million. The mortgage carries a 7.0% interest rate and matures on July 1, 2009. The mortgage is non-recourse to us and issecured by the Summerlin Hospital MOB.e.At December 31, 2004 this property had an outstanding mortgage balance of $9.2 million. The mortgage carries a 8.3% interest rate and matures on December 10, 2010. The mortgage is non-recourse to us andis secured by the Summerlin Hospital MOB II. 63Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST NOTES TO SCHEDULE IIIDECEMBER 31, 2004(amount in thousands) (1)RECONCILIATION OF REAL ESTATE PROPERTIES The following table reconciles the Real Estate Properties from January 1, 2002 to December 31, 2004: 2004 2003 2002Balance at January 1, $183,008 $182,696 $182,647Initial consolidation of variable interest entities 43,592 — — Property write-down due to hurricane damage (2,931) — — Sale of real property (11,215) — — Construction in progress 1,863 — — Additions 548 312 49 Balance at December 31, $214,865 $183,008 $182,696 (2)RECONCILIATION OF ACCUMULATED DEPRECIATION The following table reconciles the Accumulated Depreciation from January 1, 2002 to December 31, 2004: 2004 2003 2002Balance at January 1, $52,219 $47,810 $43,432Initial consolidation of variable interest entities 5,292 — — Property write-down due to hurricane damage (1,068) — — Sale of real property (4,728) — — Current year depreciation expense 5,088 4,409 4,378 Balance at December 31, $56,803 $52,219 $47,810 64EXHIBIT 10.2 December 31, 2004 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, 2004 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, 2005, 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,/s/ 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: /s/ Alan B. Miller PresidentEXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of TrusteesUniversal Health Realty Income Trust: We consent to the incorporation by reference in the registration statements (Nos. 033-56843 and 333-57815) on Form S-8 and in the registration statements(Nos. 333-81763 and 333-60638) on Form S-3 of Universal Health Realty Income Trust of our reports dated March 11, 2005, with respect to the consolidatedbalance sheets of Universal Health Realty Income Trust as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders’equity and cash flows for each of the years in the three-year period ended December 31, 2004, and the related financial statement schedule, management’sassessment of the effectiveness of internal control over financial reporting as of December 31, 2004 and the effectiveness of internal control over financialreporting as of December 31, 2004, which reports appear in the December 31, 2004 annual report on Form 10-K of Universal Health Realty Income Trust. /s/ KPMG LLP Philadelphia, PennsylvaniaMarch 11, 2005Exhibit 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 makethe statements 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 materialrespects the financial 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 inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) forthe registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared; b) designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principals; c) 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; d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’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 reasonablylikely to adversely 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 controlover financial reporting. Date: March 14, 2005 /s/ Alan B. MillerPresident 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 makethe statements 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 materialrespects the financial 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 inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) forthe registrant and we have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this annual report is being prepared; b) designed such internal controls over financial reporting, or caused such internal controls over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principals; c) 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 d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’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 reasonablylikely to adversely 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 controlover financial reporting. Date: March 14, 2005 /s/ Charles F. BoyleVice 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, 2004 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. MillerPresident and Chief Executive OfficerMarch 14, 2005 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, 2004, 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. BoyleVice President and Chief Financial OfficerMarch 14, 2005 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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