Universal Health Realty Income Trust Annual Report 2006

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549FORM 10-Kxx ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2006OR¨¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934For the transition period from to .Commission File No. 1-9321UNIVERSAL 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) 265-0688Securities 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 ExchangeSecurities registered pursuant to Section 12(g) of the Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨¨ No xxIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨¨ No xxIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirementsfor the 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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act (check one): Large accelerated filer ¨¨ Accelerated filer xx Non-accelerated filer ¨¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes ¨ No x Aggregate market value of voting shares and non-voting shares held by non-affiliates as of June 30, 2006: $367,363,752. Number of shares of beneficialinterest outstanding of registrant as of January 31, 2007: 11,792,049DOCUMENTS INCORPORATED BY REFERENCEPortions of the registrant’s definitive proxy statement for our 2007 Annual Meeting of Shareholders, which will be filed with the Securities and ExchangeCommission within 120 days after December 31, 2006 (incorporated by reference under Part III). Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST2006 FORM 10-K ANNUAL REPORTTABLE OF CONTENTS PART IItem 1 Business 1Item 1A Risk Factors 12Item 1B Unresolved Staff Comments 18Item 2 Properties 19Item 3 Legal Proceedings 24Item 4 Submission of Matters to a Vote of Security Holders 24PART IIItem 5 Market for the Registrant’s Common Equity and Related Stockholder Matters 24Item 6 Selected Financial Data 27Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 28Item 7A Quantitative and Qualitative Disclosures About Market Risk 47Item 8 Financial Statements and Supplementary Data 48Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 48Item 9A Controls and Procedures 48Item 9B Other Information 51PART IIIItem 10 Directors and Executive Officers of the Registrant 51Item 11 Executive Compensation 51Item 12 Security Ownership of Certain Beneficial Owners and Management 51Item 13 Certain Relationships and Related Transactions 51Item 14 Principal Accountant Fees and Services 51PART IVItem 15 Exhibits, Financial Statement Schedules 52SIGNATURES 54Index to Financial Statements and Schedule 55Exhibit Index 88Exhibit 10.2 — Advisory Agreement renewal Exhibit 21 — Subsidiaries of Registrant Exhibit 23.1 — Consent of KPMG LLP Exhibit 31.1 — Section 302 Certification of the Chief Executive Officer Exhibit 31.2 — Section 302 Certification of the Chief Financial Officer Exhibit 32.1 — Section 906 Certification of the Chief Executive Officer Exhibit 32.2 — Section 906 Certification of the Chief Financial Officer Table of ContentsThis Annual Report on Form 10-K is for the year ended December 31, 2006. 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. In this Annual Report on Form 10-K, the term“revenues” does not include the revenues of the unconsolidated limited liability companies in which we have various non-controlling equity interests rangingfrom 33% to 99%. We currently account for our share of the income/loss from these investments by the equity method (see Note 9).Table of ContentsPART I ITEM 1.Business General We are a real estate investment trust (“REIT”) which commenced operations in 1986. We invest in health care and human service related facilitiesincluding acute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers and medicaloffice buildings (“MOB”s). As of December 31, 2006 we have forty-five real estate investments or commitments located in fifteen states in the United Statesconsisting of: (i) six hospital facilities including three acute care, one behavioral healthcare, one rehabilitation and one sub-acute; (ii) thirty-five medical officebuildings (including five being constructed), and; (iii) four preschool and childcare centers. Available Information We have our principal executive offices at Universal Corporate Center, 367 South Gulph Road, King of Prussia, PA 19406. Our telephone number is(610) 265-0688. Our website is located 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 free of charge on our website. Additionally, we have adopted governance guidelines, a Code of Business Conductand Ethics applicable to all of our officers and directors, 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 free of charge on our website.Copies of such reports and charters are available in print to any shareholder who makes a request. Such requests should be made to our Secretary at our Kingof Prussia, PA corporate headquarters. We intend to satisfy the disclosure requirement under Item 10 of Form 8-K relating to amendments to or waivers of anyprovision of our Code of Ethics for Senior Officers by promptly posting this information on our website. The information posted on our website is notincorporated into this Annual Report. In accordance with Section 303A.12(a) of The New York Stock Exchange Listed Company Manual, we submitted our CEO’s Certification to the NewYork Stock Exchange in 2006. Additionally, contained in Exhibits 31.1 and 31.2 of this Annual Report are our CEO’s and CFO’s certifications regarding thequality of our public disclosure under Section 302 of the Sarbanes-Oxley Act of 2002. Overview of Facilities As of December 31, 2006, we have investments or commitments in forty-five facilities, including five new MOBs being constructed, located in fifteenstates and consisting of the following: Facility Name Location Type of Facility Ownership GuarantorSouthwest 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 I (B) Riverdale, GA MOB 100% —Southern Crescent Center, II (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,K) Phoenix, AZ MOB 90% —Thunderbird Paseo Medical Plaza I & II (C) Glendale, AZ MOB 75% —Cypresswood Professional Center (B) Spring, TX MOB 100% — 1Table of ContentsFacility Name Location Type of Facility Ownership GuarantorPapago Medical Park (C) Phoenix, AZ MOB 89% —Edwards Medical Plaza (C,K) Phoenix, AZ MOB 90% —Desert Springs Medical Plaza (D) Las Vegas, NV MOB 99% Triad Hospitals, Inc.Rio Rancho Medical Center (P) Rio Rancho, NM MOB 80% —Orthopaedic Specialists of Nevada Bldg. (B) Las Vegas, NV MOB 100% —Santa Fe Professional Plaza (C,K) Scottsdale, AZ MOB 90% —Sheffield Medical Building (B) Atlanta, GA MOB 100% —Centinela Medical Building Complex (C,K) Inglewood, CA MOB 90% —Summerlin Hospital MOB (L,D) Las Vegas, NV MOB 95% —Summerlin Hospital MOB II (G) Las Vegas, NV MOB 98% —Medical Center of Western Connecticut (B) Danbury, CT MOB 100% —Mid Coast Hospital MOB (C) Brunswick, ME MOB 74% —Deer Valley Medical Office II (C) Phoenix, AZ MOB 90% —Rosenberg Children’s Medical Plaza (C) Phoenix, AZ MOB 85% —700 Shadow Lane & Goldring MOBs (D) Las Vegas, NV MOB 98% —St. Mary’s Professional Office Building (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% —Spring Valley Hospital Medical Office Building II (I) Las Vegas, NV MOB 95% —Sierra San Antonio Medical Plaza (H) Fontana, CA MOB 95% —Phoenix Children’s East Valley Care Center (J) Phoenix, AZ MOB 95% —Centennial Hills Medical Office Building I (M) Las Vegas, NV MOB 95% —Canyon Springs Medical Plaza (N) Gilbert, AZ MOB 95% —Palmdale Medical Plaza (O) Palmdale, 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 have 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)The lessee on the Tri-State Rehabilitation Hospital (“Tri-State”) is HealthSouth/Deaconess L.L.C., a joint venture between HealthSouth Properties Corporation and Deaconess Hospital, Inc. The lease with Tri-State isscheduled to expire in June of 2009.(F)We have committed to invest up to $8.0 million in equity, of which $5.2 million has been funded, in exchange for a 75% non-controlling interest in a LLC that constructed and owns the St. Mary’s ProfessionalOffice Building located in Reno, Nevada. As of December 31, 2006, the LLC has an outstanding mortgage balance of $28.4 million from a third party, which is non-recourse to us. This medical office buildingopened in March of 2005.(G)Tenants of this medical office building include subsidiaries of UHS. Pursuant to FIN 46R, as a result of our related party relationship with UHS and a master lease agreement between UHS and this property inwhich we own a 98% non-controlling ownership interest, this LLC is considered to be a variable interest entity. Consequently, we began to consolidate the results of operations of this LLC in our consolidated financialstatements.(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. As of December 31, 2006, we have invested $2.6 million in equity and $485,000 in debt financing in connection with this project. The LLC has a $7.5 million total construction loancommitment from a third-party, which is non-recourse to us. This medical office building opened during the first quarter of 2006.(I)We have committed to invest a total of up to $12.3 million ($3.4 million in equity, of which $79,000 has been funded as of December 31, 2006 and $8.9 million in debt financing, of which $5.3 million has beenfunded as of December 31, 2006) in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own and operate the Spring Valley Hospital Medical Office Building II, located in Las Vegas,Nevada on the campus of a UHS facility. This project, tenants of which may include subsidiaries of UHS, is scheduled to be completed and opened during the second quarter of 2007.(J)We have committed to invest up to $3.5 million in equity, $1.5 million of which has been funded as of December 31, 2006 as well as $363,000 in debt financing, in exchange for a 95% non-controlling ownershipinterest in a LLC that will develop, construct, own and operate the Phoenix Children’s East Valley Care Center located in Gilbert, Arizona. This project is scheduled to be completed and opened during the fourthquarter of 2007.(K)The membership interests of this entity are held by a master LLC in which we hold a 90% non-controlling ownership interest.(L)The membership interests of this entity are held by a master LLC in which we hold a 95% non-controlling ownership interest.(M)We have committed to invest up to $6.6 million ($250,000 in equity of which $53,000 has been funded as of December 31, 2006, and $6.3 million in equity or debt financing, none of which has been funded as ofDecember 31, 2006) in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own and operate the Centennial Hills Medical Office Building I, located in Las Vegas, Nevada. The LLC hasa $15.7 million construction loan commitment from a third-party, which is non-recourse to us. This project, tenants of which may include subsidiaries of UHS, is scheduled to be completed and opened during thethird quarter of 2007.(N)We have committed to invest up to $6.0 million ($5.5 million in equity of which $67,000 has been funded as of December 31, 2006, and $500,000 in either equity and/or debt financing, none of which has beenfunded as of December 31, 2006) in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own and operate the Canyon Springs Medical Plaza in Gilbert, Arizona. The LLC has a $14.2million construction loan commitment from a third party, which is non-recourse to us. This project is scheduled to be completed and opened during the third quarter of 2007. 2Table of Contents(O)We have committed to invest up to $4.3 million in equity, of which $86,000 has been funded as of December 31, 2006, in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own andoperate the Palmdale Medical Plaza in Palmdale, California. The LLC has a $9.9 million construction loan commitment from a third-party, which is non-recourse to us. This project, tenants of which may includesubsidiaries of UHS, is scheduled to be completed and opened during the fourth quarter of 2007.(P)Subsequent to December 31, 2006, the real estate assets owned by this LLC were sold. See our consolidated financial statements and accompanying Notes included in this Annual Report for our total assets, revenues, income and operatinginformation. Included in our portfolio are six hospital facilities with an aggregate investment of $131.4 million. The leases with respect to the hospital facilitiescomprised approximately 56%, 55% and 58% of our revenues in 2006, 2005 and 2004, respectively, and as of December 31, 2006, these leases have fixedterms with an average of 5.75 years remaining and include renewal options ranging from two to four, 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. For the current hospital facilities owned by us, the combined Coverage Ratio was approximately 5.5 (ranging from 3.8 to 8.3) during 2006, 7.2(ranging from 5.0 to 13.6) during 2005 and 7.8 (ranging from 3.1 to 14.9) during 2004. The Coverage Ratio for individual facilities varies. See “Relationshipwith Universal Health Services, Inc.” below for Coverage Ratio information related to the four hospital facilities leased to subsidiaries of UHS. Pursuant to the terms of our leases for our six hospital facilities, each lessee, including subsidiaries of UHS, is responsible for building operations,maintenance, renovations and property insurance. We, or the LLCs in which we have invested, are responsible for the building operations, maintenance andrenovations of the preschool and childcare centers and the MOBs, however, a portion, or in some cases all, of the expenses associated with the MOBs arepassed on directly to the tenants. Cash reserves have been established to fund required building maintenance and renovations at the multi-tenant MOBs.Lessees are required to maintain all risk, replacement cost and commercial property insurance policies on the leased properties and we, or the LLC in whichwe have invested, are also named insureds on these policies. In addition, we, UHS or the LLCs in which we have invested, maintain property insurance on allproperties. For additional information on the terms of our leases, see “Relationship with Universal Health Services, Inc.” Relationship with Universal Health Services, Inc. Leases: We commenced operations in 1986 by purchasing certain subsidiaries from UHS and immediately leasing the properties back to therespective subsidiaries. Most of the leases were entered into at the time we commenced operations and provided for initial terms of 13 to 15 years with up to sixadditional 5-year renewal terms, with base rents set forth in the leases effective for all but the last two renewal terms. In 1998, the lease for McAllen MedicalCenter was amended to provide that the last two renewal terms would also be fixed at the initial agreed upon base rental. This lease amendment was inconnection with certain concessions granted by UHS with respect to the renewal of other leases. The base rents are paid monthly and each lease also providesfor additional or bonus rents which are computed and paid on a quarterly basis based upon a computation that compares current quarter revenue to acorresponding quarter in the base year. The leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another. Pursuant to the Master Lease Document by and among us and certain subsidiaries of UHS, dated December 24, 1986 (the “Master Lease”), whichgoverns all leases of properties with subsidiaries of UHS, UHS has the option to renew the leases at the lease terms described below by providing notice to usat least 90 days prior to the termination of the then current term. In addition, UHS has rights of first refusal to: (i) purchase the respective leased facilitiesduring and for 180 days after the lease terms at the same price, terms and conditions of any third-party offer, or; (ii) renew the lease on the respective leasedfacility at the end of, and for 180 days after, 3Table of Contentsthe lease term at the same terms and conditions pursuant to any third-party offer. UHS also has the right to purchase the respective leased facilities at the endof the lease terms or any renewal terms at the appraised fair market value. In addition, as part of the overall exchange and substitution proposal relating toChalmette Medical Center (“Chalmette”), as discussed below, as well as the early five year lease renewals on Southwest Healthcare System-Inland ValleyCampus (“Inland Valley”), Wellington Regional Medical Center (“Wellington”), McAllen Medical Center (“McAllen”) and The Bridgeway (“Bridgeway”), weagreed to amend the Master Lease to include a change of control provision. The change of control provision grants UHS the right, upon one month’s noticeshould a change of control of the Trust occur, to purchase any or all of the four leased hospital properties at their appraised fair market value purchase price. During the third quarter of 2005, Chalmette, a 138-bed acute care hospital located in Chalmette, Louisiana, was severely damaged and closed as a resultof Hurricane Katrina. At that time, the majority of the real estate assets of Chalmette were leased from us by a subsidiary of UHS and, in accordance with theterms of the lease, and as part of an overall evaluation of the leases between subsidiaries of UHS and us, UHS offered substitution properties rather thanexercise its right to rebuild the facility or offer cash for Chalmette. Independent appraisals were obtained by us and UHS which indicated that the pre-hurricanefair market value of the leased facility was $24.0 million. During the third quarter of 2006, we completed the previously disclosed asset exchange and substitution pursuant to the Asset Exchange andSubstitution Agreement with UHS that we entered into on April 24, 2006 whereby we agreed to terminate the lease between us and Chalmette and to transfer thereal property assets and all rights attendant thereto (including insurance proceeds) of Chalmette to UHS in exchange and substitution for newly constructedreal property assets owned by UHS (“Capital Additions”) at Wellington, Bridgeway and Inland Valley, in satisfaction of the obligations under the Chalmettelease. The Capital Additions consist of properties which were recently constructed on, or adjacent to, facilities already owned by us as well as a CapitalAddition at Inland Valley which is currently under construction and expected to be completed during 2007. UHS is obligated to complete the Inland ValleyCapital Addition or, subject to our approval, offer to either provide alternative substitution property or pay to us an amount in cash equal to the substitutionvalue of the Capital Addition. Pursuant to section 1033(a)(1) of the Internal Revenue Code of 1986, as amended (the “IRC”), we will recognize no gain forfederal income tax purposes based upon the transaction as agreed upon in the Asset Exchange and Substitution Agreement. The properties included in the Asset Exchange and Substitution Agreement consists of (amounts in thousands): Wellington—Bed Tower $8,926 Fair valueBridgeway—28 bed addition 4,072 Fair valueInland Valley—44 bed and ICU expansion currently under construction 10,967 Estimated minimum fair value Total fair value of exchanged and substituted assets $23,965 In the event the ultimate construction costs related to the Inland Valley Capital Addition exceed $11.0 million, the excess will be paid in cash by us toUHS and UHS will pay incremental rent on the excess at a rate equal to the prevailing five-year treasury rate plus 200 basis points at the time of funding(minimum rate 6.75%). During 2005, 2004 and 2003, the total rent earned by us under the Chalmette lease was approximately $1.6 million to $1.7 million annually (including$960,000 of base rental and approximately $700,000 of bonus rental). The total rent payable to us on the Capital Additions included in the substitutionpackage (excluding the rent on the Inland Valley Capital Addition in excess of $11.0 million, if any) is expected to closely approximate the total rent earned byus under the Chalmette lease. Below is the estimated rent allocation of the substitution properties. Facility Base Rent Bonus Rent Total RentWellington $534,504 $67,744 $602,248Bridgeway 247,800 26,940 274,740Inland Valley 740,012 — 740,012 Total: $1,522,316 $94,684 $1,617,000 4Table of ContentsThe amounts shown in the bonus rent column represent the estimated bonus rent effect of including the revenues generated from the Capital Additions atWellington and Bridgeway that have not been previously included in the bonus rent paid to us pursuant to the terms of the leases since the Capital Additionswere financed and owned by UHS. The bonus rent amounts reflected above were based on the net revenues generated at each facility during 2005. Futurebonus rents earned by us on the Capital Additions will be based on the actual net revenues of each facility. Also during the second quarter of 2006, as part of the overall arrangement with UHS, UHS agreed to early renewals of the leases between us and each ofInland Valley, Wellington and McAllen which were scheduled to mature on December 31, 2006, and Bridgeway, which was scheduled to mature onDecember 31, 2009. These leases were renewed on the same economic terms as the current leases. Included in our consolidated statement of income during 2005 was a property write-down charge of $6.3 million representing the book value of theChalmette property damaged by the hurricane. Included in our 2005 net income was an equal amount representing the property damage recoverable from UHS.Prior to the completion of the Asset Exchange and Substitution Agreement, Chalmette had a combined asset value of $8.3 million on our consolidated balancesheet consisting of $2.0 million of land held for exchange and $6.3 million of property damage receivable from UHS. Included in our net income during 2006was a gain of $14.0 million representing the total property transferred to us from UHS as of December 31, 2006 ($22.2 million) in excess of the $8.3 millionbook value of Chalmette. Upon the completion of the asset exchange and substitution during the third quarter of 2006, we received the above mentionedCapital Additions from Wellington and Bridgeway which had a combined fair value of $13.0 million. In addition, the construction costs related to thecompleted Capital Addition at Inland Valley amounted to $9.2 million as of December 31, 2006 ($11.0 million is total minimum estimated cost of InlandValley’s Capital Addition). Our future net income will include an additional $1.8 million of property recovered from UHS as the additional construction costsare incurred by UHS related to the Inland Valley Capital Addition, up to the $11.0 million of estimated total cost of construction. See Item 7-Management’sDiscussion and Analysis of Financial Condition and Results of Operations for additional disclosure. After giving effect to the exchange and substitution, and the various lease renewals discussed above, subsidiaries of UHS lease four hospital facilitiesowned by us with terms expiring in 2011 through 2014. The table below details the renewal options and terms for each of the four UHS hospital facilities: Hospital Name Type of Facility AnnualMinimumRent End ofLease Term RenewalTerm(years) McAllen Medical Center Acute Care $5,485,000 December, 2011 20(a)Wellington Regional Medical Center Acute Care $3,030,000 December, 2011 20(b)Southwest Healthcare System, Inland Valley Campus Acute Care $2,597,000(d) December, 2011 20(b)The Bridgeway Behavioral Health $930,000 December, 2014 10(c)(a)UHS has four 5-year renewal options at existing lease rates (through 2031).(b)UHS has two 5-year renewal options at existing lease rates (through 2021) and two 5-year renewal options at fair market value lease rates (2022 through2031).(c)UHS has two 5-year renewal options at fair market value lease rates (2015 through 2024).(d)Excludes potential incremental rent, if any, on Capital Addition in excess of $11.0 million. We cannot predict whether the leases with subsidiaries of UHS, which have renewal options at existing lease rates, or any of our other leases, will berenewed 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 facilities and/orenter into leases on terms potentially less favorable to us than the current leases. The combined revenues generated from the leases on the UHS hospital facilities accounted for approximately 53% of our total revenue for the five yearsended December 31, 2006 (approximately 49% for the 5Table of Contentsyear ended December 31, 2006). Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controlling equityinterests ranging from 33% to 99%, the leases on the UHS hospital facilities accounted for approximately 26% of the combined consolidated andunconsolidated revenue for the five years ended December 31, 2006 (approximately 24% for the year ended December 31, 2006). In addition, five MOBs (plusthree additional MOBs currently under construction) owned by LLCs in which we hold various non-controlling equity interests, include tenants which aresubsidiaries of UHS. For the four hospital facilities currently owned by us and leased to subsidiaries of UHS, the combined Coverage Ratio wasapproximately 5.7, 7.4 and 8.1 for the years ended December 31, 2006, 2005 and 2004, respectively. The Coverage Ratio for individual facilities vary andrange from 3.8 to 8.3 in 2006, 5.0 to 13.6 in 2005 and 4.0 to 14.9 in 2004. During 2006, we committed to invest up to $6.6 million ($250,000 in equity, $53,000 of which has been funded as of December 31, 2006 and $6.3million in debt financing or equity, none of which has been funded as of December 31, 2006) in exchange for a 95% non-controlling equity interest in alimited liability company that will develop, construct, own and operate the Centennial Hills Medical Office Building I, located in Las Vegas, Nevada, on thecampus of a UHS hospital. This MOB will be 60% master leased by Valley Health System (“VHS”), a majority-owned subsidiary of UHS, on a triple netbasis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenant acceptable to the LLC and VHS for a minimumterm of five years. The LLC has a $15.7 million construction loan commitment from a third-party, which is non-recourse to us. This building, tenants ofwhich may include subsidiaries of UHS, is scheduled to be completed and opened during the third quarter of 2007. Additionally, during 2006, we committed to invest up to $4.3 million in equity, of which $86,000 has been funded as of December 31, 2006, inexchange for a 95% non-controlling equity interest in a limited liability company that will develop, construct, own and operate the Palmdale Medical Plaza,located in Palmdale, California, on the campus of a UHS hospital currently under construction. This MOB will be 75% master leased by UHS of Palmdale,Inc., a subsidiary of UHS, on a triple net basis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenantacceptable to the LLC and UHS of Palmdale for a minimum term of five years. This building, tenants of which may include subsidiaries of UHS, isscheduled to be completed and opened during the fourth quarter of 2007. During 2005, we committed to invest up to $12.3 million ($3.4 million in equity and $8.9 million in debt financing, $5.4 million of which has beenfunded as of December 31, 2006) in exchange for a 95% non-controlling interest in a limited liability company that will develop, construct, own and operatethe Spring Valley Medical Office Building II, a second MOB on the campus of Spring Valley Hospital in Las Vegas, Nevada. This MOB will be 50% masterleased by VHS on a triple net basis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenant acceptable to the LLCand VHS for a minimum term of five years. This MOB is scheduled to be completed and opened during the second quarter of 2007. Upon the December, 2004 lease expiration on the Virtue Street Pavilion, the former lessee (a wholly-owned subsidiary of UHS), exercised its optionpursuant to the terms of the lease and purchased the facility at its appraised fair market value of $7,320,000. The sale resulted in a gain of $833,000 which isreflected as “Income from discontinued operations, net” in the consolidated statements of income for the year ended December 31, 2004. Prior to thetransaction, the annual minimum rent payable to us under the lease was $1,261,000 and no bonus rent was earned on this facility during 2004. As a result ofthis transaction, our cash flows from operating activities were adversely affected during 2006 and 2005 since calculated using our average incrementalborrowing rates during each year, the reduction to annual interest expense resulting from repayment of borrowings using the $7.3 million of sale proceeds wasapproximately $700,000 less during 2006, and $900,000 less during 2005, than the annual rental payments earned by us pursuant to the terms of the lease. During the third quarter of 2004, Wellington, our 121-bed acute care facility located in West Palm Beach, Florida, sustained storm damage caused by ahurricane. This facility is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease, UHS is responsible for maintainingreplacement cost property 6Table of Contentsinsurance for the facility, a substantial portion of which is insured by a commercial carrier. The facility did not experience significant business interruption.Our consolidated statements of income for the year ended December 31, 2004, included a property write-down charge of $1.9 million representing the estimatednet book value of the damaged assets. This property charge was offset at that time by an equal amount recoverable from UHS. During 2004, UHS incurredapproximately $1.9 million in replacement costs in connection with this property and that amount was included as construction in progress on ourconsolidated balance sheet as of December 31, 2004. During the twelve months ended December 31, 2005, UHS incurred an additional $4.7 million inreplacement costs and since these additional costs have also been recovered from UHS, $4.7 million has been included in net income during the year endedDecember 31, 2005. The repairs to the facility were completed as of December 31, 2005. UHS spent a total of approximately $6.6 million to replace thedamaged property at this facility and this amount is reflected as buildings and improvements on our consolidated balance sheet. UHS Legal Proceedings: We have been advised by UHS that UHS, together with its South Texas Health System affiliates, which operate McAllenMedical Center, were served with a subpoena dated November 21, 2005, issued by the Office of Inspector General of the Department of Health and HumanServices. At that time, the Civil Division of the U.S. Attorney’s office in Houston, Texas indicated that the subpoena was part of an investigation under theFalse Claims Act of compliance with Medicare and Medicaid rules and regulations pertaining to the employment of physicians and the solicitation of patientreferrals from physicians from January 1, 1999 to the date of the subpoena related to the South Texas Health System. UHS has informed us that it iscooperating in the investigation. On February 16, 2007, UHS’s South Texas Health System affiliates were served with a search warrant in connection withwhat UHS has been advised is a related criminal investigation concerning the production of documents. UHS has advised us that, at this time, it is unable toevaluate the existence or extent of any potential financial exposure in connection with this matter. UHS has advised us that it monitors all aspects of its business and that it has developed a comprehensive ethics and compliance program that isdesigned to meet or exceed applicable federal guidelines and industry standards. Because the law in this area is complex and constantly evolving, governmentalinvestigation or litigation may result in interpretations that are inconsistent with industry practices, including UHS’s. Although UHS believes their policies,procedures and practices comply with governmental regulations, no assurance can be given that UHS will not be subjected to further inquiries or actions, orthat UHS will not be faced with sanctions, fines or penalties in connection with the investigation of our South Texas Health System affiliates. Even if UHSwere to ultimately prevail, the government’s inquiry and/or action in connection with this matter could have a material adverse effect on UHS’s futureoperating results and on the future operating results of McAllen Medical Center. While the base rentals are guaranteed by UHS through the end of the leaseterm, should this matter adversely impact on the future revenues and/or operating results of McAllen Medical Center, the future bonus rental earned by us onthis facility may be materially, adversely impacted. Bonus rental revenue earned by us from McAllen Medical Center amounted to $1.9 million during each of2006 and 2005 and $2.2 million during 2004. We can provide no assurance that this matter will not have a material adverse impact on underlying value ofMcAllen Medical Center or on the future base rental earned on this facility after the December, 2011 scheduled expiration of the existing lease term. Advisory Agreement: UHS of Delaware, Inc. (the “Advisor”), a wholly-owned subsidiary of UHS, serves as Advisor to us under an AdvisoryAgreement (the “Advisory Agreement”) dated December 24, 1986. Under the Advisory Agreement, the Advisor is obligated to present an investment programto us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity tous), 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 Trustees who are unaffiliated withUHS (the “Independent Trustees”), that the Advisor’s performance has 7Table of Contentsbeen satisfactory. The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreementhas been renewed for 2007. All transactions between us and 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 0.60% of our average invested real estate assets,as derived from our consolidated balance sheet. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our audited financialstatements. In addition, the Advisor is entitled to an annual incentive fee equal to 20% of the amount by which cash available for distribution to shareholdersfor each year, as defined in the Advisory Agreement, exceeds 15% of our equity as shown on our consolidated balance sheet, determined in accordance withgenerally accepted accounting principles without reduction for return of capital dividends. The Advisory Agreement defines cash available for distribution toshareholders as net cash flow from operations less deductions for, among other things, amounts required to discharge our debt and liabilities and reserves forreplacement and capital improvements to our properties and investments. No incentive fees were paid during 2006, 2005 or 2004. Officers and Employees: Our officers are all employees of UHS and although as of December 31, 2006 we had no salaried employees, our officers doreceive stock-based compensation from time-to-time. Share Purchase Option: As of December 31, 2006, UHS owned 6.7% of our outstanding shares of beneficial interest. SEC reporting requirements of UHS: UHS is subject to the reporting requirements of the SEC and is required to file annual reports containingaudited financial information and quarterly reports containing unaudited financial information. Since the leases on the hospital facilities leased to wholly-owned subsidiaries of UHS comprised approximately 49% of our consolidated revenues for the year ended December 31, 2006, and since UHS is ourAdvisor, you are encouraged to obtain the publicly available filings for Universal Health Services, Inc. from the SEC’s website at www.sec.gov. Taxation We believe we have operated in such a manner as to qualify for taxation as a REIT under Sections 856 through 860 of the Internal Revenue Code of1986, as amended, and we intend to continue to operate in such a manner. If we qualify for taxation as a REIT, we will generally not be subject to federalcorporate income taxes on our net income that is currently distributed to shareholders. This treatment substantially eliminates the “double taxation”, e.g. at thecorporate and shareholder levels, that usually results from investment in the stock of a corporation. Please see the heading “If we fail to maintain our REITstatus, we will become subject to federal income tax on our taxable income at regular corporate rates” under “Risk Factors” for more information. Competition We compete for the acquisition, leasing and financing of health care related facilities. Our competitors include, but are not limited to, other REITs,banks and other companies, including UHS. Some of these competitors are larger and have a lower cost of capital than we do. Additionally, the potential forconsolidation at the REIT or operator level appears to have increased. These developments could result in fewer investment opportunities for us and lowerspreads over our cost of our capital, which would hurt our growth. In most geographical areas in which our facilities operate, there are other facilities that provide services comparable to those offered by our facilities. Inaddition, some competing facilities are owned by tax-supported governmental agencies or by nonprofit corporations and may be supported by endowments andcharitable 8Table of Contentscontributions and exempt from property, sale and income taxes. Such exemptions and support are not available to our facilities. In some markets, certaincompeting facilities may have greater financial resources, be better equipped and offer a broader range of services than those available at our facilities. Certainhospitals that are located in the areas served by our facilities are specialty hospitals that provide medical, surgical and behavioral health services, facilities andequipment that are not available at our hospitals. The increase in outpatient treatment and diagnostic facilities, outpatient surgical centers and freestandingambulatory surgical centers also increases competition for us. In McAllen, Texas, the location of our largest facility, McAllen Medical Center (which is operated by a subsidiary of UHS), intense competition hascontinued from other healthcare providers, including physician owned facilities. As a result, the facility has experienced significant declines in patient volumeand profitability. In response to these competitive pressures, UHS has, among other things, undertaken significant capital investment in the market includinga new dedicated 120-bed children’s facility, which was completed and opened during the first quarter of 2006, as well as a 134-bed replacement behavioralhealth facility, which was completed and opened during the second quarter of 2006. We do not have an ownership interest in the real estate assets of either ofthese newly constructed UHS facilities. A continuation of the increased provider competition in this market, as well as the additional capacity currently underconstruction, or recently completed by UHS and others, could result in additional erosion of the net revenues and financial operating results of McAllenMedical Center which may negatively impact the bonus rentals earned by us on this facility and may potentially have a negative impact on the future leaserenewal terms (current lease expires in December, 2011) and the underlying value of the property. In addition, the number and quality of the physicians on a hospital’s staff are important factors in determining a hospital’s competitive advantage.Typically, physicians are responsible for making hospital admissions decisions and for directing the course of patient treatment. The operators of our facilitiesalso compete with other health care providers in recruiting and retaining qualified hospital management, nurses and other medical personnel. The operators ofour acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and maycontinue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate. Our operators may experience difficulties attracting andretaining qualified physicians, nurses and medical support personnel. We anticipate that our operators, including UHS, will continue to encounter increasedcompetition in the future that could lead to a decline in patient volumes and harm their businesses, which in turn, could harm our business. A large portion of our non-hospital properties consist of MOBs which are located either close to or on the campuses of hospital facilities. Theseproperties are either directly or indirectly affected by the factors discussed above as well as general real estate factors such as the supply and demand of officespace and market rental rates. To improve our competitive position, we anticipate that we will continue investing in additional healthcare related facilities andleasing the facilities to qualified operators, perhaps including UHS and subsidiaries of UHS. Regulation and Other Factors During 2006, 2005 and 2004, 47%, 46% and 48%, 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 health care industry is subject to numerous laws, regulations and rules including, among others, those related to government healthcareparticipation requirements, various licensure and accreditations, reimbursement for patient services, health information privacy and security rules, andMedicare and Medicaid fraud and abuse provisions (including, but not limited to, federal statutes and regulations prohibiting kickbacks and other illegalinducements to potential referral sources, false claims submitted to federal health care programs and self-referrals by physicians). Providers that are found tohave violated any of these laws and regulations may be excluded from 9Table of Contentsparticipating in government healthcare programs, subjected to significant fines or penalties and/or required to repay amounts received from government forpreviously billed patient services. This government regulation of the healthcare industry affects us because: (i)The financial ability of lessees to make rent payments to us may be affected by governmental regulations such as licensure, certification forparticipation in government programs, and government reimbursement, and; (ii)Our bonus rents are based on our lessees’ net revenues which in turn are affected by the amount of reimbursement such lessees receive from thegovernment. Although UHS and the other operators of our acute care facilities believe that their policies, procedures and practices comply with governmentalregulations, no assurance 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 if so subjected. Because many of these laws and regulations are relatively new, in many cases, our operators don’t have the benefit ofregulatory or judicial interpretation. In the future, it is possible that different interpretations or enforcement of these laws and regulations could subject theircurrent or past practices to allegations of impropriety or illegality or could require them to make changes in the facilities, equipment, personnel, services,capital expenditure programs and operating expenses. Even if they were to ultimately prevail, a significant governmental inquiry or action under one of theabove laws, regulations or rules could have a material adverse effect upon them, and in turn, us. See Relationship with Universal Health Services, Inc.-UHS Legal Proceedings for disclosure related to McAllen Medical Center. A significant portion of the revenue earned by the operators of our acute care hospitals is derived from federal and state healthcare programs, includingMedicare and Medicaid. Under the statutory framework of the Medicare and Medicaid programs, many of the general acute care operations are subject toadministrative rulings, interpretations and discretion that may affect payments made under either or both of such programs as well as by other third partypayors. The federal government makes payments to participating hospitals under its Medicare program based on various formulas. For inpatient services, theoperators of our acute care hospitals are subject to a prospective payment system (“PPS”). Under inpatient PPS, hospitals are paid a predetermined fixedpayment amount for each hospital discharge. The fixed payment amount is based upon each patient’s diagnosis related group (“DRG”). Every DRG isassigned a payment rate based upon the estimated intensity of hospital resources necessary to treat the average patient with that particular diagnosis. Theserates are based upon historical national average costs and do not consider the actual costs incurred by a hospital in providing care. The DRG rates are adjustedannually based on geographic region. For outpatient services, both general acute and behavioral health hospitals are paid under an outpatient PPS according to ambulatory procedure codes(“APC”) that group together services that are clinically related and use similar resources. Medicare pays a set price or rate for each group, regardless of theactual costs incurred in providing care. Medicare sets the payment rate for each APC based on historical median cost data, subject to geographic modification. DRG rates are adjusted by an update factor each federal fiscal year, which begins on October 1. The index used to adjust the DRG rates, known as the“hospital market basket index,” gives consideration to the inflation experienced by hospitals in purchasing goods and services. Generally, however, thepercentage increases in the DRG payments have been lower than the projected increase in the cost of goods and services purchased by hospitals. For federalfiscal years 2006, 2005 and 2004, the update factors were 3.7%, 3.3% and 3.4%, respectively. For 2007, the update factor is 3.4%. Hospitals are allowed toreceive the full basket update if they provide the Centers for Medicare and Medicaid Services (“CMS”) with specific data relating to the quality of servicesprovided. The operators of our acute care hospital facilities have complied fully with this requirement and intend to comply fully in future periods. The APCpayment rates are updated each federal fiscal year as well. For 2006, 2005 and 2004, the payment rate update factors were 3.7%, 3.3% and 3.4%, respectively.For 2007, the update factor is 3.4%. 10Table of ContentsMedicaid is a joint federal-state funded health care benefit program that is administered by the states to provide benefits to qualifying individuals whoare unable to afford care. Most state Medicaid payments are made under a PPS-like system, or under programs that negotiate payment levels with individualhospitals. Amounts received under the Medicaid program are generally significantly less than a hospital’s customary charges for services provided. In additionto revenues received pursuant to the Medicare program, our operators receive a large portion of their revenues either directly from Medicaid programs or frommanaged care companies managing Medicaid. In addition to Medicare and Medicaid, our operators, including UHS, receive payments from private payors, including managed care companies,commercial insurance providers and individuals. The ability of our operators to negotiate favorable service contracts with purchasers of group health careservices significantly affects the revenues and operating results of our facilities. A primary collection risk for our operators relates to uninsured patients andthe portion of the bill that is the patient’s responsibility, which primarily includes co-payments and deductibles. Given increasing budget deficits, the federal government and many states are currently considering additional ways to limit increases in levels ofMedicare and Medicaid funding, which could also adversely affect future payments received by operators of our facilities. In addition to statutory andregulatory changes to the Medicare and each of the state Medicaid programs, our operators’ operations and reimbursement may be affected by administrativerulings, new or novel interpretations and determinations of existing laws and regulations, post-payment audits, requirements for utilization review and newgovernmental funding restrictions, all of which may materially increase or decrease program payments as well as affect the cost of providing services and thetiming of payments to our facilities. In addition, we cannot predict whether other legislation or regulations at the federal or state level will be adopted, what form such legislation orregulations may take or what their impact may be. An increasing number of legislative initiatives have been introduced or proposed in recent years that wouldresult in major changes in the health care delivery system on a national or a state level. Among the proposals that have been introduced are price controls onhospitals, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer healthinsurance coverage to their employees and the creation of government health insurance plans that would cover all citizens and increase payments bybeneficiaries. We cannot predict whether any proposals will be adopted or, if adopted, what effect, if any, these proposals would have on operators and, thus,our business. Executive Officers of the Registrant Name Age PositionAlan B. Miller 69 Chairman of the Board, Chief Executive Officer and PresidentCharles F. Boyle 47 Vice President and Chief Financial OfficerCheryl K. Ramagano 44 Vice President, Treasurer and SecretaryTimothy J. Fowler 51 Vice President, Acquisition and Development Mr. Alan B. Miller has been our Chairman of the Board and Chief Executive Officer since our inception in 1986 and was appointed President inFebruary of 2003. He had previously served as our President until March, 1990. Mr. Miller has been Chairman of the Board, President and Chief ExecutiveOfficer 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-commercemarketplace for healthcare supplies, equipment and services). Mr. Charles F. Boyle was appointed Chief Financial Officer in February of 2003 and has served as our Vice President and Controller since 1991.Mr. Boyle, who has held various positions at UHS since 1983, was promoted to Controller of UHS in November, 2003 and has served as its Assistant VicePresident — Corporate Accounting since 1994. 11Table of ContentsMs. Cheryl K. Ramagano was appointed Secretary in February of 2003 and served as our Vice President and Treasurer since 1992. Ms. Ramagano,who has held various positions at UHS since 1983, was promoted to Treasurer of UHS in November, 2003 and has served as its Assistant Treasurer since1994. Mr. Timothy J. Fowler was elected as our Vice President of Acquisition and Development 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. ITEM 1A.Risk Factors We are subject to numerous known and unknown risks, many of which are described below and elsewhere in this Annual Report. Any of the eventsdescribed below could have a material adverse effect on our business, financial condition and results of operations. Additional risks and uncertainties that weare not aware of, or that we currently deem to be immaterial, could also impact our business and results of operations. A substantial portion of our revenues are dependent upon one operator. If UHS experiences financial difficulties, or otherwise fails to makepayments to us, our revenues will significantly decline. For the year ended December 31, 2006, UHS accounted for 49% of our revenues. In addition, as of December 31, 2006, subsidiaries of UHS leasedfour of the six hospital facilities owned by us with terms expiring in 2011or 2014. We cannot assure you that UHS will continue to satisfy its obligations tous. The failure or inability of UHS to satisfy its obligations to us could materially reduce our revenues and net income, which could in turn reduce the amountof dividends we pay and cause our stock price to decline. Our relationship with UHS may create conflicts of interest. In addition to being dependent upon UHS for a substantial portion of our revenues and leases, since 1986, UHS of Delaware, Inc. (the “Advisor”), awholly-owned subsidiary of UHS, has served as our Advisor. Pursuant to our Advisory Agreement, the Advisor is obligated to present an investment programto us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity tous), to provide administrative services to us and to conduct our day-to-day affairs. Further, all of our officers are all employees of UHS. As of December 31,2006, we had no employees. We believe that the quality and depth of the management and advisory services provided to us by our Advisor and UHS couldnot be replicated by contracting with unrelated third parties or by being self-advised without considerable cost increases. We believe that these relationshipshave been beneficial to us in the past, but we cannot guarantee that will not become detrimental to us in the future. All transactions with UHS must be approved by a majority of our Independent Trustees. We believe that our current leases and business dealings withUHS have been entered into on commercially reasonable terms. However, because of our historical and continuing relationship with UHS and its subsidiaries,in the future, our business dealings may not be on the same or as favorable terms as we might achieve with a third party with whom we do not have such arelationship. Disputes may arise between us and UHS that we are unable to resolve or the resolution of these disputes may not be as favorable to us as aresolution we might achieve with a third party. We hold significant, non-controlling equity ownership interests in various LLCs. For the year ended December 31, 2006, 61% of our consolidated and unconsolidated revenues were generated by LLCs in which we hold a majority,non-controlling equity ownership interest. Our level of investment and lack of control exposes us to potential losses of our investments and revenues. Althoughour ownership arrangements have been beneficial to us in the past, we cannot guarantee that they will continue to be beneficial in the future. 12Table of ContentsWe cannot be certain of the availability and terms of external sources of capital to fund the growth of our business when needed. To retain our status as a REIT, we are required to distribute 90% of our taxable income to shareholders and, therefore, we generally cannot use incomefrom operations to fund our growth. Accordingly, our growth strategy depends, in part, upon our ability to raise additional capital at reasonable costs to fundnew investments. We believe we will be able to raise additional debt and equity capital at reasonable costs to refinance our debts at or prior to their maturitiesand to invest at yields which exceed our cost of capital. We cannot predict, however, whether financing will be available to us on satisfactory terms whenneeded, which could harm our business. Our growth strategy is not assured and may fail. In addition, the degree to which we are, or in the future may become, leveraged, our ability to obtain financing could be adversely impacted and couldmake us more vulnerable to competitive pressures. Our ability to meet existing and future debt obligations, depends upon our future performance and ourability to secure additional financing on satisfactory terms, each of which is subject to financial, business and other factors that are beyond our control. Anyfailure by us to meet our financial obligations would harm our business. The bankruptcy, default, insolvency or financial deterioration of our tenants could significantly delay our ability to collect unpaid rents orrequire us to find new operators. Our financial position and our ability to make distributions to our shareholders may be adversely affected by financial difficulties experienced by anyof our major tenants, including bankruptcy, insolvency or a general downturn in the business. We are exposed to the risk that our operators may not be able tomeet their obligations, which may result in their bankruptcy or insolvency. Although our leases and loans provide us the right to terminate an investment, evictan operator, demand immediate repayment and other remedies, the bankruptcy laws afford certain rights to a party that has filed for bankruptcy orreorganization. An operator in bankruptcy may be able to restrict our ability to collect unpaid rents or interest during the bankruptcy proceeding. Real estate ownership creates risks and liabilities that may result in unanticipated losses or expenses. Our business is subject to risks associated with real estate acquisitions and ownership, including: • general liability, property and casualty losses, some of which may be uninsured; • the illiquid nature of real estate and the real estate market that impairs our ability to purchase or sell our assets rapidly to respond to changingeconomic conditions; • real estate market factors, such as the supply and demand of office space and market rental rates, changes in interest rates as well as an increase inthe development of medical office condominiums in certain markets; • costs that may be incurred relating to maintenance and repair, and the need to make expenditures due to changes in governmental regulations,including the Americans with Disabilities Act; • environmental hazards at our properties for which we may be liable, including those created by prior owners or occupants, existing tenants,mortgagors or other persons, and; • defaults and bankruptcies by our tenants. In addition to the foregoing risks, we cannot predict whether the leases on our properties, including the leases on the properties leased to subsidiaries ofUHS, which have options to purchase the respective leased facilities at the end of the lease or renewal terms at the appraised fair market value, will be renewedat their current rates at the end of the lease terms in 2011 or 2014. If the leases are not renewed, we may be required to find other operators for these facilitiesand/or enter into leases with less favorable terms. The exercise of purchase options for our facilities may result in a less favorable rate of return for us than therental revenue currently earned on such facilities. Further, the purchase options and rights of first refusal granted to the 13Table of Contentsrespective lessees to purchase or lease the respective leased facilities, after the expiration of the lease term, may adversely affect our ability to sell or lease afacility, and may 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, inpart, upon the financial performance of the facility during the final years of the lease term. Significant potential liabilities and rising insurance costs and availability may have an adverse effect on the operations of our operators,which may negatively impact their ability to meet their obligations to us. As is typical in the healthcare industry, in the ordinary course of business, our operators, including UHS, are subject to medical malpractice lawsuits,product liability lawsuits and other legal actions. Some of these actions may involve large claims, as well as significant defense costs. If their ultimate liabilityfor professional and general liability claims could change materially from current estimates, if such policy limitations should be partially or fully exhausted inthe future, or payments of claims exceed estimates or are not covered by insurance, it could have a material adverse effect on the operations of our operators. In addition, the malpractice expenses of our operators, including UHS, have increased in recent years and they continue to experience unfavorablepricing and availability trends in the professional and general liability insurance markets. There can be no assurance that insurance will continue to beavailable at reasonable prices that allow them to maintain adequate coverage. If these trends continue, they could have a material adverse effect on theiroperations. Property insurance rates, particularly for earthquake insurance in California, have also continued to increase. Two LLCs that own properties inCalifornia, in which we have various non-controlling equity interests, could not obtain earthquake insurance at rates which are economically beneficial inrelation to the risks covered. Our tenants and operators, including UHS, may be unable to fulfill their insurance, indemnification and other obligations to us under their leases andmortgages and thereby potentially expose us to those risks. In addition, our tenants and operators may be unable to pay their lease or mortgage payments,which could potentially decrease our revenues and increase our collection and litigation costs. Moreover, to the extent we are required to foreclose on the affectedfacilities, our revenues from those facilities could be reduced or eliminated for an extended period of time. In addition, we may in some circumstances benamed as a defendant in litigation involving the actions of our operators. Although we have no involvement in the activities of our operators and our standardleases generally require our operators to carry insurance to cover us in certain cases, a significant judgment against us in such litigation could exceed our andour operators’ insurance coverage, which would require us to make payments to cover the judgment. Increased competition in the health care industry has resulted in lower revenues and higher costs for our operators, including UHS, andmay affect our revenues, property values and lease renewal terms. The health care industry is highly competitive and competition among hospitals and other health care providers for patients has intensified in recentyears. In most geographical areas in which our facilities are operated, there are other facilities that provide services comparable to those offered by our facilities.In addition, some competing facilities are owned by tax-supported governmental agencies or by nonprofit corporations and may be supported by endowmentsand charitable contributions and exempt from property, sale and income taxes. Such exemptions and support are not available to our operators. In somemarkets, certain competing facilities may have greater financial resources, be better equipped and offer a broader range of services than those available at ourfacilities. Certain hospitals that are located in the areas served by our operators’ facilities are specialty or large hospitals that provide medical, surgical andbehavioral health services, facilities and equipment that are not available at our operators’ hospitals. The increase in outpatient treatment and diagnosticfacilities, outpatient surgical centers and freestanding ambulatory surgical centers also increases competition for our operators. In McAllen, Texas, the location of our largest facility, McAllen Medical Center (which is operated by a subsidiary of UHS), intense competition hascontinued from other healthcare providers, including physician 14Table of Contentsowned facilities. As a result, the facility has experienced significant declines in patient volume and profitability. In response to these competitive pressures,UHS has, among other things, undertaken significant capital investment in the market including a new dedicated 120-bed children’s facility, which wascompleted and opened during the first quarter of 2006, as well as a 134-bed replacement behavioral health facility, which was completed and opened during thesecond quarter of 2006. We do not have an ownership interest in the real estate assets of either of these newly constructed UHS facilities. A continuation of theincreased provider competition in this market, as well as the additional capacity currently under construction, or recently completed by UHS and others,could result in additional erosion of the net revenues and financial operating results of McAllen Medical Center which may negatively impact the bonus rentalsearned by us on this facility and may potentially have a negative impact on the future lease renewal terms (current lease expires in December, 2011) and theunderlying value of the property. In addition, the number and quality of the physicians on a hospital’s staff are important factors in determining a hospital’s competitive advantage.Typically, physicians are responsible for making hospital admissions decisions and for directing the course of patient treatment. The operators of our facilitiesalso compete with other health care providers in recruiting and retaining qualified hospital management, nurses and other medical personnel. The operators ofour acute care and behavioral health care facilities are experiencing the effects of a shortage of skilled nursing staff nationwide, which has caused and maycontinue to cause an increase in salaries, wages and benefits expense in excess of the inflation rate. Our operators may experience difficulties attracting andretaining qualified physicians, nurses and medical support personnel. We anticipate that our operators, including UHS, will continue to encounter increasedcompetition in the future that could lead to a decline in patient volumes and harm their businesses, which in turn, could harm our business. Operators that fail to comply with governmental reimbursement programs such as Medicare or Medicaid, licensing and certificationrequirements, fraud and abuse regulations or new legislative developments may be unable to meet their obligations to us. Our operators, including UHS and its subsidiaries, are subject to numerous federal, state and local laws and regulations that are subject to frequent andsubstantial changes (sometimes applied retroactively) resulting from legislation, adoption of rules and regulations, and administrative and judicialinterpretations of existing law. The ultimate timing or effect of these changes cannot be predicted. Government regulation may have a dramatic effect on ouroperators’ costs of doing business and the amount of reimbursement received by both government and other third-party payors. The failure of any of ouroperators to comply with these laws, requirements and regulations could adversely affect their ability to meet their obligations to us. These regulations include,among other items: • hospital billing practices; • relationships with physicians and other referral sources; • adequacy of medical care; • quality of medical equipment and services; • qualifications of medical and support personnel; • confidentiality, maintenance and security issues associated with health-related information and patient medical records; • the screening, stabilization and transfer of patients who have emergency medical conditions; • licensure and accreditation of our facilities; • hospital rate or budget review; • operating policies and procedures, and; • construction or expansion of facilities and services. 15Table of ContentsIf our operators fail to comply with applicable laws and regulations, they could be subjected to liabilities, including criminal penalties, civil penalties(including the loss of their licenses to operate one or more facilities), and exclusion of one or more facilities from participation in the Medicare, Medicaid andother federal and state health care programs. The imposition of such penalties could jeopardize that operator’s ability to make lease or mortgage payments to usor to continue operating its facility. In addition, our bonus rents are based on our operators net revenues, which in turn are affected by the amount ofreimbursement that such lessees receive from the government. Although UHS and the other operators of our acute care facilities, believe that their policies, procedures and practices comply with governmentalregulations, no assurance 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 if so subjected. Because many of these laws and regulations are relatively new, in many cases, our operators don’t have the benefit ofregulatory or judicial interpretation. In the future, it is possible that different interpretations or enforcement of these laws and regulations could subject theircurrent or past practices to allegations of impropriety or illegality or could require them to make changes in the facilities, equipment, personnel, services,capital expenditure programs and operating expenses. Even if they were to ultimately prevail, a significant governmental inquiry or action under one of theabove laws, regulations or rules could have a material adverse effect upon them, and in turn, us. UHS Legal Proceedings: We have been advised by UHS that UHS, together with its South Texas Health System affiliates, which operate McAllenMedical Center, were served with a subpoena dated November 21, 2005, issued by the Office of Inspector General of the Department of Health and HumanServices. At that time, the Civil Division of the U.S. Attorney’s office in Houston, Texas indicated that the subpoena was part of an investigation under theFalse Claims Act of compliance with Medicare and Medicaid rules and regulations pertaining to the employment of physicians and the solicitation of patientreferrals from physicians from January 1, 1999 to the date of the subpoena related to the South Texas Health System. UHS has informed us that it iscooperating in the investigation. On February 16, 2007, UHS’s South Texas Health System affiliates were served with a search warrant in connection withwhat UHS has been advised is a related criminal investigation concerning the production of documents. UHS has advised us that, at this time, it is unable toevaluate the existence or extent of any potential financial exposure in connection with this matter. UHS has advised us that it monitors all aspects of its business and that is has developed a comprehensive ethics and compliance program that isdesigned to meet or exceed applicable federal guidelines and industry standards. Because the law in this area is complex and constantly evolving, governmentalinvestigation or litigation may result in interpretations that are inconsistent with industry practices, including UHS’s. Although UHS believes their policies,procedures and practices comply with governmental regulations, no assurance can be given that UHS will not be subjected to further inquiries or actions, orthat UHS will not be faced with sanctions, fines or penalties in connection with the investigation of our South Texas Health System affiliates. Even if UHSwere to ultimately prevail, the government’s inquiry and/or action in connection with this matter could have a material adverse effect on UHS’s futureoperating results and on the future operating results of McAllen Medical Center. While the base rentals are guaranteed by UHS through the end of the leaseterm, should this matter adversely impact on the future revenues and/or operating results of McAllen Medical Center, the future bonus rental earned by us onthis facility may be materially, adversely impacted. Bonus rental revenue earned by us from McAllen Medical Center amounted to $1.9 million during each of2006 and 2005 and $2.2 million during 2004. We can provide no assurance that this matter will not have a material adverse impact on underlying value ofMcAllen Medical Center or on the future base rental earned on this facility after the December, 2011 scheduled expiration of the existing lease term. Medicare, Medicaid and Private Payor Reimbursement: A significant portion of the revenue earned by the operators of our acute care hospitals isderived from federal and state healthcare programs, including Medicare and Medicaid. Given increasing budget deficits, the federal government and manystates are currently considering additional ways to limit increases in levels of Medicare and Medicaid funding, which could also 16Table of Contentsadversely affect future payments received by operators of our facilities. In addition to statutory and regulatory changes to the Medicare and each of the stateMedicaid programs, our operators’ operations and reimbursement may be affected by administrative rulings, new or novel interpretations and determinationsof existing laws and regulations, post-payment audits, requirements for utilization review and new governmental funding restrictions, all of which maymaterially increase or decrease program payments as well as affect the cost of providing services and the timing of payments to our facilities. In addition to changes in government reimbursement programs, our operators’ ability to negotiate favorable service contracts with purchasers of grouphealth services, including managed care providers, significantly affects the revenues and operating results of our facilities. Further, a primary collection riskfor our operators relates to uninsured patients and the portion of the bill that is the patient’s responsibility, which primarily includes co-payments anddeductibles. Health Care Reform: An increasing number of legislative initiatives have been introduced or proposed in recent years that would result in majorchanges in the health care delivery system on a national or a state level. Among the proposals that have been introduced are price controls on hospitals,insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurancecoverage to their employees and the creation of government health insurance plans that would cover all citizens and increase payments by beneficiaries. Wecannot predict whether any proposals will be adopted or, if adopted, what effect, if any, these proposals would have on operators and, thus, our business. If we fail to maintain our REIT status, we will become subject to federal income tax on our taxable income at regular corporate rates. In order to qualify as a REIT, we must comply with certain highly technical and complex Internal Revenue Code provisions. Although we believe wehave been qualified as a REIT since our inception, there can be no assurance that we have been so qualified or will remain qualified in the future. Failure toqualify as a REIT may subject us to income tax liabilities, including federal income tax at regular corporate rates. The additional income tax incurred maysignificantly reduce the cash flow available for distribution to shareholders and for debt service. In addition, if disqualified, we might be barred fromqualification as a REIT for four years following disqualification. The market value of our common stock could be substantially affected by various factors. Many factors, certain of which are outside of our control, could have an adverse effect on the share price of our common stock. These factors includecertain of the risks discussed herein, our financial condition, performance and prospects, the market for similar securities issued by REITs, demographicchanges, operating results of our operators and other hospital companies, changes in our financial estimates or recommendations of securities analysts,speculation in the press or investment community, the possible effects of war, terrorist and other hostilities, adverse weather conditions, the level of seasonalillnesses, changes in general conditions in the economy or the financial markets, or other developments affecting the health care industry. Ownership limitations and anti-takeover provisions in our declaration of trust and bylaws and under Maryland law may delay, defer orprevent a change in control or other transactions that could provide shareholders with a take-over premium. We are subject to significant anti-takeover provisions. In order to protect us against the risk of losing our REIT status for federal income tax purposes, our declaration of trust permits our Trustees to redeemshares acquired or held in excess of 9.8% of the issued and outstanding shares of our voting stock and, which in the opinion of the Trustees would jeopardizeour REIT status. In addition, any acquisition of our common or preferred shares that would result in our disqualification as a REIT is null and void. Theright of redemption may have the effect of delaying, deferring or preventing a change in control of our company and could adversely affect our shareholders’ability to realize a premium over the market price for the shares of our common stock. 17Table of ContentsOur declaration of trust authorizes our Board of Trustees to issue additional shares of common and preferred stock and to establish the preferences,rights and other terms of any series of preferred stock that we issue. Although our Board of Trustees has no intention to do so at the present time, it couldestablish a series of preferred stock that could delay, defer or prevent a transaction or a change in control that might involve the payment of a premium over themarket price for our common stock or otherwise be in the best interests of our shareholders. These provisions could discourage unsolicited acquisition proposals or make it more difficult for a third-party to gain control of us, which couldadversely affect the market price of our securities and prevent shareholders from receiving a take-over premium. We depend heavily on key management personnel and the departure of one or more of our key executives or a significant portion of ouroperators’ local hospital management personnel could harm our business. The expertise and efforts of our senior executives and key members of our operators’ local hospital management personnel are critical to the success ofour business. The loss of the services of one or more of our senior executives or of a significant portion of our operators’ local hospital management personnelcould significantly undermine our management expertise and our operators’ ability to provide efficient, quality health care services at our facilities, whichcould harm their business, and in turn, harm our business. Increasing investor interest in our sector and consolidation at the operator or REIT level could increase competition and reduce ourprofitability. Our business is highly competitive and we expect that it may become more competitive in the future. We compete for the acquisition, leasing andfinancing of health care related facilities. Our competitors include, but are not limited to, other REITs, banks and other companies, including UHS, some ofwhich are larger and have a lower cost of capital than we do. Additionally, the potential for consolidation at the REIT or operator level appears to haveincreased. These developments could result in fewer investment opportunities for us and lower spreads over our cost of our capital, which would hurt ourgrowth. We are subject to significant corporate regulation as a public company and failure to comply with all applicable regulations could subject usto liability or negatively affect our stock price. As a publicly traded company, we are subject to a significant body of regulation, including the Sarbanes-Oxley Act of 2002. While we have developedand instituted a corporate compliance program based on what we believe are the current best practices in corporate governance and continue to update thisprogram in response to newly implemented or changing regulatory requirements, we cannot provide assurance that we are or will be in compliance with allpotentially applicable corporate regulations. For example, we cannot provide assurance that in the future our management will not find a material weakness inconnection with its annual review of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. We also cannot provideassurance that we could correct any such weakness to allow our management to assess the effectiveness of our internal control over financial reporting as of theend of our fiscal year in time to enable our independent registered public accounting firm to state that such assessment will have been fairly stated in ourAnnual Report on Form 10-K or state that we have maintained effective internal control over financial reporting as of the end of our fiscal year. If we fail tocomply with any of these regulations, we could be subject to a range of regulatory actions, fines or other sanctions or litigation. If we must disclose anymaterial weakness in our internal control over financial reporting, our stock price could decline. Item 1B.Unresolved Staff Comments None. 18Table of ContentsITEM 2.Properties The following table shows our investments in hospital facilities leased to UHS and other non-related parties. The table on the next page providesinformation related to various properties in which we have significant investments, some of which are accounted for by the equity method. The capacity interms of beds (for the hospital facilities) and the five-year occupancy levels are based on information provided by the lessees. Lease TermHospital Facility Name and Location Type offacility Numberofavailablebeds @12/31/06 Average Occupancy(1) Minimumrent End ofinitialorrenewedterm Renewalterm(years) 2006 2005 2004 2003 2002 Southwest Healthcare System:Inland Valley Campus(2)Wildomar, California Acute Care 124 85% 87% 78% 74% 71% $2,597,000 2011 20McAllen Medical Center(3)McAllen, Texas Acute Care 490 52% 59% 68% 72% 73% 5,485,000 2011 20Wellington Regional MedicalCenterWest Palm Beach, Florida Acute Care 143 77% 73% 72% 68% 58% 3,030,000 2011 20The BridgewayNorth Little Rock, Arkansas BehavioralHealth 98 92% 96% 98% 98% 97% 930,000 2014 10Tri-State Rehabilitation HospitalEvansville, Indiana Rehabilitation 80 53% 74% 74% 75% 74% 885,000 2009 15Kindred Hospital Chicago CentralChicago, Illinois Sub-Acute Care 84 46% 47% 47% 71% 78% 1,326,000 2011 15 19Table of ContentsITEM 2.Properties (continued) Lease Term Average Occupancy(1) Minimumrent End ofinitialorrenewedterm(4) Renewalterm(years)Facility Name and Location Type offacility 2005 2005 2004 2003 2002 Fresno Herndon Medical PlazaFresno, California MOB 67% 67% 67% 73% 92% $528,000 2007-2008 variousKelsey-Seybold Clinic atKings CrossingKingwood, Texas MOB 100% 100% 100% 100% 100% 339,000 2008 noneProfessional Bldgs. at KingsCrossingKingwood, Texas MOB 90% 90% 91% 82% 83% 280,000 2007-2015 variousSouthern Crescent CenterRiverdale, Georgia MOB 36% 49% 64% 70% 77% 176,000 2007-2012 variousSouthern Crescent Center, II Riverdale, Georgia MOB 94% 94% 98% 98% 88% 1,099,000 2010 10Cypresswood ProfessionalCenter Spring, Texas MOB 92% 100% 100% 97% 96% 465,000 2007-2009 variousDesert Springs MedicalPlaza(5)Las Vegas, Nevada MOB 96% 100% 100% 100% 100% 1,136,000 2007-2016 variousOrthopaedic Specialists ofNevada BuildingLas Vegas, Nevada MOB 100% 100% 100% 100% 100% 224,000 2009 20Summerlin HospitalMOB(5)Las Vegas, Nevada MOB 98% 100% 100% 100% 100% 1,425,000 2007-2014 variousSummerlin HospitalMOB II(5)Las Vegas, Nevada MOB 100% 100% 100% 100% 100% 1,566,000 2007-2013 variousSheffield Medical BuildingAtlanta, Georgia MOB 86% 85% 88% 99% 98% 1,370,000 2007-2012 variousMedical Center of Western Connecticut Danbury,Connecticut MOB 85% 100% 100% 94% 94% 787,000 2008-2017 variousChesterbrook AcademyAudubon, New Britain, Newtown and Uwchlan,Pennsylvania Preschool andChildcareCenters N/A N/A N/A N/A N/A 593,000 2010 10Family Doctor’s MedicalOffice BuildingShreveport, Louisiana MOB 100% 100% 100% 100% 100% 303,000 2011 10700 Shadow Lane andGoldring MOBs(5)Las Vegas, Nevada MOB 90% 99% 99% 99% — 2,028,000 2007-2016 variousSt. Mary’s ProfessionalOffice BuildingReno, Nevada MOB 92% 77% — — — 3,612,000 2007-2025 various 20Table of ContentsN/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, 2006. 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 staff available for patient care. A hospital may have appropriate licenses for more beds than are in service for a number ofreasons, including lack of demand, incomplete construction and anticipation of future needs. The average occupancy rate of a hospital is affected by anumber of factors, including the number of physicians using the hospital, changes in the number of beds, the composition and size of the population ofthe community in which the hospital is located, general and local economic conditions, variations in local medical and surgical practices and the degreeof outpatient use of the hospital services. Average occupancy rate for the multi-tenant medical office buildings is based on the occupied square footage ofeach 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 for all years were based on the combined number of bedsoccupied at the Inland Valley and Rancho Springs campuses.(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). During 2000, UHS purchased the South Texas Behavioral Health Center, a behavioral health care facility located in McAllen, Texas. Thelicense for this facility, the real property of which was not owned by us, was merged with the license for McAllen Medical Center and the financialresults of the facilities are no longer separable. During the second quarter of 2006, UHS opened a newly constructed behavioral health care facility andthe operations of South Texas Behavioral Health Center were transferred into this new facility. We do not own the real property of this newly constructedbuilding. There was no amendment to the McAllen Medical Center lease related to the operations of the South Texas Behavioral Health Center. Noassurance can be given as to the effect, if any, the consolidation of the facilities as mentioned above, had on the underlying value of McAllen MedicalCenter. Base rental commitments and the guarantee by UHS under the original lease continue for the remainder of the lease terms. The averageoccupancy rates shown for this facility in all years presented were based on the combined number of beds at McAllen Medical Center, McAllen HeartHospital and South Texas Behavioral Health Center.(4)Properties are multi-tenant MOBs which have various lease maturity dates.(5)The real estate assets of this facility are owned by a LLC in which we own a non-controlling equity interest and include tenants who are unaffiliatedthird-parties or subsidiaries of UHS. 21Table 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: AvailableforLeaseJan. 1,2007 Percentage of RSF with lease expirations Total RSF 2007 2008 2009 2010 2011 2012andlater Hospital Investments McAllen Medical Center 532,403 0% 0% 0% 0% 0% 100% 0%Wellington Regional Medical Center 121,015 0% 0% 0% 0% 0% 100% 0%Kindred Hospital Chicago Central 115,554 0% 0% 0% 0% 0% 100% 0%Southwest Healthcare System, Inland Valley Campus 108,499 0% 0% 0% 0% 0% 100% 0%The Bridgeway 77,901 0% 0% 0% 0% 0% 0% 100%Tri-State Regional Rehabilitation Hospital 77,440 0% 0% 0% 100% 0% 0% 0% Subtotal Hospitals 1,032,812 0% 0% 0% 7% 0% 85% 8% Other Investments Medical Office Buildings: Desert Samaritan Hospital MOBs (a.) 200,755 3% 30% 31% 10% 9% 12% 5%Saint Mary's Professional Office Building 190,268 5% 0% 0% 0% 0% 0% 95%Edwards Medical Plaza 141,945 13% 19% 22% 12% 9% 0% 25%700 Shadow Lane & Goldring MOBs 114,042 9% 19% 18% 11% 3% 2% 38%Desert Springs Medical Plaza 106,474 25% 7% 7% 21% 12% 7% 21%Centinela Medical Building Complex 103,353 7% 20% 4% 47% 2% 14% 6%Suburban Medical Plaza II 102,818 0% 2% 2% 12% 0% 34% 50%Thunderbird Paseo Medical Plaza I & II 96,569 0% 20% 43% 10% 10% 17% 0%Summerlin Hospital MOB II (b.) 92,110 0% 17% 9% 7% 6% 25% 36%Summerlin Hospital MOB 89,636 7% 8% 16% 40% 9% 10% 10%Papago Medical Park 79,251 17% 0% 28% 47% 8% 0% 0%Deer Valley Medical Office II 77,264 0% 5% 0% 6% 5% 0% 84%Mid Coast Hospital MOB 73,762 0% 0% 0% 0% 0% 44% 56%Sheffield Medical Building 71,940 17% 8% 18% 15% 14% 2% 26%Rosenberg Children's Medical Plaza 66,231 8% 0% 21% 0% 24% 7% 40%Sierra San Antonio Medical Plaza (c.) 59,160 41% 0% 0% 0% 0% 25% 34%Spring Valley Medical Office Building 57,830 7% 0% 0% 47% 11% 11% 24%Southern Crescent Center, II (d.) 53,680 6% 0% 0% 8% 86% 0% 0%Desert Valley Medical Center 53,625 8% 18% 23% 14% 10% 22% 5%Southern Crescent Center, I 41,400 72% 6% 0% 0% 0% 0% 22%Cypresswood Professional Center 40,082 9% 51% 33% 7% 0% 0% 0%Medical Center of Western Connecticut 37,522 1% 0% 4% 15% 62% 0% 18%Fresno-Herndon Medical Plaza 36,417 33% 47% 20% 0% 0% 0% 0%Apache Junction Medical Plaza 26,901 0% 26% 17% 4% 9% 9% 35%Santa Fe Professional Plaza 25,294 0% 15% 50% 18% 12% 5% 0%Rio Rancho Medical Center 22,956 0% 0% 0% 0% 0% 0% 100%Kelsey-Seybold Clinic at Kings Crossing 20,470 0% 0% 100% 0% 0% 0% 0%Professional Bldgs. at Kings Crossing 20,447 10% 22% 14% 0% 0% 24% 30%Orthopaedic Specialists of Nevada Bldg. 11,000 0% 0% 0% 100% 0% 0% 0%Family Doctor's MOB 9,155 0% 0% 0% 0% 0% 100% 0%Preschool and Childcare Centers: Chesterbrook Academy 8,300 0% 0% 0% 0% 0% 100% 0%Chesterbrook Academy 8,163 0% 0% 0% 0% 0% 100% 0%Chesterbrook Academy 8,100 0% 0% 0% 0% 0% 100% 0%Chesterbrook Academy 7,998 0% 0% 0% 0% 0% 100% 0% Sub-total Other Investments 2,154,918 9% 12% 15% 14% 9% 12% 29% Total 3,187,730 6% 8% 10% 12% 6% 36% 22% 22Table of Contents(a.)The Desert Samaritan Hospital MOBs is composed of three different MOB buildings, the first of which contains a master lease provision that covers allvacancies through March 31, 2008. The remaining two MOBs do not have a master lease provision.(b.)The Summerlin Hospital Medical Office Building II has a master lease provision that expires on September 30, 2010 which covers all vacancies.(c.)The Sierra San Antonio Medical Plaza has a master lease provision that expires when 45,000 RSF of the building has been occupied or the expirationterm of 2011, whichever occurs first.(d.)The Southern Crescent Center II has a master lease agreement that covers 46,300 RSF of space until June 30, 2010. 23Table 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, 2006 to a vote of security holders. PART II ITEM 5.Market for Registrant’s Common Equity and Related Stockholder Matters Market Information 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, 2006 and 2005 are summarized below: 2006 2005 HighPrice LowPrice HighPrice LowPriceFirst Quarter $37.35 $32.08 $32.15 $28.06Second Quarter $35.95 $29.72 $39.25 $27.47Third Quarter $36.65 $31.12 $40.80 $33.15Fourth Quarter $40.24 $35.09 $34.39 $31.15 Holders As of January 31, 2007, there were approximately 569 shareholders of record of our shares of beneficial interest. Dividends It is our intention to declare quarterly dividends to the holders of our shares of beneficial interest so as to comply with applicable sections of the InternalRevenue Code governing REITs. Our revolving credit facility limits our ability to increase dividends in excess of 95% of cash available for distribution, asdefined in our revolving credit agreement, unless additional distributions are required to be made so as to comply with applicable sections of the InternalRevenue Code and related regulations governing REITs. In each of the past two years, dividends per share were declared as follows: 2006 2005First Quarter $.560 $.505Second Quarter .565 .555Third Quarter .565 .555Fourth Quarter .570 .560 $2.260 $2.175 24Table of ContentsSecurities Authorized for Issuance Under Equity Compensation Plans The table below provides information, as of December 31, 2006, concerning securities authorized for issuance under our equity compensation plans. Equity Compensation Plan Information Plan category Number of securitiesto be issued uponexercise of outstandingoptions, warrants and rights(a) Weighted-average exerciseprice of outstandingoptions, warrants and rights Number of securitiesremaining available forfuture issuance underequity compensationplans (excluding column(a))Equity compensation plans approvedby security holders 218,000 $7.58 166,000Equity compensation plans notapproved by security holders — — — TOTAL 218,000 $7.58 166,000 25Table of ContentsStock Price Performance Graph The following graph compares our performance with that of the S&P 500 and a group of peer companies, where performance has been weighted basedon market capitalization. Companies in our peer group are as follows: Health Care Property Investors, Inc., Nationwide Health Properties, Inc., OmegaHealthcare Investors, Inc., Health Care REIT, Inc., Healthcare Realty Trust, Inc., LTC Properties, Inc., National Health Investors, Inc. and National HealthRealty, Inc. The Stock Price Performance Graph shall not be deemed incorporated by reference by any general statement incorporating by reference in this Form 10-K into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934, except to the extent we specifically incorporate thisinformation by reference, and shall not otherwise be deemed filed under such Acts. The total cumulative return on investment (change in the year-end stock price plus reinvested dividends) for each of the periods for us, the peer groupand the S&P 500 Composite is based on the stock price or composite index at the end of fiscal 2001. BasePeriodDec01 INDEXED RETURNS Years EndingCompany Name / Index Dec02 Dec03 Dec04 Dec05 Dec06Universal Health Realty Income Trust $100 $120.31 $148.07 $168.47 $175.69 $232.79S&P 500 Index $100 $77.90 $100.25 $111.15 $116.61 $135.03Peer Group $100 $109.64 $162.08 $195.07 $188.82 $271.05 26Table of ContentsITEM 6.Selected Financial Data The following table contains our selected financial data for, or at the end of, each of the five years ended December 31, 2006. You should read this tablein conjunction with our consolidated financial statements and related notes contained elsewhere in this Annual Report and in Part II, Item 7, Management’sDiscussion and Analysis of Financial Condition and Results of Operations. (000s, except per share amounts) 2006(1) 2005(1) 2004(1) 2003 2002 Operating Results: Total revenue(2) $32,509 $33,338 $31,777 $27,052 $27,168 Income from continuing operations 34,697 25,423 21,712 23,433 20,631 Income from discontinued operations, net (including gain on sale of realproperty of $833 during 2004) — — 1,959 992 992 Net income $34,697 $25,423 $23,671 $24,425 $21,623 Balance Sheet Data: Real estate investments, net of accumulated depreciation(2) $143,363 $152,865 $157,601 $130,298 $134,375 Investments in LLCs(2) 47,223 29,572 40,523 61,001 48,314 Total assets(2) 194,139 196,889 204,583 194,291 185,117 Total indebtedness(2)(3) 26,337 35,548 46,210 37,242 30,493 Other Data: Funds from operations(4) $28,930 $29,202 $31,149 $30,101 $28,527 Cash provided by (used in): Operating activities 24,702 25,303 26,967 26,218 25,059 Investing activities (2,045) 8,408 11,905 (10,194) (199)Financing activities (23,217) (35,582) (36,387) (15,994) (24,891)Per Share Data: Basic earnings per share: From continuing operations $2.94 $2.16 $1.85 $2.00 $1.77 From discontinued operations — — 0.17 0.09 0.08 Total basic earnings per share $2.94 $2.16 $2.02 $2.09 $1.85 Diluted earnings per share: From continuing operations $2.92 $2.15 $1.84 $1.99 $1.76 From discontinued operations — — 0.16 0.08 0.08 Total diluted earnings per share $2.92 $2.15 $2.00 $2.07 $1.84 Dividends per share $2.260 $2.175 $2.000 $1.960 $1.920 Other Information (in thousands) Weighted average number of shares outstanding—basic 11,784 11,764 11,744 11,713 11,687 Weighted average number of shares and share equivalents outstanding—diluted 11,866 11,841 11,813 11,779 11,750 (1)See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”(2)During the first quarter of 2004, pursuant to the terms of FASB Interpretation No. 46R, Consolidation of Variable Interest Entities, an Interpretationof ARB No. 51, we began recording the operating results of three LLCs, in which we hold majority, non-controlling ownership interests, on aconsolidated basis. At that time, these LLCs were recorded on a consolidated basis due to certain master lease, lease assurance or lease guaranteeagreement between UHS and the properties owned by the LLCs. As a result of the expiration of 27Table of Contents the master lease arrangements between UHS and two of these LLCs, during the fourth quarter of 2006, we began recording the financial results of theseLLCs on an unconsolidated basis. There was no impact on our net income as a result of recording these LLCs on an unconsolidated or a consolidatedbasis.(3)Excludes $180.9 million as of December 31, 2006 and $152.3 million as of December 31, 2005, of third-party debt, that is non-recourse to us,incurred by unconsolidated LLCs in which we hold various non-controlling equity interests (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 Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO inaccordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. To facilitate a clearunderstanding of our historical operating results, FFO should be examined in conjunction with net income, determined in accordance with GAAP. FFOdoes not represent cash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net incomedetermined in accordance with GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordancewith GAAP; (ii) as an alternative to cash flow from operating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) noris FFO an indicator of funds available for our cash needs, including our ability to make cash distributions to shareholders. A reconciliation of ourreported net income to FFO is shown below. FFO shown above is calculated is follows: (000s) 2006 2005 2004 2003 2002 Net income $34,697 $25,423 $23,671 $24,425 $21,623 Depreciation expense: Consolidated investments 5,438 5,503 5,038 4,361 4,333 Unconsolidated affiliates 4,613 4,012 4,282 4,146 3,791 Less gains: Previously deferred gain on sale of our interest in an unconsolidated LLC (1,860) — — — — Gain on asset exchange and substitution agreement with UHS—Chalmette (13,958) — — — — Property damage recovered from UHS-Wellington — (4,693) — — — Gains recorded by unconsolidated affiliates — (1,043) (1,009) (2,831) (1,220)Gain on sale of real property, included in income from discontinued operations — — (833) — — FFO $28,930 $29,202 $31,149 $30,101 $28,527 ITEM 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview We are a real estate investment trust (“REIT”) that commenced operations in 1986. We invest in healthcare and human service related facilities includingacute care hospitals, behavioral healthcare facilities, rehabilitation hospitals, sub-acute facilities, surgery centers, childcare centers and medical officebuildings. As of December 31, 2006, we have forty-five real estate investments or commitments in fifteen states consisting of: • six hospital facilities including three acute care, one behavioral healthcare, one rehabilitation and one sub-acute; • thirty-five medical office buildings (including five being constructed), and; • four preschool and childcare centers. 28Table of ContentsForward Looking Statements This Annual Report contains “forward-looking statements” that reflect our current estimates, expectations and projections about our future results,performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results ofoperations, business and growth strategies, financing plans, expectations that regulatory developments or other matters will not have a material adverse effecton our business or financial condition, our competitive position and the effects of competition, the projected growth of the industry in which we operate, andthe benefits and synergies to be obtained from our completed and any future acquisitions, and statements of our goals and objectives, and other similarexpressions concerning matters that are not historical facts. Words such as “may,” “will,” “should,” “could,” “would,” “predicts,” “potential,” “continue,”“expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates,” “appears,” “projects” and similar expressions, as well as statements in futuretense, identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of thetimes at, or by which, such performance or results will be achieved. Forward-looking information is based on information available at the time and/or ourgood faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially fromthose expressed in the statements. Such factors include, among other things, the following: • a substantial portion of our revenues are dependent upon one operator, Universal Health Services, Inc., (“UHS”); • a subsidiary of UHS is our Advisor and our officers are all employees of UHS, which may create the potential for conflicts of interest; • lost revenues from purchase option exercises and lease expirations and renewals, loan repayments and other restructuring; • the availability and terms of capital to fund the growth of our business; • the outcome of known and unknown litigation, government investigations, and liabilities and other claims asserted against us or the operators ofour facilities, including the investigation of UHS’s South Texas Health Systems affiliates, which includes McAllen Medical Center, as describedherein; • our majority ownership interests in various LLCs in which we hold non-controlling equity interests; • real estate market factors, including without limitation the supply and demand of office space and market rental rates, changes in interest rates aswell as an increase in the development of medical office condominiums in certain markets; • government regulations, including changes in the reimbursement levels under the Medicare and Medicaid program; • the issues facing the health care industry that affect the operators of our facilities, including UHS, such as: changes in, or the ability to complywith, existing laws and government regulations; unfavorable changes in the levels and terms of reimbursement for our charges by third partypayors or government programs, including Medicare or Medicaid; demographic changes; the ability to enter into managed care provider agreementson acceptable terms; an increase in uninsured and self-pay patients which unfavorably impacts the collectibility of patient accounts; decreasing in-patient admission trends; technological and pharmaceutical improvements that may increase the cost of providing, or reduce the demand for, healthcare; the ability to attract and retain qualified medical personnel, including physicians; • the ability of operators of our facilities, particularly UHS, to obtain adequate levels of general and professional liability insurance; • two LLCs that own properties in California, in which we have various non-controlling equity interests, could not obtain earthquake insurance atrates which are economically beneficial in relation to the risks covered; 29Table of Contents • competition for our operators from other REITs; • competition from other health care providers, including physician owned facilities and other facilities owned by UHS, including, but not limited to,McAllen, Texas, the site of our largest acute care facility; • changes in, or inadvertent violations of, tax laws and regulations and other factors than can affect REITs and our status as a REIT; • fluctuations in the value of our common stock, and; • other factors referenced herein or in our other filings with the Securities and Exchange Commission. Given these uncertainties, risks and assumptions, you are cautioned not to place undue reliance on such forward-looking statements. Our actual resultsand financial condition, including the operating results of our lessees and the facilities leased to subsidiaries of UHS, could differ materially from thoseexpressed in, or implied by, the forward-looking statements. Forward-looking statements speak only as of the date the statements are made. We assume no obligation to publicly update any forward-lookingstatements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except as may be required bylaw. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimatesand assumptions that affect the amounts reported in our consolidated financial statements and accompanying notes. A summary of our significant accounting policies is outlined in Note 1 to the consolidated financial statements. We consider our critical accountingpolicies to be those that require us to make significant judgments and estimates when we prepare our financial statements, including the following: Revenue Recognition — Our revenues consist primarily of rentals received from tenants, which are comprised of minimum rent (base rentals), bonusrentals and reimbursements from tenants for their pro-rata share of expenses such as common area maintenance costs, real estate taxes and utilities. The minimum rent for all hospital facilities is fixed over the initial term or renewal term of the respective leases. Rental income recorded by ourconsolidated and unconsolidated MOBs relating to leases in excess of one year in length, is recognized using the straight-line method under which contractualrents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting from straight-line rent adjustmentsis dependent on many factors including the nature and amount of any rental concessions granted to new tenants, scheduled rent increases under existingleases, as well as the acquisitions and sales of properties that have existing in-place leases with terms in excess of one year. As a result, the straight-lineadjustments to rental revenue may vary from period-to-period. Bonus rents are recognized when earned based upon increases in each facility’s net revenue inexcess of stipulated amounts. Bonus rentals are determined and paid each quarter based upon a computation that compares the respective facility’s currentquarter’s net revenue to the corresponding quarter in the base year. Tenant reimbursements for operating expenses are accrued as revenue in the same period therelated 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. In accordance with theAmerican Institute of Certified Public Accountants’ Statement of Position 78-9 “Accounting for Investments in Real Estate Ventures” as amended by FASBStaff Position SOP 78-9-1 “Interaction of AICPA Statement of Position 78-9 and EITF Issue 30Table of ContentsNo. 04-5”, Emerging Issues Task Force Issue (EITF) 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interestbut the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights” and EITF 04-5 “Determining Whether a General Partner, or theGeneral Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights” we account for ourunconsolidated investments in LLCs which we do not control using the equity method of accounting. The third-party members in these investments haveequal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and; (iii) financing commitments.These investments, which represent 33% to 99% non-controlling ownership interests, are recorded initially at our cost and subsequently adjusted for our netequity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements, allocations of profits and losses ofsome of the LLC investments may be allocated disproportionately as compared to ownership interests after specified preferred return rate thresholds have beensatisfied. 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. As aresult of our related party relationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and variousproperties owned by three LLCs in which we own non-controlling ownership interests ranging from 95% to 99%, these LLCs were considered to be variableinterest entities (see Note 9 to the consolidated financial statements). In addition, we were the primary beneficiary of these LLC investments. Upon the adoptionof FIN 46R on March 31, 2004, we began consolidating the results of operations of these three LLC investments in our consolidated financial statements. As a result of the expiration of the master lease arrangements between subsidiaries of UHS and two of these three LLCs, during the fourth quarter of2006, we began recording the financial results of two LLCs on an unconsolidated basis in our consolidated financial statements. During the fourth quarter of2006, the revenues and expenses of these two LLCs are no longer included in our consolidated revenues and expenses; instead, our share of the net incomegenerated from each of these LLCs is included in our consolidated statements of income as “Equity in income of unconsolidated LLCs”. The revenues andexpenses for these LLCs related to the periods prior to the fourth quarter are included in our revenues and expenses in our consolidated statements of income.There was no impact on our net income as a result of the change in accounting for these LLCs. The other LLCs in which we hold various non-controlling ownership interests are not variable interest entities and therefore are not subject to theconsolidation requirements of FIN 46R. Federal Income Taxes — No provision has been made for federal income tax purposes since we qualify as a REIT under Sections 856 to 860 of theInternal Revenue Code of 1986, and intend to continue to remain so qualified. As such, we are exempt from federal income taxes and we are required todistribute 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 is our principal tenant and through UHS of Delaware, Inc., a wholly owned subsidiary of UHS, serves as our advisor (the “Advisor”) under anAdvisory Agreement dated December 24, 1986 between the Advisor and 31Table of Contentsus (the “Advisory Agreement”). Our officers are all employees of UHS and although as of December 31, 2006 we had no salaried employees, our officers doreceive stock-based compensation from time-to-time. Under the Advisory Agreement, the Advisor is obligated to present an investment program to us, to use its best efforts to obtain investments suitable forsuch program (although it is not obligated to present any particular investment opportunity to us), to provide administrative services to us and to conduct ourday-to-day affairs. In performing its services under the Advisory Agreement, the Advisor may utilize independent professional services, including accounting,legal, tax and other services, for which the Advisor is reimbursed directly by us. The Advisory Agreement expires on December 31 of each year; however, it isrenewable by us, subject to a determination by the Independent Trustees who are unaffiliated with UHS, that the Advisor’s performance has been satisfactory.The Advisory Agreement may be terminated for any reason upon sixty days written notice by us or the Advisor. The Advisory Agreement has been renewed for2007. All transactions between us and UHS must be approved by the Independent Trustees. The Advisor is entitled to certain advisory and incentive fees for it services. No incentive fees were paid during 2006, 2005 and 2004. The advisory feeis payable quarterly, subject to adjustment at year end, based upon our audited financial statements. See “Relationship with Universal Health Services, Inc.”in Item 1 and Note 2 to the consolidated financial statements for additional information on the Advisory Agreement and related fees. The leases on the hospital facilities leased to wholly-owned subsidiaries of UHS comprised approximately 49%, 48% and 51% of our revenues for theyears ended December 31, 2006, 2005 and 2004, respectively. Including 100% of the revenues generated at the unconsolidated LLCs in which we have variousnon-controlling equity interests ranging from 33% to 99%, the leases with wholly-owned UHS hospital facilities accounted for 24%, 25% and 27% of thecombined consolidated and unconsolidated revenues for the years ended December 31, 2006, 2005 and 2004, respectively. The leases to the hospital facilitiesof UHS are guaranteed by UHS and cross-defaulted with one another. Recent Accounting Pronouncements In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109.The statement provides a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. In accordance with the statement, before a tax benefit can be recognized, a tax position is evaluated using a threshold that itis more likely than not that the tax position will be sustained upon examination. When evaluating the more-likely-than-not recognition threshold, theinterpretation provides that a company should presume the tax position will be examined by the appropriate taxing authority that has full knowledge of allrelevant information. If the tax position meets the more-likely-than-not recognition threshold, it is initially and subsequently measured as the largest amount ofbenefit that is greater than 50% likely of being realized upon ultimate settlement. The interpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure and transition. This statement is effective on January 1, 2007. Since we believe we haveoperated in such a manner as to qualify for taxation as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and weintend to continue to operate in such a manner, we do not expect the adoption of this statement to have a material impact on our financial position or results ofoperations. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). This guidance was issued to resolve diversity incurrent practice among registrants. The bulletin establishes that registrants must quantify the impact of correcting all misstatements on the financial statementsby using both the rollover and iron curtain approaches to evaluate the errors. The rollover approach quantifies the misstatement based on the amount of theerror originating in the current year income statement and the iron curtain approach quantifies a misstatement based on the amount of the error existing in thebalance sheet at the end of the fiscal year. The bulletin contains guidance on correcting errors under the dual approach and transition guidance. The adoption ofSAB 108 did not have a material impact on our financial position or results of operations. 32Table of ContentsIn September, 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), whichclarifies the definition of fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands the disclosures regarding fair valuemeasurements. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accountingpronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within thosefiscal years. We do not anticipate the adoption of SFAS 157 will have a material effect on our financial position or results of operations. Results of Operations Year ended December 31, 2006 as compared to the year ended December 31, 2005: As a result of the expiration of the master lease arrangements between subsidiaries of UHS and two LLCs in which we own non-controlling ownershipinterests of 95% and 99%, during the fourth quarter of 2006, we began recording the financial results of these LLCs on an unconsolidated basis. Prior to thefourth quarter of 2006, these LLCs were included in our financial results on a consolidated basis in accordance with Financial Interpretation No. 46R,Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51, (“FIN 46R”). Accordingly, commencing with the fourth quarter of 2006, therevenues and expenses of these LLCs are no longer included in our consolidated revenues and expenses, but instead, our share of the net income generated fromeach of these LLCs in included in our consolidated statements of income as “Equity in income of unconsolidated LLCs”. There was no impact on our netincome as a result of the change in accounting for these two LLCs. The following table shows the combined operating results for these two LLCs during theperiod the results were recorded on an unconsolidated basis. The “As Adjusted” column on the table below presents our consolidated income statement for thetwelve month period ended December 31, 2006 as if we continued to consolidate these two LLCs through December 31, 2006. For comparative purposes, theamounts in the “As Adjusted” column are used in the discussions below (amounts in thousands). Twelve Months Ended December 31, 2006 As Reported in2006ConsolidatedStatement ofIncome Combinedresults fortwoLLCs duringperiod theywere recordedon anunconsolidatedbasis 2006 AsAdjusted As Reported in2005ConsolidatedStatement ofIncome Revenues $32,509 $834 $33,343 $33,338 Expenses: Depreciation and amortization 5,757 172 5,929 5,825 Advisory fee to UHS 1,424 — 1,424 1,420 Other operating expenses 6,547 377 6,924 6,667 13,728 549 14,277 13,912 Income before equity in unconsolidated LLCs, property damage recoveredfrom UHS and interest expense 18,781 285 19,066 19,426 Equity in income of unconsolidated LLCs (including recognition ofpreviously deferred gain of $1,860 during 2006 and gain on sale of realproperty of $1,043 during 2005) 4,241 (93) 4,148 4,602 Replacement property recovered from UHS—Chalmette 13,958 — 13,958 — Property damage recovered from UHS—Wellington — — — 4,693 Interest expense (2,283) (192) (2,475) (3,298) Net income $34,697 — $34,697 $25,423 33Table of ContentsTotal revenue decreased $829,000 during 2006, as compared to 2005, due primarily to the recording of the two LLCs on an unconsolidated basisduring the fourth quarter of 2006, as indicated above. Income from continuing operations and net income increased $9.3 million to $34.7 million, or $2.92per diluted share, during 2006 as compared to $25.4 million, or $2.15 per diluted share, during 2005. The $9.3 million, or $.77 per diluted share, increasein income from continuing operations and net income during 2006, as compared to 2005, was primarily attributable to: • a favorable change of $14.0 million, or $1.18 per diluted share, resulting from the Chalmette asset exchange and substitution transaction withUHS, as discussed herein; • an unfavorable change of $1.3 million, or $.10 per diluted share, resulting from a decrease in our equity in unconsolidated LLCs, as discussedbelow (excluding gains recorded by LLCs during 2006 and 2005 and after adjusting for $93,000 LLC impact, as indicated above); • a favorable change of $1.9 million, or $.16 per diluted share, resulting from the 2006 recognition of a deferred gain recorded in connection with thesale of our interest in an unconsolidated LLC during 2005; • an unfavorable change of $1.0 million, or $.09 per diluted share, resulting from a gain on the sale of real property recorded by an unconsolidatedLLC during 2005; • an unfavorable change of $4.7 million, or $.40 per diluted share, resulting from property damage recovered from UHS during 2005 related tohurricane damage sustained at Wellington Regional Medical Center; • a favorable change of $823,000, or $.07 per diluted share, resulting from a decrease in interest expense, as discussed below (after adjusting for the$192,000 LLC impact, as indicated above); • an unfavorable change of $257,000, or $.02 per diluted share, resulting from an increase in other operating expenses (after adjusting for the$377,000 LLC impact, as indicated above), and; • an unfavorable change of approximately $200,000, or $.02 per diluted share, resulting from other combined unfavorable changes including a$104,000 increase in depreciation and amortization expense, as discussed below (after adjusting for the $172,000 LLC impact, as indicated above). Included in our consolidated statement of income during 2005 was a property write-down charge of $6.3 million representing the book value of theChalmette property damaged by the hurricane. Included in our 2005 net income was an equal amount representing the property damage recoverable from UHS.Prior to the completion of the Asset Exchange and Substitution Agreement, Chalmette had a combined asset value of $8.3 million on our consolidated balancesheet consisting of $2.0 million of land held for exchange and $6.3 million of property damage receivable from UHS. Included in our net income during 2006was a gain of $14.0 million representing the total property transferred to us from UHS as of December 31, 2006 ($22.2 million) in excess of the $8.3 millionbook value of Chalmette. Upon the completion of the asset exchange and substitution during the third quarter of 2006, we received the above mentionedCapital Additions from Wellington and Bridgeway which had a combined fair value of $13.0 million. In addition, the construction costs related to thecompleted Capital Addition at Inland Valley amounted to $9.2 million as of December 31, 2006 ($11.0 million is total minimum estimated cost of InlandValley’s Capital Addition). Our future net income will include an additional $1.8 million of property recovered from UHS as the additional construction costsare incurred by UHS related to the Inland Valley Capital Addition, up to $11.0 million estimated total cost of construction. FASB Interpretation No. 30 (“FIN 30”), Accounting for Involuntary Conversion of Nonmonetary Assets to Monetary Assets, an Interpretation ofAPB No. 29 (“APB29”), provides guidance on the accounting for involuntary conversions of nonmonetary assets (such as property) to monetary assets(such as insurance proceeds). Although the damage to Chalmette did not directly result in the conversion of a nonmonetary asset to a monetary asset, we do notbelieve that the receipt of a nonmonetary asset is in substance different than the receipt of a monetary asset in the context of an involuntary conversion. Theguidance in FIN 30 would result in recognition of the assets received upon the involuntary conversion at their fair values with gain or loss 34Table of Contentsrecognized for the difference between the fair value of the assets received and the carrying value of the assets converted. Because it is not clear that the loss ofChalmette and related recovery from UHS represented a monetary conversion as described by FIN 30, we also considered the guidance in SFAS No. 153(“SFAS No. 153”), Exchanges of Nonmonetary Assets, as Amendment of APB 29, which is effective for nonmonetary asset exchanges occurring in thefiscal year beginning after June 15, 2005. SFAS No. 153 is based upon the principle that exchanges of nonmonetary assets should be measured based on thefair value of the assets exchanged, unless the exchange lacks “commercial substance”, as defined in paragraph 21 of APB 29, as amended by SFAS 153.After evaluating the provisions of SFAS No. 153, we concluded that the exchange of these assets had “commercial substance” since, as indicated above, thebase or minimum rent component of the total rental earned on the substituted assets has increased (by $562,000) over the base rental amount earned pursuantto the terms of the Chalmette lease. As a result, the risk component of the future lease stream has been significantly and favorably impacted. In addition, thefuture bonus rental earned on the substituted assets at Wellington, Bridgeway and Inland Valley will be impacted (either favorably or unfavorably) by thedistinct operating characteristics of those facilities such as the nature of the healthcare care services provided, the geographic markets serviced and patient andpayor mix, among other things. As a result of the facts and conclusions detailed above, and pursuant to the contingent gain guidance in SFAS No, 5,Accounting for Contingencies, we recorded the $14.0 million gain during 2006 which reflects the fair value of the assets transferred from UHS to us as ofDecember 31, 2006, net of the $6.3 million recoverable from UHS recorded during 2005 and the $2.0 million of Chalmette land relinquished. Included in our financial results was equity in income of unconsolidated LLCs of $4.2 million during 2006 and $4.6 million during 2005. After givingeffect to the $93,000 LLC impact, as indicated above, the equity in income of unconsolidated LLCs decreased by approximately $500,000 during 2006, ascompared to 2005, as follows: (i) an increase of $1.9 million resulting from the 2006 recognition of a deferred gain recorded in connection with the sale of ourinterest in an unconsolidated LLC during 2005; (ii) a decrease of $1.0 million resulting from a gain on the sale of real property recorded by an unconsolidatedLLC during 2005; (iii) a combined decrease of approximately $500,000 due to our share of the increased interest expense incurred by two LLCs during 2006,as compared to 2005, as a result of increased borrowings from refinancing of third-party debt, that is non-recourse to us; (iv) a decrease of approximately$300,000 due to the losses incurred by a newly constructed MOB that was completed and opened in March of 2006; (v) a decrease of approximately $200,000due to the recording of our share of a charge incurred by a LLC to write-off unamortized financing costs in connection with the refinancing of third-party debt,and; (vi) approximately $400,000 of other combined decreases. After giving effect to the $192,000 LLC impact, as indicated above, interest expense decreased $823,000 during 2006, as compared to 2005, dueprimarily to: (i) a $369,000 decrease due to the expiration of two interest-rate swaps that expired during 2005 and 2006; (ii) a $252,000 decrease due to a netcharge recorded during 2005 related to an interest-rate swap agreement that became ineffective based upon the forecasted borrowings under our revolving creditfacility; (iii) a decrease of $145,000 due to interest earned during 2006 on a note receivable related to the sale of our ownership interest in a LLC, and;(iv) $57,000 of other combined decreases. After giving effect to the $377,000 LLC impact, as indicated above, other operating expenses increased $257,000 during 2006, as compared to 2005, asfollows: (i) $175,000 of combined increases in expense resulting primarily from increased operating expenses at our MOBs, and; (ii) $82,000 of expenserecorded during 2006 in connection with the adoption of SFAS No. 123R. Included in our other operating expenses are expenses related to the consolidatedMOBs, a portion of which are passed on directly to the tenants. During 2006, the operating expenses associated with our consolidated MOBs totaled $5.2million (without giving effect to the $377,000 LLC impact, as indicated above) of which, $3.8 million or 73% were passed on directly to the tenants. During2005, the operating expenses associated with our MOBs totaled $5.4 million, of which $4.0 million or 75% were passed on directly to the tenants. Buildingexpenses allocated to tenants for reimbursement are dependent upon various factors such as overall building occupancy levels and terms of individual leases. 35Table of ContentsAfter giving effect to the $172,000 LLC impact, as indicated above, depreciation and amortization expense increased $104,000 during 2006, ascompared to 2005. The majority of the increase resulted from the increased depreciation expense recorded during 2006 on the Wellington and Bridgeway assetsreceived in connection with the asset exchange and substitution agreement with UHS (related to the damage sustained at Chalmette from Hurricane Katrina)and replacement property at Wellington (related to hurricane damage sustained during 2004). Funds from operations (“FFO”), is a widely recognized measure of REIT performance. Although FFO is a non-GAAP financial measure, we believe thatinformation regarding FFO is helpful to shareholders and potential investors. We compute FFO in accordance with standards established by the NationalAssociation of Real Estate Investment Trusts (“NAREIT”), which may not be comparable to FFO reported by other REITs that do not compute FFO inaccordance with the NAREIT definition, or that interpret the NAREIT definition differently than we interpret the definition. To facilitate a clear understandingof our historical operating results, FFO should be examined in conjunction with net income, determined in accordance with GAAP. FFO does not representcash generated from operating activities in accordance with GAAP and should not be considered to be an alternative to net income determined in accordancewith GAAP. In addition, FFO should not be used as: (i) an indication of our financial performance determined in accordance with GAAP; (ii) as an alternativeto cash flow from operating activities determined in accordance with GAAP; (iii) as a measure of our liquidity; (iv) nor is FFO an indicator of funds availablefor our cash needs, including our ability to make cash distributions to shareholders. Below is a reconciliation of our reported net income to FFO for 2006 and 2005 (in thousands): 2006 2005 Net income $34,697 $25,423 Depreciation expense: Consolidated investments 5,438 5,503 Unconsolidated affiliates 4,613 4,012 Less gains: Previously deferred gain on sale of our interest in an unconsolidated LLC (1,860) — Gain on asset exchange and substitution agreement with UHS – Chalmette (13,958) — Property damage recovered from UHS-Wellington — (4,693)Gains recorded by unconsolidated affiliates — (1,043)Gain on sale of real property, included in income from discontinued operations — — Funds From Operations $28,930 $29,202 Our FFO decreased 0.9% or $272,000 to $28.9 million during 2006 as compared to $29.2 million during 2005. This decrease in FFO was dueprimarily to: • an unfavorable change of approximately $900,000 of FFO generated from our unconsolidated LLCs. This decrease, which excludes depreciationand amortization expense recorded at the LLCs, resulted primarily from a $1.3 million decrease in our equity in unconsolidated LLCs, asdiscussed above (excluding gains recorded by LLCs during 2006 and 2005 and after adjusting for $93,000 LLC impact, as indicated above); • a favorable change of $823,000 resulting from a decrease in interest expense, as discussed above (after adjusting for the $192,000 LLC impact, asindicated above), and; • other combined unfavorable changes of approximately $200,000. Year ended December 31, 2005 as compared to the year ended December 31, 2004: Income from continuing operations increased $3.7 million to $25.4 million, or $2.15 per diluted share, during 2005 as compared to $21.7 million, or$1.84 per diluted share, during 2004. For the 2004 year, income from discontinued operations totaled $2.0 million, including a $833,000 gain on sale of realproperty. Net income increased $1.7 million to $25.4 million, or $2.15 per diluted share, during 2005 as compared to $23.7 million, or $2.00 per dilutedshare, during 2004. 36Table of ContentsThe $1.7 million, or $.15 per diluted share, increase in net income during 2005, as compared to 2004, was primarily attributable to: • a favorable change of $4.7 million, or $.40 per diluted share, resulting from the property damage recovered from UHS during 2005 in connectionwith replacement of hurricane-damaged property at Wellington; • an unfavorable change of approximately $1.2 million, or $.10 per diluted share, from an increase in other operating expenses (excluding the impactof FIN 46R) resulting primarily from increased operating expenses related to our MOBs, increased administrative costs, including insuranceexpense, and an asset write-off charge recorded during 2005 in connection with building renovations at one of our MOBs; • an unfavorable change of $700,000, or $.06 per diluted share, resulting from the purchase of Virtue Street Pavilion by UHS in December of 2004(net of interest expense savings on the $7.3 million of sale proceeds received and the depreciation expense decrease); • an unfavorable change of $833,000, or $.07 per diluted share, resulting from the gain recorded during 2004 on the purchase of Virtue Street Pavilionby UHS during 2004, and; • other unfavorable changes of approximately $300,000, or $.02 per diluted share, including increased depreciation expense recorded in connectionwith the replacement of hurricane-damaged property at Wellington. Total revenues increased by $1.6 million to $33.3 million in 2005 as compared to $31.8 million in 2004. The increase was due primarily to theconsolidation of the results of operations of the three LLCs as of April 1, 2004 pursuant to FIN 46R, as discussed below. Other operating expenses increased $1.7 million to $6.7 million during 2005 as compared to $5.0 million during 2004. Approximately $500,000 of theincrease in operating expenses is due to the consolidation of the three LLCs pursuant to FIN 46R, as discussed below. Also contributing to the increase in otheroperating expense during 2005, as compared to 2004, was increased administrative costs, including increased insurance expense, and an asset write-off chargeof approximately $100,000 recorded during 2005 in connection with building renovations at one of our MOBs. Included in our other operating expenses areexpenses related to the consolidated medical office buildings, which totaled $5.3 million during 2005 and $4.3 million during 2004. A portion of the expensesassociated with our consolidated medical office buildings is passed on directly to the tenants. Tenant reimbursements for operating expenses are accrued asrevenue in the same period the related expenses are incurred and are included as tenant reimbursement revenue in our statements of income. Approximately $4.0million or 75% in 2005, and $3.3 million or 75% in 2004, of the operating expenses related to the medical office buildings were passed on directly to thetenants. Building expenses allocated to tenants for reimbursement are dependent upon various factors such as overall building occupancy levels and terms ofindividual leases. Depreciation and amortization increased $648,000 during 2005, as compared to 2004, due primarily to the consolidation of the LLCs pursuant to FIN46R, as discussed below, as well as an increase resulting from the depreciation expense recorded on the replacement of hurricane-damaged property atWellington. Interest expense decreased $59,000 during 2005 as compared to 2004, due primarily to: (i) an increase of $426,000 resulting from the consolidation ofthe LLCs pursuant to FIN 46R , as discussed below; (ii) a net charge of $252,000 related to an interest-rate swap agreement that became ineffective basedupon the forecasted borrowings under our revolving credit facility, and; (iii) a decrease of approximately $737,000 due primarily to a decrease in our averageoutstanding borrowings, partially offset by an increase in our average cost of funds. Contributing to the decrease in our average outstanding borrowing during2005, as compared to 2004, is the repayment of debt using the $7.3 million of proceeds received related to UHS’s purchase of Virtue Street Pavilion inDecember of 2004. Included in our financial results was $4.6 million during 2005 and $5.0 million during 2004, of operating income generated from our ownership ofequity interests in limited liability companies which own medical office 37Table of Contentsbuildings in Arizona, California, Kentucky, New Mexico, Nevada and Maine (see Note 9 to the consolidated financial statements). Included in our financialresults during each of the years ended December 31, 2005 and 2004 were gains of $1.0 million resulting from the sale of real property by unconsolidatedLLCs. The $400,000 decrease during 2005, as compared to 2004, is due primarily to the consolidation of the three LLCs pursuant to FIN 46R, as discussedbelow. As of December 31, 2005, we had investments or commitments in twenty-two limited liability companies (“LLCs”), nineteen of which were accountedfor by the equity method and three that were 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” (“VIEs”), an Interpretation of ARB No. 51. As a result of our related partyrelationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and various properties owned by three LLCsin which we own non-controlling ownership interests ranging from 95% to 99%, these LLCs were considered to be variable interest entities. In addition, weare primary 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. The remaining LLCs were not variable interest entities and therefore were not subject to the consolidationrequirements of FIN 46R. As a result of the expiration of the master lease arrangements between subsidiaries of UHS and two LLCs in which we own non-controlling ownership interests of 95% and 99%, during the fourth quarter of 2006, we began recording the financial results of these two LLCs on anunconsolidated basis again. Our consolidated statements of income for the three and twelve month periods ended December 31, 2005 include the revenue and expenses associatedwith the three consolidated LLCs. The revenue and expenses associated with these properties were also included in our consolidated statements of income forthe nine month period of April 1, 2004 through December 31, 2004. Prior to April 1, 2004, the operations of these LLCs were recorded in our consolidatedstatements of income using the equity method of accounting and, therefore, the revenue and expenses of these three LLCs were not consolidated in ourconsolidated statements of income. As detailed in the table below, during the three month period ended March 31, 2004, these properties generatedapproximately $1.6 million of revenue, $300,000 of depreciation and amortization expense, $500,000 of other operating expenses and $400,000 of interestexpense. The “As Adjusted” column in the table below presents the effect this three month period ended March 31, 2004 would have had on our consolidatedstatement of income for the twelve month period ended December 31, 2004, had we consolidated these three VIEs for the three month period ended March 31,2004. There was no impact on our net income as a result of the consolidation of these LLCs (amounts in thousands). Twelve Months Ended December 31, 2004 As reported inConsolidatedStatements ofIncome Jan –Mar,2004CombinedStatementsof Incomefor LLCs AsAdjusted Revenues $31,777 $1,646 $33,423 Expenses: Depreciation and amortization 5,177 292 5,469 Advisory fee to UHS 1,498 — 1,498 Other operating expenses 5,000 559 5,559 Property write-down - hurricane damage—Wellington 1,863 — 1,863 Property damage recoverable from UHS—Wellington (1,863) — (1,863) 11,675 851 12,526 Income before equity in unconsolidated LLCs, hurricane recoveries in excess of expense and interestexpense 20,102 795 20,897 Equity in income of unconsolidated LLCs (including gain on sale of real property of $1,009) 4,967 (360) 4,607 Interest expense (3,357) (435) (3,792)Income from discontinued operations 1,959 — 1,959 Net Income $23,671 — $23,671 38Table of ContentsDuring the fourth quarter of 2005, we sold our 48% non-controlling ownership interest in West Highland Holdings, a LLC which owned the St. JudeHeritage Health Complex, located in California, in exchange for a $3.1 million note receivable which is collateralized by the entire ownership interest of theLLC. This transaction resulted in a deferred gain of $1.9 million which we recognized as income during 2006 when the cash proceeds to repay the notereceivable were received by us. During the third quarter of 2005, Chalmette Medical Center, a 138-bed acute care hospital located in Chalmette, Louisiana, was severely damaged andclosed as a result of Hurricane Katrina. At that time, the majority of the real estate assets of Chalmette were leased from us by a subsidiary of UHS and, inaccordance with the terms of the lease, and as part of an overall evaluation of the leases between subsidiaries of UHS and us, UHS offered substitutionproperties rather than exercise its right to rebuild the facility or offer cash for Chalmette. During 2006, we executed an asset exchange and substitutionagreement with UHS whereby we received, or are scheduled to receive, additional assets at Wellington, Bridgeway and Inland Valley in replacement of theChalmette assets. See Note 2 to the consolidated financial statements for additional disclosure. 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, located in Mesa, Arizona. Our share of the net sale proceeds resulting from this transaction was $2.9 million. The transactionresulted in a gain of which our share was approximately $1.0 million, which is included in our results of operations for 2005. 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. The facility did notexperience significant business interruption. Our Consolidated Statements of Income for the year ended December 31, 2004, included a property write-downcharge of $1.9 million representing the estimated net book value of the damaged assets. This property charge was offset at that time by an equal amountrecoverable from UHS. During 2004, UHS incurred approximately $1.9 million in replacement costs in connection with this property and that amount wasincluded as construction in progress on our Consolidated Balance Sheet as of December 31, 2004. During the twelve months ended December 31, 2005, UHSincurred an additional $4.7 million in replacement costs and since these additional costs were also recovered from UHS, $4.7 million was included in netincome during the year ended December 31, 2005. As of December 31, 2005, UHS spent a total of approximately $6.6 million to replace the damagedproperty at this facility and this amount is reflected as buildings and improvements on our Consolidated Balance Sheet. During the first quarter of 2004, thelessee of this facility completed and financed an $8.5 million expansion to the facility in order to meet patient demand. Accordingly, since the bonus rentcalculation on this facility is based on net revenues, the lease was amended at that time to exclude from the bonus rent calculation the estimated net revenuesgenerated from the UHS-owned real estate assets (as calculated pursuant to a percentage based allocation determined at the time of expansion). 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. Upon the December, 2004 lease expiration on the Virtue Street Pavilion, the former lessee (a wholly-owned subsidiary of UHS), exercised its optionpursuant to the terms of the lease and purchased the facility at its appraised fair market value of $7,320,000. Prior to the transaction, the annual minimumrent payable to us under the lease was $1,261,000 and no bonus rent was earned on this facility during 2004. As a result of this transaction, our cash flowsfrom operating activities were adversely affected since calculated using our average incremental borrowing rate during 2005, the reduction in annual interestexpense resulting from repayment of borrowings using the $7.3 million of sale proceeds was approximately $900,000 less than the annual rental 39Table of Contentspayments earned by us pursuant to the terms of the lease. After adjusting for the decreased deprecation expense resulting from this transaction, our net incomedecreased approximately $700,000 during 2005, as compared to 2004. The following table shows the results of operations for the Virtue Street Pavilion which were reflected as “Income from discontinued operations, net” inthe consolidated statements of income for the year ended December 31, 2004 (in thousands): Year EndedDecember 31,2004 Revenues $1,261 Depreciation expense (135) Income from operations 1,126 Gain on sale 833 Income from discontinued operations, net $1,959 Below is a reconciliation of our reported net income to FFO for 2005 and 2004 (in thousands): 2005 2004 Net income $25,423 $23,671 Depreciation expense: Consolidated investments 5,503 5,038 Unconsolidated affiliates 4,012 4,282 Less gains: Property damage recovered from UHS-Wellington (4,693) — Gains recorded by unconsolidated affiliates (1,043) (1,009)Gain on sale of real property, included in income from discontinued operations — (833) FFO $29,202 $31,149 Our FFO decreased 6.3% or $1.9 million to $29.2 million 2005 as compared to $31.1 million in 2004. This decrease in FFO was due primarily to: • an unfavorable change caused by an increase in other operating expenses of approximately $1.2 million (excluding the impact of FIN 46R) resultingprimarily from increased operating expenses related to our MOBs, increased administrative costs, including insurance expense, and an asset write-off charge recorded during 2005 in connection with building renovations at one of our MOBs; • an unfavorable change of approximately $900,000 resulting from the purchase of Virtue Street Pavilion by UHS in December of 2004 (net of interestexpense savings on the $7.3 million of sale proceeds received), and; • other combined favorable changes of approximately $200,000. 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 40Table of Contentspredict 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 thesetrends will not have a material adverse effect on the future results of operations of the operators of our facilities which may affect their ability to make leasepayments 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 MOBleases require the tenant to pay an allocable share of operating expenses, including common area maintenance costs, insurance and real estate taxes. Theseprovisions may reduce our exposure to increases in operating costs resulting from inflation. To the extent that some leases do not contain such provisions, ourfuture operating results may be adversely impacted by the effects of inflation. Liquidity and Capital Resources Year ended December 31, 2006 as compared to December 31, 2005: Net cash provided by operating activities Net cash provided by operating activities was $24.7 million during 2006 as compared to $25.3 million during 2005. The $601,000 net decrease wasattributable to: • an unfavorable change of $1.1 million due to a decrease in net income plus or minus the adjustments to reconcile net income to net cash providedby operating activities (depreciation and amortization, gain on sales of properties by LLCs, gain on sale of our interest in a LLC, property write-down from hurricane damage-Chalmette, property damage recoverable from UHS-Chalmette, property damage recovered from UHS (Chalmette andWellington) and net loss on ineffective cash flow hedge); • a favorable change of $574,000 in rent receivable; • a favorable change of $140,000 in tenant reserves, escrows, deposits and prepaid rents; • an unfavorable change of $136,000 in accrued interest, and; • $79,000 of other unfavorable changes. The $1.1 million unfavorable change in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activitieswas due to: (i) a $1.3 million unfavorable change resulting from a decrease in equity in income of unconsolidated LLCs, as discussed above (excludes thegains from both periods); (ii) an $823,000 favorable change resulting from a decrease in interest expense, as discussed above; (iii) an unfavorable change of$257,000 due to an increase in other operating expenses, as discussed above, and; (iv) other combined unfavorable changes of $366,000. Net cash (used in)/provided by investing activities Net cash (used in)/provided by investing activities was ($2.0 million) during 2006 as compared to $8.4 million during 2005. 2006: During 2006, we used $2.0 million of net cash in investing activities as follows: • spent $7.6 million to fund advances to unconsolidated LLCs; • spent $5.3 million to fund equity investments in unconsolidated LLCs; • spent $1.3 million to fund capital additions at certain of our consolidated real estate investments; 41Table of Contents • received $5.7 million of cash proceeds in connection with refinancing of third-party debt by an unconsolidated LLC; • received $3.1 million of cash proceeds related to the sale of our interest in a LLC; • received $1.9 million of repayments of advances made to unconsolidated LLCs, and; • received $1.4 million of cash distributions in excess of income from our unconsolidated LLCs. During 2006, we spent $7.6 million to fund advances to unconsolidated LLCs as follows: • $5.3 million advance made to a LLC that will develop, construct, own and operate the Spring Valley Hospital Medical Office Building II, located inLas Vegas, Nevada on the campus of a UHS facility, in which we have a 95% non-controlling equity interest. We have committed to a total of $8.9million of debt financing to this LLC, of which $5.3 million has been funded as of December 31, 2006. This project is scheduled to be completedand opened during the second quarter of 2007; • $630,000 advance made to the LLC that owns Rio Rancho Medical Center, an existing LLC in which we have a 80% non-controlling equity interest(subsequent to December 31, 2006, the real estate assets of this LLC were sold) ; • $540,000 advance (which was fully repaid during the third quarter) made to a master LLC which governs four unconsolidated LLCs in which wehave a 90% non-controlling equity interest; • $485,000 advance made to the LLC that constructed and owns the Sierra San Antonio Medical Plaza, located in Fontana, California, in which wehave a 95% non-controlling equity interest. The LLC also obtained a $7.5 million third-party construction loan, which is non-recourse to us. Thisproject was completed and opened during the first quarter of 2006; • $363,000 advance made to the LLC that will develop, construct, own and operate the Phoenix Children’s East Valley Care Center, located inGilbert, Arizona, in which we have a 95% non-controlling equity interest. This project is scheduled to be completed and opened during the thirdquarter of 2007, and; • $259,000 of advances made to various LLCs in which we own a non-controlling equity interest. During 2006, we spent $5.3 million spent to fund equity investments in unconsolidated LLCs as follows: • $1.6 million of equity funded to the LLC that constructed and owns the Sierra San Antonio Medical Plaza, located in Fontana, California, inwhich we have a 95% non-controlling equity interest. We have committed to invest a total of up to $3.5 million in equity in this LLC, of which$2.6 million has been funded to date. The LLC also obtained a $7.5 million third-party construction loan, which is non-recourse to us. Thisproject was completed and opened during the first quarter of 2006; • $1.5 million of equity funded to the LLC that will develop, construct, own and operate the Phoenix Children’s East Valley Care Center, located inGilbert, Arizona, in which we have a 95% non-controlling equity interest. We have committed to invest a total of up to $3.5 million in equity in thisLLC. This project is scheduled to be completed and opened during the third quarter of 2007; • $637,000 of additional equity funded to the LLC that constructed and owns the Saint Mary’s Professional Office Building located in Reno,Nevada, in which we have a 75% non-controlling equity interest. We have committed to invest a total of $8.0 million in equity in this LLC, ofwhich $5.0 million has been funded as of December 31, 2006. The LLC also obtained a $29 million third-party mortgage that is non-recourse tous; • $532,000 of additional equity funded to the LLC that owns the Desert Samaritan Hospital MOBs located in Mesa, Arizona, in which we have a76% non-controlling equity interest; 42Table of Contents • $329,000 of additional equity funded to the LLC that owns the 700 Shadow Lane & Goldring MOBs located in Las Vegas, Nevada, in which wehave a 98% non-controlling equity interest; • $214,000 of additional equity funded to the LLC that owns the Spring Valley Medical Office Building located in Las Vegas, Nevada, on thecampus of a UHS facility, in which we have a 95% non-controlling equity interest, and; • $562,000 of additional investments in various LLCs in which we own a non-controlling equity interest. Also during 2006, the $1.9 million of cash received in connection with repayments of advances previously made to LLCs, was as follows: • $1.2 million received from the LLC that owns the Suburban Medical Plaza II, located in Louisville, Kentucky, in which we have a 33% non-controlling equity interest; • $540,000 received from the master LLC which governs four unconsolidated LLCs in which we have a 90% non-controlling equity interest, and; • $160,000 received from various LLCs in which we own non-controlling equity interests. 2005: During 2005, we generated $8.4 million of net cash provided by investing activities as follows: • spent $8.3 million to fund equity investments in unconsolidated LLCs; • spent $2.9 million to fund advances to unconsolidated LLCs; • spent $2.4 million to fund capital additions at certain of our consolidated real estate investments; • received $9.6 million of repayments of advances made to unconsolidated LLCs; • received $8.5 million of cash proceeds in connection with refinancing of third-party debt by unconsolidated LLCs; • received $2.9 million of cash proceeds related to sales of properties by unconsolidated LLCs; • received $1.0 million of cash distributions in excess of income from our unconsolidated LLCs. Included in the $8.3 million of equity investments in unconsolidated LLCs and the $2.9 million of advances made to unconsolidated LLCs during2005 ($11.2 million in total) was the following: • $4.5 million of equity funded in connection with the purchase of a 75% non-controlling interest in a LLC that constructed and owns the SaintMary’s Center for Health located in Reno, Nevada, which opened in March, 2005; • $2.5 million paid to an unrelated third-party member as net consideration in connection with the restructure of the ownership interests in fiveexisting unconsolidated LLCs (see Note 9 to the consolidated financial statements); • $1.0 million funded in exchange for a 95% non-controlling interest in a LLC that constructed and owns the Sierra San Antonio Medical Plaza,located in Fontana, California. This project was completed and opened during 2006; • $235,000 of additional equity funded during the third quarter of 2005 to the LLC that owns the 700 Shadow Lane & Goldring MOBs located inLas Vegas, Nevada, in which we have a 98% non-controlling equity interest; • $400,000 additional advance to a LLC that owns the Saint Mary’s Center for Health, in connection with the purchase of a 75% non-controllinginterest in the LLC (which was fully repaid during 2005); • $680,000 advance made to Desert Samaritan Hospital MOBs, an existing LLC which we have a 76% non-controlling equity interest (which wasfully repaid during 2005); 43Table of Contents • $425,000 advance made to Edwards Medical Plaza, an existing LLC in which we have a 90% non-controlling equity interest; • $1.3 million advance made to Suburban Medical Plaza II, an existing LLC in which we have a 33% non-controlling equity interest, and; • $85,000 advance made to Rio Rancho Medical Center, an existing LLC in which we have a 80% non-controlling equity interest (subsequent toDecember 31, 2006, the real estate assets of this LLC were sold). Also during 2005, the $9.6 million of cash received in connection with repayments of advances previously made to LLCs, was as follows: • $6.5 million received as repaid advances previously provided to a LLC that owns the 700 Shadow Lane & Goldring MOBs located in Las Vegas,Nevada, in which we have a 98% non-controlling equity interest; • $2.5 million received as repaid advances previously provided to a LLC that owns the Saint Mary’s Center for Health located in Reno, Nevada, inwhich we have a 75% non-controlling equity interest, and; • $680,000 received as repaid advances previously provided to a LLC that owns the Desert Samaritan Hospital MOBs located in Mesa, Arizona, inwhich we have a 76% non-controlling equity interest. Net cash used in financing activities Net cash used in financing activities was $23.2 million during 2006 and $35.6 million during 2005. During 2006, we had net debt borrowings of $3.6 million on our revolving line of credit, paid $26.6 million of dividends, paid $577,000 on mortgagenotes payable that are non-recourse to us and generated $391,000 of net cash from the issuance of shares of beneficial interest. During 2005, we had net debt repayments of $10.0 million on our revolving line of credit, paid $25.6 million in dividends, paid $662,000 onmortgage notes payable that are non-recourse to us and generated $668,000 of cash from the issuance of shares of beneficial interest. We expect to meet our short-term liquidity requirements generally through our available working capital and net cash provided by operations. We believethat our net cash provided by operations will be sufficient to allow us to make any distributions necessary to enable us to continue to qualify as a REIT underSections 856 to 860 of the Internal Revenue Code of 1986. Year ended December 31, 2005 as compared to December 31, 2004: Net cash provided by operating activities Net cash provided by operating activities was $25.3 million during 2005 as compared to $27.0 million during 2004. The $1.7 million net unfavorable change during 2005, as compared to 2004, was primarily attributable to: (i) a $1.4 million unfavorable change in netincome plus or minus the adjustments to reconcile net income to net cash provided by operating activities (depreciation and amortization, gains on sales ofproperties by LLCs, gain on sale of real property, property write-down from hurricane damage at Wellington, property write-down from hurricane damage atChalmette, property damage recovered from UHS-Wellington, property damage recoverable from UHS-Chalmette and net loss on ineffective cash flow hedge);(ii) a $537,000 unfavorable change in rent receivable, and; (iii) $264,000 favorable change in accrued expenses and other liabilities. 44Table of ContentsThe $1.4 million unfavorable change in net income plus or minus the adjustments to reconcile net income to net cash provided by operating activitieswas due primarily to: (i) an unfavorable change of approximately $1.2 million resulting from an increase in other operating expenses, as mentioned above(excluding the impact of FIN 46R); (ii) an unfavorable change of approximately $900,000 resulting from the purchase of the Virtue Street Pavilion by UHS inDecember of 2004 (net of interest expense savings on the $7.3 million of sale proceeds received); (iii) a favorable change of approximately $300,000 resultingfrom the add-back of additional depreciation and amortization expense incurred by three LLCs that we began including in our financial statements, on aconsolidated basis, on April 1, 2004 as a result of FIN 46R, and; (iv) $400,000 of other favorable changes including a decrease in interest expense. Net cash provided by investing activities Net cash provided by investing activities was $8.4 million during 2005, as discussed above, as compared to $11.9 million during 2004. During 2004, we generated $11.9 million of net cash provided by investing activities as follows: • spent $2.8 million to fund equity investments in unconsolidated LLCs; • spent $1.4 million to fund advances to unconsolidated LLCs; • spent $528,000 to fund capital additions at certain of our consolidated real estate investments; • received $7.3 million of cash proceeds in connection with the sale of Virtue Street Pavilion; • received $6.4 million of cash proceeds in connection with the 2003 sales by two LLCs that owned the real estate assets of Skypark ProfessionalMedical Office Building and Pacifica Palms Medical Plaza; • received $800,000 of cash proceeds in connection with refinancing of third-party debt by unconsolidated LLCs; • received $1.0 million of cash proceeds related to sale of property by an unconsolidated LLC, and; • received $1.0 million of cash distributions in excess of income from our unconsolidated 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 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 Medical OfficeBuilding located in Las Vegas, Nevada; • $830,000 additional net loan funded in connection our 75% non-controlling equity interest in a LLC that owns the St. Mary’s Center for Healthlocated in Reno, Nevada; • $600,000 additional net loan funded in connection with 98% non-controlling equity interest in the Gold Shadow Properties LLC; • $700,000 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 $35.6 million during 2005, as discussed above, and $36.4 million during 2004. During 2004, we: (i) paid dividends of $23.5 million; (ii) repaid $13.0 million of revolving credit facility borrowings; (iii) repaid $435,000 of mortgagenotes payable, and; (iv) received $593,000 of proceeds from the issuance of shares of beneficial interest during 2004. 45Table of ContentsCredit facilities and mortgage debt In January 2007, we entered into a new unsecured $100 million revolving credit agreement (the “Agreement”) which expires on January 19, 2012. Wehave a one time option, which can be exercised at any time, subject to bank approval, to increase the amount by $50 million for a total commitment of $150million. The Agreement provides for interest at our option, at the Eurodollar rate plus .75% to 1.125%, or the prime rate plus zero to .125%. A fee of .15% to.225% is paid on the unused portion of the commitment. The margins over the Eurodollar, prime rate and commitment fee are based upon our debt to totalcapital ratio as defined by the Agreement. As of January 2007, the applicable margin over the Eurodollar rate was .75%, the prime rate was zero, and thecommitment fee was .15% At December 31, 2006, we had $13.6 million of outstanding borrowings and $18.9 million of letters of credit outstanding against the previousrevolving credit agreement. After giving effect to the increased borrowing capacity in the Agreement entered into in January of 2007, we had $67.5 million ofavailable borrowing capacity, net of the outstanding borrowings and letters of credit outstanding as of December 31, 2006. There are no compensating balancerequirements. The Agreement contains a provision whereby the commitments will be reduced by 50% of the proceeds generated from any new equity offering.The average amounts outstanding under our previous revolving credit agreement were $11.9 million in 2006, $12.0 million in 2005, and $26.4 million in2004 with corresponding effective interest rates, including commitment fees and interest rate swap expense, of 7.9% in 2006, 9.0% in 2005, and 7.0% in 2004.The carrying value of the amounts borrowed approximates fair market value. Covenants relating to the Agreement require the maintenance of a minimum tangible net worth and specified financial ratios, limit our ability to incuradditional debt, limit the aggregate amount of mortgage receivables and limit our ability to increase dividends in excess of 95% of cash available fordistribution, unless additional distributions are required to comply with the applicable section of the Internal Revenue Code and related regulations governingreal estate investment trusts. We were in compliance with all of the covenants at the time we entered the Agreement. The carrying value of this instrumentapproximates fair value. We have two mortgages, which are non-recourse to us, included on our consolidated balance sheet as of December 31, 2006, with a combinedoutstanding balance of $12.7 million. Both mortgages carry an interest rate of 8.3% and both have maturity dates in 2010. The mortgages are secured by thereal property of the buildings as well as property leases and rents. These two mortgages have a combined fair value of approximately $13.7 million as ofDecember 31, 2006. Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow. The following represents the scheduled maturities of our contractual obligations as of December 31, 2006: 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) $12,737 $332 $755 $11,650 $— Long-term debt-variable(b) 13,600 — — — 13,600Estimated future interest payments on debt outstanding as ofDecember 31, 2006(c) 8,131 1,953 3,739 2,394 45Equity and debt financing commitments(d) 28,415 28,415 — — — Total contractual cash obligations $62,883 $30,700 $4,494 $14,044 $13,645 (a)Consists of two mortgages, which are non-recourse to us, included on our consolidated balance sheet as of December 31, 2006. Excluded from the tableabove is the $180.9 million of combined third-party debt outstanding as of December 31, 2006, that is non-recourse to us, at the unconsolidated LLCsin which we hold various non-controlling ownership interests (see Note 9 to the consolidated financial statements). 46Table of Contents(b)Consists of borrowings outstanding under the terms of our new $100 million revolving credit agreement enter into in January of 2007.(c)Assumes that all debt outstanding as of December 31, 2006, including borrowings under our revolving credit agreement and two mortgage notes payablewhich are non-recourse to us, remain outstanding until the final maturity of the debt agreements at the same interest rates which were in effect as ofDecember 31, 2006. We have the right to repay borrowings under the revolving credit agreement at any time during the term of the agreement, withoutpenalty.(d)As of December 31, 2006, we have equity investment and debt financing commitments remaining in connection with our investments in various LLCs,as follows (in thousands): AmountArlington Medical Properties $2,800Sierra Medical Properties 400Spring Valley Medical Properties II 6,921PCH Southern Properties 1,600Centennial Hills Medical Properties 6,547Canyon Healthcare Properties 5,933Palmdale Medical Properties 4,214 Total $28,415 Off Balance Sheet Arrangements As of December 31, 2006, we are party to certain off balance sheet arrangements consisting of standby letters of credit and equity and debt financingcommitments as detailed on the above “Contractual Obligations” table. Our outstanding letters of credit at December 31, 2006 totaled $18.9 million consistingof: (i) $600,000 related to 653 Town Center, Phase II; (ii) $900,000 related to Arlington Medical Properties, (iii) $600,000 related to Spring Valley MedicalProperties; (iv) $1.3 million related to Sierra Medical Properties; (v) $200,000 related to Gold Shadow Properties; (vi) $6.0 million related to Centennial HillsMedical Properties, (vii) $5.4 million related to Canyon Healthcare Properties, (viii) $3.9 million related to Palmdale Medical Properties. 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 interest rates. To mitigate the impact of fluctuations in interest rates, we have, from timeto time, fixed the rate on a portion of our debt by entering into interest rate swap agreements. Interest rate swap agreements are contracts that require us to pay afixed 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. As of December 31, 2006, we had no outstanding interest rate swap agreements. As of December 31, 2005 we had one outstanding swap agreementhaving a total notional principal amount of $10 million which matured in July, 2006. As of December 31, 2004, we had two outstanding swap agreementshaving a total notional principal amount of $20 million, one which, as previously mentioned, had a notional principal amount of $10 million that matured inJuly, 2006 and one that had a notional principal amount of $10 million that was terminated during 2005. Additional interest expense recorded as a result of our hedging activity, was $62,000, $431,000 and $1,106,000 in 2006, 2005 and 2004, respectively.For the years ended December 31, 2006, 2005 and 2004, we received a weighted average rate of 4.8%, 3.2% and 1.4%, respectively, and paid a weightedaverage rate on our interest rate swap agreements of 6.9%, 6.1% and 7.0% in 2006, 2005 and 2004, respectively (including the revolver spread of 1.00% in2006, 2005 and 2004). 47Table of ContentsThe sensitivity analysis related to our fixed-rate debt assumes an immediate 100 basis point move in interest rates from their 2005 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$105,000. 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 $109,000. The table below presents information about our derivative financial instruments that are sensitive to changes in interest rates, including debt obligationsas of December 31, 2006. For debt obligations, the table presents principal cash flows and related weighted average interest rates by contractual maturity dates. Maturity Date, Year Ending December 31(Dollars in thousands) 2007 2008 2009 2010 2011 Thereafter TotalLong-term debt: Fixed rate $332 $361 $394 $11,650 — — $12,737Weighted average interest rates 8.3% 8.3% 8.3% 8.3% — — — Variable rate long-term debt (a) — — — — — $13,600 $13,600(a)Consists of borrowings outstanding under the terms of our $100 million revolving credit agreement, as amended in January of 2007. ITEM 8.Financial Statements and Supplementary Data Our Consolidated Balance Sheets, Consolidated Statements of Income, Shareholders’ Equity and Cash Flows, together with the report of KPMG LLP,independent public accountants, are included elsewhere herein. Reference is made to the “Index to Financial Statements and Schedule.” ITEM 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. ITEM 9A.Controls and Procedures Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures As of December 31, 2006, under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) andChief Financial Officer (“CFO”), we performed an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15(e) orRule 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “1934 Act”). Based on this evaluation, the CEO and CFO have concludedthat our disclosure controls and procedures are effective to ensure that material information is recorded, processed, summarized and reported by managementon a timely basis in order to comply with our disclosure obligations under the Securities and Exchange Act of 1934 and the SEC rules thereunder. Changes in Internal Control Over Financial Reporting There have been no changes in our internal control over financial reporting or in other factors during the fourth quarter of 2006 that have materiallyaffected, or are reasonably likely to materially affect, our internal control over financial reporting. Management’s Report on Internal Control Over Financial Reporting Management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting. In order to evaluate theeffectiveness of internal control over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act, management has conducted an assessment,including testing, using the criteria in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of 48Table of Contentsthe Treadway Commission (COSO). Our 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 we maintained effective internal control over financial reporting as of December 31, 2006,based on criteria in Internal Control – Integrated Framework, issued by the COSO. Management’s assessment of the effectiveness of our internal controlover financial reporting as of December 31, 2006, has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their reportwhich is included herein. 49Table 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, 2006, 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, 2006, is fairly stated, in all material respects, based on criteria established in Internal Control – Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, Universal Health Realty Income Trust maintained, inall material respects, effective internal control over financial reporting as of December 31, 2006, 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, 2006 and 2005, 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, 2006, and our report dated March 14, 2007, expressedan unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Philadelphia, PennsylvaniaMarch 14, 2007 50Table of ContentsITEM 9B.Other Information None. PART III ITEM 10.Directors and Executive Officers of the Registrant The information requested by this item is hereby incorporated herein by reference to our definitive Proxy Statement to be filed with the Securities andExchange Commission within 120 days after December 31, 2006. See also “Executive Officers of the Registrant” appearing in Part I hereof. ITEM 11.Executive Compensation The information requested by this item is hereby incorporated herein by reference to our definitive Proxy Statement to be filed with the Securities andExchange Commission within 120 days after December 31, 2006. ITEM 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters The information requested by this item is hereby incorporated herein by reference to our definitive Proxy Statement to be filed with the Securities andExchange Commission within 120 days after December 31, 2006. ITEM 13.Certain Relationships and Related Transactions The information requested by this item is hereby incorporated herein by reference to our definitive Proxy Statement to be filed with the Securities andExchange Commission within 120 days after December 31, 2006. ITEM 14.Principal Accounting Fees and Services There is hereby incorporated herein by reference the information to appear under the caption “Relationship with Independent Auditor” in our ProxyStatement, to be filed with the Securities and Exchange Commission within 120 days after December 31, 2006. 51Table of ContentsPART IV ITEM 15.Exhibits, Financial Statement Schedules (a)Documents filed as part of this report: (1)Financial Statements: See “Index to Financial Statements and Financial Statement Schedules.” (2)Financial Statement Schedules: See “Index to Financial Statements and Financial Statement Schedules.” (3)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 dated December 29, 2006, 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. 10.4 Form of Leases, including Form of Master Lease Document Leases, between certain subsidiaries of Universal Health Services, Inc. and the Trust,previously filed as Exhibit 10.3 to Amendment No. 3 of the Registration Statement on Form S-11 and Form S-2 of Universal Health Services, Inc. and theTrust (File No. 33-7872), is incorporated herein by reference. 10.5 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. 10.6* 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. 10.7 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. 10.8* 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. 52Table of Contents10.9 Credit Agreement, dated as of January 19, 2007, by and among the Trust, the financial institutions from time to time party thereto and WachoviaBank, National Association, as Administrative Agent, previously filed as Exhibit 10.1 to the Trust’s Current Report on Form 8-K dated January 24, 2007, isincorporated herein by reference. 10.10 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. 10.11 Asset Exchange and Substitution Agreement, dated as of April 24, 2006, by and among the Trust and Universal Health Services, Inc. and certainof its subsidiaries, previously filed as Exhibit 10.1 to the Trust’s Current Report on Form 8-K dated April 25, 2006, is incorporated herein by reference. 10.12 Amendment No. 1 to the Master Lease Document, between certain subsidiaries of Universal Health Services, Inc. and the Trust, previously filedas Exhibit 10.2 to the Trust’s Current Report on Form 8-K dated April 25, 2006, is incorporated herein by reference. 11 Statement re computation of per share earnings is set forth on the Consolidated Statements of Income. 21 Subsidiaries of Registrant. 23.1 Consent of Independent Registered Public Accounting Firm. 31.1 Certification from the Trust’s Chief Executive Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934. 31.2 Certification from the Trust’s Chief Financial Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934. 32.1 Certification from the Trust’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification from the Trust’s Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*Management contract or compensatory plan or arrangement. Exhibits, other than those incorporated by reference, have been included in copies of this Annual Report filed with the Securities and Exchange Commission.Shareholders of the Trust will be provided with copies of those exhibits upon written request to the Company. 53Table 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 14, 2007 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, ChiefExecutive Officer and President(Principal Executive Officer) March 14, 2007/s/ JAMES E. DALTON, JR. James E. Dalton, Jr Trustee March 14, 2007/s/ MYLES H. TANENBAUM Myles H. Tanenbaum Trustee March 14, 2007/s/ MILES L. BERGER Miles L. Berger Trustee March 14, 2007/s/ ELLIOT J. SUSSMAN Elliot J. Sussman, M.D., M.B.A. Trustee March 14, 2007/s/ CHARLES F. BOYLE Charles F. Boyle Vice President and Chief Financial Officer(Principal Financial and Accounting Officer) March 14, 2007/s/ CHERYL K. RAMAGANO Cheryl K. Ramagano Vice President, Treasurer and Secretary March 14, 2007 54Table of ContentsINDEX TO FINANCIAL STATEMENTS AND SCHEDULE PageConsolidated Financial Statements: Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements and Schedule 56Consolidated Balance Sheets—December 31, 2006 and December 31, 2005 57Consolidated Statements of Income—Years Ended December 31, 2006, 2005 and 2004 58Consolidated Statements of Shareholders’ Equity—Years Ended December 31, 2006, 2005 and 2004 59Consolidated Statements of Cash Flows—Years Ended December 31, 2006, 2005 and 2004 60Notes to the Consolidated Financial Statements—December 31, 2006 61Schedule III—Real Estate and Accumulated Depreciation—December 31, 2006 86Notes to Schedule III—December 31, 2006 87 55Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Shareholders and Board of TrusteesUniversal Health Realty Income Trust: We have audited the consolidated balance sheets of Universal Health Realty Income Trust and subsidiaries as of December 31, 2006 and 2005, and therelated consolidated statements of income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. Inconnection with our audits of the consolidated financial statements, we also have audited financial statement schedule III. These consolidated financialstatements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on theseconsolidated 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, 2006 and 2005, and the results of their operations and their cash flows for each of the years in thethree-year period ended December 31, 2006, 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. 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, 2006, 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 14, 2007,expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting. /s/ KPMG LLP Philadelphia, PennsylvaniaMarch 14, 2007 56Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED BALANCE SHEETS(dollar amounts in thousands) December 31,2006 December 31,2005 ASSETS: Real Estate Investments: Buildings and improvements $171,761 $187,451 Accumulated depreciation (56,935) (57,729) 114,826 129,722 Land 19,317 23,143 Construction in progress 9,220 — Net Real Estate Investments 143,363 152,865 Investments in and advances to limited liability companies (“LLCs”) 47,223 29,572 Other Assets: Cash and cash equivalents 798 1,717 Bonus rent receivable from UHS 1,025 1,088 Rent receivable-other 814 1,000 Note receivable from sale of property — 3,102 Property replacement receivable from UHS—Chalmette — 6,259 Deferred charges and other assets, net 916 1,286 Total Assets $194,139 $196,889 LIABILITIES AND SHAREHOLDERS' EQUITY: Liabilities: Line of credit borrowings $13,600 $10,000 Mortgage note payable, non-recourse to us 3,849 3,972 Mortgage notes payable of consolidated LLCs, non-recourse to us 8,888 21,576 Deferred gain on sale of our interest in an unconsolidated LLC — 1,860 Accrued interest 84 357 Accrued expenses and other liabilities 2,857 2,575 Fair value of derivative instruments — 100 Tenant reserves, escrows, deposits and prepaid rents 595 697 Total Liabilities 29,873 41,137 Minority interests 69 302 Shareholders' Equity: Preferred shares of beneficial interest, $.01 par value; 5,000,000 shares authorized; none issued and outstanding — — Common shares, $.01 par value; 95,000,000 shares authorized; issued and outstanding: 2006—11,791,950;2005—11,777,829 118 118 Capital in excess of par value 187,524 186,943 Cumulative net income 304,874 270,177 Accumulated other comprehensive loss — (100)Cumulative dividends (328,319) (301,688) Total Shareholders’ Equity 164,197 155,450 Total Liabilities and Shareholders’ Equity $194,139 $196,889 See the accompanying notes to these consolidated financial statements. 57Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF INCOME(amounts in thousands, except per share amounts) Year ended December 31, 2006 2005 2004 Revenues (Note 1): Base rental—UHS facilities $12,448 $12,567 $12,481 Base rental—Non-related parties 11,860 12,237 11,275 Bonus rental—UHS facilities 4,317 4,509 4,668 Tenant reimbursements and other—Non-related parties 3,584 3,622 2,962 Tenant reimbursements and other—UHS facilities 300 403 391 32,509 33,338 31,777 Expenses: Depreciation and amortization 5,757 5,825 5,177 Advisory fees to UHS (Note 2) 1,424 1,420 1,498 Other operating expenses 6,547 6,667 5,000 Property write-down—hurricane damage—Chalmette — 6,259 — Property write-down—hurricane damage—Wellington — — 1,863 Property replacement recoverable from UHS—Chalmette — (6,259) — Property damage recoverable from UHS—Wellington — — (1,863) 13,728 13,912 11,675 Income before equity in unconsolidated limited liability companies (“LLCs”), property damage recoveredfrom UHS, and interest expense 18,781 19,426 20,102 Equity in income of unconsolidated LLCs (including recognition of previously deferred gain of $1,860 onsale of our interest in an unconsolidated LLC during 2006 and gains on sales of real properties of$1,043 and $1,009 during 2005 and 2004, respectively) 4,241 4,602 4,967 Replacement property recovered from UHS—Chalmette 13,958 — — Property damage recovered from UHS—Wellington — 4,693 — Interest expense, net (2,283) (3,298) (3,357) Income from continuing operations 34,697 25,423 21,712 Income from discontinued operations, net (including gain on sale of real property of $833 during 2004) — — 1,959 Net Income $34,697 $25,423 $23,671 Basic earnings per share: From continuing operations $2.94 $2.16 $1.85 From discontinued operations — — $0.17 Total basic earnings per share $2.94 $2.16 $2.02 Diluted earnings per share: From continuing operations $2.92 $2.15 $1.84 From discontinued operations — — $0.16 Total diluted earnings per share $2.92 $2.15 $2.00 Weighted average number of shares outstanding—Basic 11,784 11,764 11,744 Weighted average number of share equivalents 82 77 69 Weighted average number of shares and equivalents outstanding—Diluted 11,866 11,841 11,813 See the accompanying notes to these consolidated financial statements. 58Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the Years Ended December 31, 2006, 2005 and 2004(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, 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 — — — 23,671 — 1,071 24,742 December 31, 2004 11,756 118 186,275 244,754 (276,100) (994) 154,053 Issuance of shares of beneficial interest 22 — 668 — — — 668 Dividends ($2.175/share) — — — — (25,588) — (25,588)Comprehensive income: Net income — — — 25,423 — — 25,423 Adjustment for settlement amounts reclassified intoincome — — — — — 863 863 Unrealized derivative gains on cash flow hedges — — — — — 31 31 Total—comprehensive income — — — 25,423 — 894 26,317 December 31, 2005 11,778 118 186,943 270,177 (301,688) (100) 155,450 Issuance of shares of beneficial interest 14 — 499 — — — 499 Dividends ($2.26/share) — — — — (26,631) — (26,631)Stock-based compensation expense — — 82 — — — 82 Comprehensive income: Net income — — — 34,697 — — 34,697 Adjustment for settlement amounts reclassified intoincome — — — — — 62 62 Unrealized derivative gains on cash flow hedges — — — — — 38 38 Total—comprehensive income — — — 34,697 — 100 34,797 December 31, 2006 11,792 $118 $187,524 $304,874 ($328,319) $— $164,197 See the accompanying notes to these consolidated financial statements. 59Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS(amounts in thousands) Year ended December 31, 2006 2005 2004 Cash flows from operating activities: Net income $34,697 $25,423 $23,671 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 5,757 5,825 5,312 Gains on sales of properties by LLCs — (1,043) (1,009)Gain on sale of our interest in a LLC (1,860) — — Gain on sale of real property — — (833)Property write-down from hurricane damage—Wellington — — 1,863 Property write-down from hurricane damage—Chalmette — 6,259 — Property damage recoverable from UHS—Chalmette — (6,259) — Property damage recovered from UHS—Chalmette (13,958) — — Property damage recovered from UHS—Wellington — (4,693) (1,863)Net loss on ineffective cash flow hedge — 254 — Changes in assets and liabilities: Rent receivable 6 (568) (31)Accrued expenses and other liabilities 386 354 90 Tenant reserves, escrows, deposits and prepaid rents 134 (6) 22 Accrued interest (196) (60) (101)Other, net (264) (183) (154) Net cash provided by operating activities 24,702 25,303 26,967 Cash flows from investing activities: Investments in limited liability companies (“LLCs”) (5,332) (8,281) (2,764)Repayments of advances made to LLCs 1,949 9,631 — Advances made to LLCs (7,573) (2,902) (1,375)Cash distributions in excess of income from LLCs 1,399 954 1,038 Cash escrow account distributions/(deposits) from LLC sale proceeds — — 6,405 Proceeds received from sale of our interest in a LLC 3,102 — — Cash distributions from sales of properties by LLCs — 2,851 1,009 Cash distributions of refinancing proceeds from LLCs 5,704 8,499 800 Cash received from sale of real property — — 7,320 Additions to real estate investments (1,294) (2,391) (528)Proceeds received from sale of minority ownership interest in LLC — 47 — Net cash (used in) provided by investing activities (2,045) 8,408 11,905 Cash flows from financing activities: Net borrowings/(repayments) on line of credit 3,600 (10,000) (13,057)Repayments of mortgage notes payable of consolidated LLCs (454) (551) (333)Repayments of mortgage notes payable (123) (111) (102)Dividends paid (26,631) (25,588) (23,488)Issuance of shares of beneficial interest 499 668 593 Dividend reinvestment receivable (108) — — Net cash used in financing activities (23,217) (35,582) (36,387) (Decrease) increase in cash (560) (1,871) 2,485 (Decrease) increase in cash due to recording of LLCs on unconsolidated/consolidated basis (359) — 475 Cash and cash equivalents, beginning of year 1,717 3,588 628 Cash and cash equivalents, end of year $798 $1,717 $3,588 Supplemental disclosures of cash information: Interest paid $2,661 $3,104 $3,582 Supplemental disclosures of non-cash information: Replacement property capitalized—UHS—Wellington $8,923 — — Replacement property capitalized—UHS—Bridgeway 4,072 — — Replacement property—CIP—UHS—Inland Valley 9,219 — — Assets exchanged—Chalmette (8,259) — — Property damage costs capitalized —UHS—Wellington — 4,693 1,863 (Decrease) increase in net property due to recording of LLCs on unconsolidated/consolidated basis (25,571) — 38,299 (Decrease) increase in debt due to recording of LLCs on unconsolidated/consolidated basis (12,234) — 22,460 See the accompanying notes to these consolidated financial statements. 60Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUSTNOTES TO CONSOLIDATED FINANCIAL STATEMENTSDecember 31, 2006 (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, 2006, we have forty-five real estate investments or commitments located in fifteenstates consisting of: •six hospital facilities including three acute care, one behavioral healthcare, one rehabilitation and one sub-acute; •thirty-five medical office buildings (including five being constructed), and; •four pre-school and childcare centers. Since we have significant investments in six hospital facilities, which comprised 56%, 55% and 58% of net revenues in 2006, 2005 and 2004,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. Four ofour six hospital facilities and all or a portion of seven medical office buildings are or may be 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. Management’s estimate of future cash flows from our leased properties could bematerially affected in the near term, if certain of the leases are not renewed at the end of their lease terms. Revenue Recognition Our revenues consist primarily of rentals received from tenants, which are comprised of minimum rent (base rentals), bonus rentals andreimbursements from tenants for their pro-rata share of expenses such as common area maintenance costs, real estate taxes and utilities. The minimum rent for all hospital facilities is fixed over the initial term or renewal term of the respective leases. Rental income recorded by ourconsolidated and unconsolidated medical office buildings (“MOBs”) relating to leases in excess of one year in length, is recognized using the straight-linemethod under which contractual rents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resultingfrom straight-line rent adjustments is dependent on many factors including the nature and amount of any rental concessions granted to new tenants, scheduledrent increases under existing leases, as well as the acquisitions and sales of properties that have existing in-place leases. As a result, the straight-lineadjustments to rental revenue may vary from period-to-period. Bonus rents are recognized when earned based upon increases in each facility’s net revenue inexcess of stipulated amounts. Bonus rentals are determined and paid each quarter based upon a computation that compares the respective facility’s currentquarter’s revenue to the corresponding quarter in the base year. Tenant reimbursements for operating expenses are accrued as revenue in the same period therelated expenses are incurred. 61Table of ContentsCash and Cash Equivalents We consider all highly liquid investment instruments with original maturities of three months or less to be cash equivalents. Real 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. We follow the provisions of FASB Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets.” The Statement establishes a single accounting model for long-lived assets to be disposed of by sale. It requires companies to reportseparately discontinued operations, and extends that reporting for all periods presented to a component of an entity that either has been disposed of or isclassified as held for sale. Additionally, SFAS No. 144 requires that assets and liabilities of components held for sale, if material, be disclosed separately inthe 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. In accordance with the American Institute of Certified Public Accountants’ Statement of Position78-9 “Accounting for Investments in Real Estate Ventures,” as amended by FASB Staff Position SOP 78-9-1 “Interaction of AICPA Statement of Position78-9 and EITF Issue No. 04-5”, and Emerging Issues Task Force Issue (EITF) 96-16, “Investor’s Accounting for an Investee When the Investor Has aMajority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights” and EITF 04-5 “Determining Whether aGeneral Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have CertainRights”, we account for our unconsolidated investments in LLCs, which we do not control, using the equity method of accounting. The third-party membersin these investments have equal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and;(iii) financing commitments. These investments, which represent 33% to 99% non-controlling ownership interests, are recorded initially at our cost andsubsequently adjusted for our net equity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements,allocations of profits and losses of some of the LLC investments may be allocated disproportionately as compared to ownership interests after specifiedpreferred return rate thresholds have been satisfied. In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. ThisInterpretation, as revised (“FIN 46R”), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. As aresult of our related party relationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and variousproperties owned by three LLCs in which we own non-controlling ownership interests ranging from 95% to 99%, these LLCs were considered to be variableinterest entities (see note 9 to the consolidated financial statements). In addition, we were the primary beneficiary of these LLC investments. Upon the adoptionof FIN 46R on March 31, 2004, we began consolidating the results of operations of these three LLC investments in our consolidated financial statements. 62Table of ContentsAs a result of the expiration of the master lease arrangements between subsidiaries of UHS and two of the three LLCs, during the fourth quarter of 2006,we began recording the financial results of two LLCs on an unconsolidated basis in our consolidated financial statements. Commencing in the fourth quarterof 2006, the revenues and expenses of these two LLCs are no longer included in our consolidated revenues and expenses; instead, our share of the net incomegenerated from each of these LLCs is included in our consolidated statements of income as “Equity in income of unconsolidated LLCs”. The revenues andexpenses for these LLCs related to the periods prior to the fourth quarter are included in our revenues and expenses in our consolidated statements of income.There was no impact on our net income as a result of recording of the financial results of these LLCs on a consolidated or an unconsolidated basis. The other LLCs in which we hold various non-controlling ownership interests are not variable interest entities and therefore are not subject to theconsolidation 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 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 impairment losses. The aggregate gross cost basis and net book value of the properties for federal income tax purposes are approximately $170 million and $111 millionrespectively, at December 31, 2006 and $202 million and $140 million, respectively, at December 31, 2005. Stock-Based Compensation At December 31, 2006, we have two stock-based compensation plans. Effective January 1, 2006, we adopted SFAS No. 123R, “Share-Based Payment”and related interpretations and began expensing the grant-date fair value of stock options. SFAS No. 123R requires companies to recognize the grant-date fairvalue of stock options and other equity-based compensation. SFAS 123R generally requires that a company account for these transactions using the fair-valuebased method and eliminates a company’s ability to account for share-based compensation transactions using the intrinsic value method of accountingprovided in Accounting Principles Board, (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” which was permitted under StatementNo. 123, as originally issued. Prior to January 1, 2006, we accounted for these plans under the recognition and measurement principles of APB OpinionNo. 25, and related interpretations. Accordingly, no compensation expense was reflected in net income for stock option grants, as all options granted under theplan had an original exercise price equal to the market value of the underlying shares on the date of grant. The impact of adopting SFAS No. 123R for the yearended December 31, 2006, is a reduction in net income of $82,000. In accordance with SFAS No. 123, the pro forma impact of expensing stock options forthe years ended December 31, 2005 and 2004 would have been a reduction in net income of $9,000 and $11,000, respectively. We adopted SFAS No. 123R using the modified prospective transition method and; therefore, we have not restated prior periods. Under this transitionmethod, compensation costs associated with stock options recognized 63Table of Contentsin 2006 includes amortization related to the remaining unvested portion of stock option and dividend equivalent rights awards granted prior to January 1,2006, and will include amortization expense related to new awards granted after January 1, 2006. We use the Black-Scholes model as our option pricing modelfor applying SFAS 123R. The expense associated with share-based compensation arrangements is a non-cash charge. In the consolidated statements of cash flows, share-basedcompensation expense is an adjustment to reconcile net income to cash provided by operating activities. For stock options and DERs granted prior to the adoption of SFAS No. 123R, the effect on net income and earnings per share if we had applied the fairvalue recognition provisions of SFAS No. 123R to our stock option and DER plans for 2005 and 2004 is shown in the table below. We recognize compensationcost related to restricted share awards over the respective vesting periods. As of December 31, 2006, there were no unvested restricted share awardsoutstanding. Twelve Months EndedDecember 31, 2005 2004 (in thousands, exceptper share data) Income from continuing operations $25,423 $21,712 Income from discontinued operations, net (including gain on sale during 2004) — 1,959 Net income $25,423 $23,671 Income from continuing operations $25,423 $21,712 Add: total stock-based compensation expenses included in net income 227 192 Deduct: total stock-based employee compensation expenses determined under fair value based methods for all awards: (236) (203) Pro forma net income from continuing operations $25,414 $21,701 Income from discontinued operations, net (including gain on sale during 2004) — 1,959 Total pro forma net income $25,414 $23,660 Basic earnings per share, as reported: From continuing operations $2.16 $1.85 From discontinued operations — 0.17 Total basic earnings per share, as reported $2.16 $2.02 Basic earnings per share, pro forma: From continuing operations $2.16 $1.84 From discontinued operations — 0.17 Total basic earnings per share, pro forma $2.16 $2.01 Diluted earnings per share, as reported: From continuing operations $2.15 $1.84 From discontinued operations — 0.16 Total diluted earnings per share, as reported $2.15 $2.00 Diluted earnings per share, pro forma: From continuing operations $2.15 $1.84 From discontinued operations — 0.16 Diluted earnings per share $2.15 $2.00 64Table of ContentsFair Value of Financial Instruments From time to time, we may enter into interest rate swap agreements and the fair value of such interest rate swap agreements would be based on quotedmarket prices. The carrying amounts reported in the balance sheet for cash, receivables, and short-term borrowings would approximate their fair values due tothe short-term nature of these instruments. Accordingly, these items are excluded from the fair value disclosures included elsewhere in these notes toconsolidated financial statements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Accounting for Derivative Instruments and Hedging Activities At December 31, 2006, we had no outstanding swap agreements. 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 de-designated 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. 65Table of ContentsWe 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. Recent Accounting Pronouncements In July 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”.The statement provides a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. In accordance with the interpretation, before a tax benefit can be recognized, a tax position is evaluated using a thresholdthat it is more likely than not that the tax position will be sustained upon examination. When evaluating the more-likely-than-not recognition threshold, theinterpretation provides that a company should presume the tax position will be examined by the appropriate taxing authority that has full knowledge of allrelevant information. If the tax position meets the more-likely-than-not recognition threshold, it is initially and subsequently measured as the largest amount ofbenefit that is greater than 50% likely of being realized upon ultimate settlement. The interpretation also provides guidance on derecognition, classification,interest and penalties, accounting in interim periods, disclosure and transition. This interpretation is effective on January 1, 2007. Since we believe we haveoperated in such a manner as to qualify for taxation as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, and weintend to continue to operate in such a manner, we do not expect the adoption of this interpretation to have a material impact on our financial position or resultsof operations. In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year Financial Statements (“SAB 108”). This guidance was issued to resolve diversity incurrent practice among registrants. The bulletin establishes that registrants must quantify the impact of correcting all misstatements on the financial statementsby using both the rollover and iron curtain approaches to evaluate the errors. The rollover approach quantifies the misstatement based on the amount of theerror originating in the current year income statement and the iron curtain approach quantifies a misstatement based on the amount of the error existing in thebalance sheet at the end of the fiscal year. The bulletin contains guidance on correcting errors under the dual approach and transition guidance. The adoption ofSAB 108 did not have a material impact on our financial position or results of operations. In September, 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”), whichclarifies the definition of fair value, establishes a framework for measuring fair value in U.S. GAAP, and expands the disclosures regarding fair valuemeasurements. SFAS 157 does not require any new fair value measurements and eliminates inconsistencies in guidance found in various prior accountingpronouncements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within thosefiscal years. We do not anticipate the adoption of SFAS 157 will have a material effect on our financial position or results of operations. (2)RELATIONSHIP WITH UHS AND RELATED PARTY TRANSACTIONS Leases: We commenced operations in 1986 by purchasing certain subsidiaries from UHS and immediately leasing the properties back to therespective subsidiaries. Most of the leases were entered into at the time we commenced operations and provided for initial terms of 13 to 15 years with up to sixadditional 5-year renewal terms, with base rents set forth in the leases effective for all but the last two renewal terms. In 1998, the lease for McAllen MedicalCenter was amended to provide that the last two renewal terms would also be fixed at the initial agreed upon base rental. This lease amendment was inconnection with certain concessions granted by UHS with respect to the renewal of other leases. The base rents are paid monthly and each lease also providesfor additional or bonus rents which are computed and paid on a quarterly basis based upon a computation that compares current quarter revenue to acorresponding quarter in the base year. The leases with subsidiaries of UHS are unconditionally guaranteed by UHS and are cross-defaulted with one another. Pursuant to the Master Lease Document by and among us and certain subsidiaries of UHS, dated December 24, 1986 (the “Master Lease”), whichgoverns all leases of properties with subsidiaries of UHS, UHS 66Table of Contentshas the option to renew the leases at the lease terms described below by providing notice to us at least 90 days prior to the termination of the then current term.In addition, UHS has rights of first refusal to: (i) purchase the respective leased facilities during and for 180 days after the lease terms at the same price, termsand conditions of any third-party offer, or; (ii) renew the lease on the respective leased facility at the end of, and for 180 days after, the lease term at the sameterms and conditions pursuant to any third-party offer. UHS also has the right to purchase the respective leased facilities at the end of the lease terms or anyrenewal terms at the appraised fair market value. In addition, as part of the overall exchange and substitution proposal relating to Chalmette Medical Center(“Chalmette”), as discussed below, as well as the early five year lease renewals on Southwest Healthcare System-Inland Valley Campus (“Inland Valley”),Wellington Regional Medical Center (“Wellington”), McAllen Medical Center (“McAllen”) and The Bridgeway (“Bridgeway”), we agreed to amend the MasterLease to include a change of control provision. The change of control provision grants UHS the right, upon one month’s notice should a change of control ofthe Trust occur, to purchase any or all of the four leased hospital properties at their appraised fair market value purchase price. During the third quarter of 2005, Chalmette, a 138-bed acute care hospital located in Chalmette, Louisiana, was severely damaged and closed as a resultof Hurricane Katrina. At that time, the majority of the real estate assets of Chalmette were leased from us by a subsidiary of UHS and, in accordance with theterms of the lease, and as part of an overall evaluation of the leases between subsidiaries of UHS and us, UHS offered substitution properties rather thanexercise its right to rebuild the facility or offer cash for Chalmette. Independent appraisals were obtained by us and UHS which indicated that the pre-hurricanefair market value of the leased facility was $24.0 million. During the third quarter of 2006, we completed the previously disclosed asset exchange and substitution pursuant to the Asset Exchange andSubstitution Agreement with UHS that we entered into on April 24, 2006 whereby we agreed to terminate the lease between us and Chalmette and to transfer thereal property assets and all rights attendant thereto (including insurance proceeds) of Chalmette to UHS in exchange and substitution for newly constructedreal property assets owned by UHS (“Capital Additions”) at Wellington, Bridgeway and Inland Valley, in satisfaction of the obligations under the Chalmettelease. The Capital Additions consist of properties which were recently constructed on, or adjacent to, facilities already owned by us as well as a CapitalAddition at Inland Valley which is currently under construction and expected to be completed during 2007. UHS is obligated to complete the Inland ValleyCapital Addition or, subject to our approval, offer to either provide alternative substitution property or pay to us an amount in cash equal to the substitutionvalue of the Capital Addition. Pursuant to section 1033(a)(1) of the Internal Revenue Code of 1986, as amended (the “IRC”), we will recognize no gain forfederal income tax purposes based upon the transaction as agreed upon in the Asset Exchange and Substitution Agreement. The properties included in the Asset Exchange and Substitution Agreement consists of (amounts in thousands): Wellington—Bed Tower $8,926 Fair valueBridgeway—28 bed addition 4,072 Fair valueInland Valley—44 bed and ICU expansion currently under construction 10,967 Estimated minimum fair value Total fair value of exchanged and substituted assets $23,965 In the event the ultimate construction costs related to the Inland Valley Capital Addition exceed $11.0 million, the excess will be paid in cash by us toUHS and UHS will pay incremental rent on the excess at a rate equal to the prevailing five-year treasury rate plus 200 basis points at the time of funding(minimum rate 6.75%). During 2005, 2004 and 2003, the total rent earned by us under the Chalmette lease was approximately $1.6 million to $1.7 million annually (including$960,000 of base rental and approximately $700,000 of bonus rental). The total rent payable to us on the Capital Additions included in the substitutionpackage (excluding the rent 67Table of Contentson the Inland Valley Capital Addition in excess of $11.0 million, if any) is expected to closely approximate the total rent earned by us under the Chalmettelease. Below is the estimated rent of the substitution properties. Facility Base Rent Bonus Rent Total RentWellington $534,504 $67,744 $602,248Bridgeway 247,800 26,940 274,740Inland Valley 740,012 — 740,012 Total: $1,522,316 $94,684 $1,617,000 The amounts shown in the bonus rent column represent the estimated bonus rent effect of including the revenues generated from the Capital Additions atWellington and Bridgeway that have not been previously included in the bonus rent paid to us pursuant to the terms of the leases since the Capital Additionswere financed and owned by UHS. The bonus rent amounts reflected above were based on the net revenues generated at each facility during 2005. Futurebonus rents earned by us on the Capital Additions will be based on the actual net revenues of each facility. During the second quarter of 2006, as part of the overall arrangement with UHS, UHS agreed to early renewals of the leases between us and each ofInland Valley, Wellington and McAllen which were scheduled to mature on December 31, 2006, and Bridgeway, which was scheduled to mature onDecember 31, 2009. These leases were renewed on the same economic terms as the current leases. Included in our consolidated statement of income during 2005 was a property write-down charge of $6.3 million representing the book value of theChalmette property damaged by the hurricane. Included in our 2005 net income was an equal amount representing the property damage recoverable from UHS.Prior to the completion of the Asset Exchange and Substitution Agreement, Chalmette had a combined asset value of $8.3 million on our consolidated balancesheet consisting of $2.0 million of land held for exchange and $6.3 million of property damage receivable from UHS. Included in our net income during 2006was a gain of $14.0 million representing the total property transferred to us from UHS as of December 31, 2006 ($22.2 million) in excess of the $8.3 millionbook value of Chalmette. Upon the completion of the asset exchange and substitution during the third quarter of 2006, we received the above mentionedCapital Additions from Wellington and Bridgeway which had a combined fair value of $13.0 million. In addition, the construction costs related to thecompleted Capital Addition at Inland Valley amounted to $9.2 million as of December 31, 2006 ($11.0 million is total minimum estimated cost of InlandValley’s Capital Addition). Our future net income will include an additional $1.8 million of property recovered from UHS as the additional construction costsare incurred by UHS related to the Inland Valley Capital Addition, up to $11.0 million estimated total cost of construction. FASB Interpretation No. 30 (“FIN 30”), “Accounting for Involuntary Conversion of Nonmonetary Assets to Monetary Assets, an Interpretation ofAPB No. 29 (“APB29”)”, provides guidance on the accounting for involuntary conversions of nonmonetary assets (such as property) to monetary assets(such as insurance proceeds). Although the damage to Chalmette did not directly result in the conversion of a nonmonetary asset to a monetary asset, we do notbelieve that the receipt of a nonmonetary asset is in substance different than the receipt of a monetary asset in the context of an involuntary conversion. Theguidance in FIN 30 would result in recognition of the assets received upon the involuntary conversion at their fair values with gain or loss recognized for thedifference between the fair value of the assets received and the carrying value of the assets converted. Because it is not clear that the loss of Chalmette andrelated recovery from UHS represented a monetary conversion as described by FIN 30, we also considered the guidance in SFAS No. 153 (“SFAS No. 153”),“Exchanges of Nonmonetary Assets, as Amendment of APB 29,” which is effective for nonmonetary asset exchanges occurring in the fiscal year beginningafter June 15, 2005. SFAS No. 153 is based upon the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assetsexchanged, unless the exchange lacks “commercial substance”, as defined in paragraph 21 of APB 29, as amended by SFAS 153. After evaluating theprovisions of SFAS No. 153, we concluded that the exchange of 68Table of Contentsthese assets had “commercial substance” since, as indicated above, the base or minimum rent component of the total rental earned on the substituted assetshas increased (by $562,000) over the base rental amount earned pursuant to the terms of the Chalmette lease. As a result, the risk component of the futurelease stream has been significantly and favorably impacted. In addition, the future bonus rental earned on the substituted assets at Wellington, Bridgeway andInland Valley will be impacted (either favorably or unfavorably) by the distinct operating characteristics of those facilities such as the nature of the healthcarecare services provided, the geographic markets serviced and patient and payor mix, among other things. As a result of the facts and conclusions detailedabove, and pursuant to the contingent gain guidance in SFAS No, 5, Accounting for Contingencies, we recorded the $14.0 million gain during 2006 whichreflects the fair value of the assets transferred from UHS to us as of December 31, 2006, net of the $6.3 million recoverable from UHS recorded during 2005and the $2.0 million of Chalmette land relinquished. After giving effect to the exchange and substitution, and the various lease renewals discussed above, subsidiaries of UHS lease four hospital facilitiesowned by us with terms expiring in 2011 through 2014. The table below details the renewal options and terms for each of the four UHS hospital facilities: Hospital Name Type of Facility AnnualMinimumRent End ofLease Term RenewalTerm(years)McAllen Medical Center Acute Care $5,485,000 December, 2011 20(a)Wellington Regional Medical Center Acute Care $3,030,000 December, 2011 20(b)Southwest Healthcare System, Inland Valley Campus Acute Care $2,597,000(d) December, 2011 20(b)The Bridgeway Behavioral Health $930,000 December, 2014 10(c)(a)UHS has four 5-year renewal options at existing lease rates (through 2031).(b)UHS has two 5-year renewal options at existing lease rates (through 2021) and two 5-year renewal options at fair market value lease rates (2022 through2031).(c)UHS has two 5-year renewal options at fair market value lease rates (2015 through 2024).(d)Excludes potential incremental rent, if any, on Capital Addition in excess of $11.0 million. We cannot predict whether the leases with subsidiaries of UHS, which have renewal options at existing lease rates, or any of our other leases, will berenewed 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 facilities and/orenter into leases on terms potentially less favorable to us than the current leases. The combined revenues generated from the leases on the UHS hospital facilities accounted for approximately 49% of our consolidated revenues for theyear ended December 31, 2006. Including 100% of the revenues generated at the unconsolidated LLCs in which we have various non-controlling equityinterests ranging from 33% to 99%, the leases on the UHS hospital facilities accounted for approximately 24% for the year ended December 31, 2006. Inaddition, five MOBs (plus three additional MOBs currently under construction) owned by LLCs in which we hold various non-controlling equity interests,include tenants which are subsidiaries of UHS. During 2006, we committed to invest up to $6.6 million ($250,000 in equity, $53,000 of which has been funded as of December 31, 2006 and $6.3million in debt financing or equity, none of which has been funded as of December 31, 2006) in exchange for a 95% non-controlling equity interest in alimited liability company that will develop, construct, own and operate the Centennial Hills Medical Office Building I, located in Las Vegas, Nevada, on thecampus of a UHS hospital. This MOB will be 60% master leased by Valley Health System (“VHS”), a majority-owned subsidiary of UHS, on a triple netbasis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenant acceptable to the LLC and VHS for a minimumterm of five years. The LLC has a $15.7 million construction loan commitment from a third-party, which is non-recourse to us. This building, tenants ofwhich may include subsidiaries of UHS, is scheduled to be completed and opened during the third quarter of 2007. 69Table of Contents Additionally, during 2006, we committed to invest up to $4.3 million in equity, of which $86,000 has been funded as of December 31, 2006, inexchange for a 95% non-controlling equity interest in a limited liability company that will develop, construct, own and operate the Palmdale Medical Plaza,located in Palmdale, California, on the campus of a UHS hospital currently under construction. This MOB will be 75% master leased by UHS of Palmdale,Inc., a subsidiary of UHS, on a triple net basis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenantacceptable to the LLC and UHS of Palmdale, Inc. for a minimum term of five years. This building, tenants of which may include subsidiaries of UHS, isscheduled to be completed and opened during the fourth quarter of 2007. During 2005, we committed to invest up to $12.3 million ($3.4 million in equity and $8.9 million in debt financing, $5.4 million of debt has beenfunded as of December 31, 2006) in exchange for a 95% non-controlling interest in a limited liability company that will develop, construct, own and operatethe Spring Valley Medical Office Building II, a second MOB on the campus of Spring Valley Hospital in Las Vegas, Nevada. This MOB will be 50% masterleased by VHS on a triple net basis. The master lease for each suite will be cancelled at such time that the suite is leased to another tenant acceptable to the LLCand VHS for a minimum term of five years. This MOB is scheduled to be completed and opened during the second quarter of 2007. Upon the December, 2004 lease expiration on the Virtue Street Pavilion, the former lessee (a wholly-owned subsidiary of UHS), exercised its optionpursuant to the terms of the lease and purchased the facility at its appraised fair market value of $7,320,000. The sale resulted in a gain of $833,000 which isreflected as “Income from discontinued operations, net” in the consolidated statements of income for the year ended December 31, 2004. Prior to thetransaction, the annual minimum rent payable to us under the lease was $1,261,000 and no bonus rent was earned on this facility during 2004. As a result ofthis transaction, our cash flows from operating activities were adversely affected during 2006 and 2005 since calculated using our average incrementalborrowing rates during each year, the reduction to annual interest expense resulting from repayment of borrowings using the $7.3 million of sale proceeds wasapproximately $700,000 less during 2006, and $900,000 less during 2005, than the annual rental payments earned by us pursuant to the terms of the lease. The following table summarizes the results of operations for the Virtue Street Pavilion during 2004 (in thousands): Year EndedDecember 31, 2004 Revenues $1,261 Depreciation expense (135) Income from operations 1,126 Gain on sale 833 Income from discontinued operations, net $1,959 During the third quarter of 2004, Wellington, our 121-bed acute care facility located in West Palm Beach, Florida, sustained storm damage caused by ahurricane. This facility is leased by a wholly-owned subsidiary of UHS and pursuant to the terms of the lease, UHS is responsible for maintainingreplacement cost property insurance for the facility, a substantial portion of which is insured by a commercial carrier. The facility did not experiencesignificant business interruption. Our consolidated statements of income for the year ended December 31, 2004, included a property write-down charge of $1.9million representing the estimated net book value of the damaged assets. This property charge was offset at that time by an equal amount recoverable fromUHS. During 2004, UHS incurred approximately $1.9 million in replacement costs in connection with this property and that amount was included asconstruction in progress on our consolidated balance sheet as of December 31, 2004. During the twelve months ended December 31, 2005, UHS incurred anadditional $4.7 million in replacement costs and since these additional costs have also been recovered from UHS, 70Table of Contents$4.7 million has been included in net income during the year ended December 31, 2005. The repairs to the facility were completed as of December 31, 2005.UHS spent a total of approximately $6.6 million to replace the damaged property at this facility and this amount is reflected as buildings and improvementson our consolidated balance sheet. During 2004 we invested an additional $2.1 million in exchange for a 95% non-controlling interest in a limited liability company that acquired theSpring Valley Medical Office Building, a 60,000 square foot medical office building on the campus of Spring Valley Hospital in Las Vegas, Nevada. Thismedical office building has tenants which are subsidiaries of UHS. During the fourth quarter of 2004 we invested an additional $600,000 (for a total of $3.0 million in equity and $6.5 million of debt financing, whichwas repaid to us during the first quarter of 2005) for the purchase of a 98% non-controlling equity interest in a limited liability company that simultaneouslypurchased the 700 Shadow Lane & Goldring MOBs, consisting of three medical office buildings on the campus of Valley Hospital Medical Center in LasVegas, Nevada. These medical office buildings were purchased from VHS and have tenants which are subsidiaries of UHS. UHS Legal Proceedings: We have been advised by UHS that UHS, together with its South Texas Health System affiliates, which operate McAllenMedical Center, were served with a subpoena dated November 21, 2005, issued by the Office of Inspector General of the Department of Health and HumanServices. At that time, the Civil Division of the U.S. Attorney’s office in Houston, Texas indicated that the subpoena was part of an investigation under theFalse Claims Act of compliance with Medicare and Medicaid rules and regulations pertaining to the employment of physicians and the solicitation of patientreferrals from physicians from January 1, 1999 to the date of the subpoena related to the South Texas Health System. UHS has informed us that it iscooperating in the investigation. On February 16, 2007, UHS’s South Texas Health System affiliates were served with a search warrant in connection withwhat UHS has been advised is a related criminal investigation concerning the production of documents. UHS has advised us that, at this time, it is unable toevaluate the existence or extent of any potential financial exposure in connection with this matter. UHS has advised us that it monitors all aspects of its business and that is has developed a comprehensive ethics and compliance program that isdesigned to meet or exceed applicable federal guidelines and industry standards. Because the law in this area is complex and constantly evolving, governmentalinvestigation or litigation may result in interpretations that are inconsistent with industry practices, including UHS’s. Although UHS believes their policies,procedures and practices comply with governmental regulations, no assurance can be given that UHS will not be subjected to further inquiries or actions, orthat UHS will not be faced with sanctions, fines or penalties in connection with the investigation of our South Texas Health System affiliates. Even if UHSwere to ultimately prevail, the government’s inquiry and/or action in connection with this matter could have a material adverse effect on UHS’s futureoperating results and on the future operating results of McAllen Medical Center. While the base rentals are guaranteed by UHS through the end of the leaseterm, should this matter adversely impact on the future revenues and/or operating results of McAllen Medical Center, the future bonus rental earned by us onthis facility may be materially, adversely impacted. Bonus rental revenue earned by us from McAllen Medical Center amounted to $1.9 million during each of2006 and 2005 and $2.2 million during 2004. We can provide no assurance that this matter will not have a material adverse impact on underlying value ofMcAllen Medical Center or on the future base rental earned on this facility after the December, 2011 scheduled expiration of the existing lease term. Advisory Agreement: UHS of Delaware, Inc. (the “Advisor”), a wholly-owned subsidiary of UHS, serves as Advisor to us under an AdvisoryAgreement (the “Advisory Agreement”) dated December 24, 1986. Under the Advisory Agreement, the Advisor is obligated to present an investment programto us, to use its best efforts to obtain investments suitable for such program (although it is not obligated to present any particular investment opportunity tous), 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 71Table of ContentsAgreement expires on December 31 of each year; however, it is renewable by us, subject to a determination by the Trustees who are unaffiliated with UHS (the“Independent Trustees”), that the Advisor’s performance has been satisfactory. The Advisory Agreement may be terminated for any reason upon sixty dayswritten notice by us or the Advisor. The Advisory Agreement has been renewed for 2007. All transactions between us and UHS must be approved by theIndependent Trustees. The Advisory Agreement provides that the Advisor is entitled to receive an annual advisory fee equal to 0.60% of our average invested real estate assets,as derived from our consolidated balance sheet. The advisory fee is payable quarterly, subject to adjustment at year-end based upon our audited financialstatements. In addition, the Advisor is entitled to an annual incentive fee equal to 20% of the amount by which cash available for distribution to shareholdersfor each year, as defined in the Advisory Agreement, exceeds 15% of our equity as shown on our consolidated balance sheet, determined in accordance withgenerally accepted accounting principles without reduction for return of capital dividends. The Advisory Agreement defines cash available for distribution toshareholders as net cash flow from operations less deductions for, among other things, amounts required to discharge debt and liabilities of the Trust andreserves for replacement and capital improvements to the Trust’s properties and investments. No incentive fees were paid during 2006, 2005 or 2004.Advisory fees incurred and paid (or payable) to UHS amounted to $1.4 million during each of 2006 and 2005 and $1.5 million for 2004. Officers and Employees: Our officers are all employees of UHS and although as of December 31, 2006 we had no salaried employees, our officers doreceive stock-based compensation from time-to-time. Share Purchase Option: As of December 31, 2006, UHS owned 6.7% of our outstanding shares of beneficial interest. (3)ACQUISITIONS AND DISPOSITIONS 2007 — Subsequent to December 31, 2006, Rio Med Investments, a LLC in which we owned a 80% non-controlling ownership interest, sold the realestate assets of the Rio Rancho Medical Center, located in Rio Rancho, New Mexico. Our share of the net sale proceeds resulting from this transaction is $1.1million. The transaction resulted in a gain of approximately $250,000 which will be included in our results of operations during the first quarter of 2007. 2006 — We invested $5.3 million in the following LLCs: • $1.6 million of equity funded to the LLC that constructed and owns the Sierra San Antonio Medical Plaza, located in Fontana, California, inwhich we have a 95% non-controlling equity interest. We have committed to invest a total of up to $3.5 million in equity in this LLC, of which$2.6 million has been funded as of December 31, 2006. The LLC also obtained a $7.5 million third-party construction loan, which is non-recourse to us. This project was completed and opened during the first quarter of 2006; • $1.5 million of equity funded to the LLC that will develop, construct, own and operate the Phoenix Children’s East Valley Care Center, located inGilbert, Arizona, in which we have a 95% non-controlling equity interest. We have committed to invest a total of up to $3.5 million in equity in thisLLC, of which $1.5 million has been funded as of December 31, 2006. This project is scheduled to be completed and opened during the thirdquarter of 2007; • $637,000 of additional equity funded to the LLC that constructed and owns the Saint Mary’s Professional Office Building located in Reno,Nevada, in which we have a 75% non-controlling equity interest. We have committed to invest a total of $8.0 million in equity in this LLC, ofwhich $5.2 million has been funded as of December 31, 2006. The LLC also obtained a $29 million third-party mortgage that is non-recourse tous; • $532,000 of additional equity funded to the LLC that owns the Desert Samaritan Hospital MOBs located in Mesa, Arizona, in which we have a76% non-controlling equity interest; 72Table of Contents • $329,000 of additional equity funded to the LLC that owns the 700 Shadow Lane & Goldring MOBs located in Las Vegas, Nevada, in which wehave a 98% non-controlling equity interest; • $214,000 of additional equity funded to the LLC that owns the Spring Valley Medical Office Building located in Las Vegas, Nevada, on thecampus of a UHS facility, in which we have a 95% non-controlling equity interest, and; • $562,000 of additional investments in various LLCs in which we own a non-controlling equity interest. We advanced $7.6 million to the following LLCs: • $5.3 million advance made to a LLC that will develop, construct, own and operate the Spring Valley Hospital Medical Office Building II, located inLas Vegas, Nevada on the campus of a UHS facility, in which we have a 95% non-controlling equity interest. We have committed to a total of $8.9million of debt financing to this LLC, of which $5.3 million has been funded as of December 31, 2006. This project is scheduled to be completedand opened during the second quarter of 2007; • $630,000 advance made to the LLC that owns Rio Rancho Medical Center, an existing LLC in which we have a 80% non-controlling equity interest(subsequent to December 31, 2006, the real estate assets of this LLC were sold); • $540,000 advance (which was fully repaid during the third quarter) made to a master LLC which governs four unconsolidated LLCs in which wehave a 90% non-controlling equity interest; • $485,000 advance made to the LLC that constructed and owns the Sierra San Antonio Medical Plaza, located in Fontana, California, in which wehave a 95% non-controlling equity interest. The LLC also obtained a $7.5 million third-party construction loan, which is non-recourse to us. Thisproject was completed and opened during the first quarter of 2006; • $363,000 advance made to the LLC that will develop, construct, own and operate the Phoenix Children’s East Valley Care Center, located inGilbert, Arizona, in which we have a 95% non-controlling equity interest. This project is scheduled to be completed and opened during the thirdquarter of 2007, and; • $259,000 of advances made to various LLCs in which we own a non-controlling equity interest. We received $1.9 million of repayments of advances from the following LLCs: • $1.2 million received as repayments of advances provided to a LLC that owns the Suburban Medical Plaza II, located in Louisville, Kentucky, inwhich we have a 33% non-controlling equity interest; • $540,000 received as repayments of advances provided to a master LLC which governs four unconsolidated LLCs in which we have a 90% non-controlling equity interest, and; • $160,000 received as repayments of advances provided to various LLCs in which we own a non-controlling equity interest. Additionally, during 2006, we received $3.1 million as repayment of a note receivable relating to the 2005 sale of our interest in a LLC which owned theSt. Jude Heritage Health Complex. This transaction resulted in a $1.9 million gain which was deferred in 2005 and recognized during the second quarter of2006 when the cash proceeds were received by us. 2005 — We invested $8.3 million in the following LLCs: • $4.5 million of equity funded in connection with the purchase of a 75% non-controlling interest in a LLC that constructed and owns the SaintMary’s Center for Health located in Reno, Nevada, which opened in March, 2005. We committed to invest a total of $10.5 million ($8.0 million inequity and $2.5 million in debt financing, which was repaid to us during 2005). The LLC also obtained a $29 million third-party mortgage that isnon-recourse to us; 73Table of Contents • $2.5 million paid to an unrelated third-party member as net consideration in connection with the restructure of the ownership interests in fiveexisting unconsolidated LLCs (see note 9); • $1.0 million funded in exchange for a 95% non-controlling interest in a LLC that owns the Sierra San Antonio Medical Plaza, located in Fontana,California. We committed to invest a total of up to $3.5 million in equity in this LLC. The LLC also obtained a $7.5 million third-partyconstruction loan, which is non-recourse to us. This project was completed and opened during the fist quarter of 2006, and; • $235,000 of additional equity funded during the third quarter of 2005 to the LLC that owns the 700 Shadow Lane & Goldring MOBs located inLas Vegas, Nevada, in which we have a 98% non-controlling equity interest. We advanced $2.9 million to the following LLCs: • $400,000 additional advance to a LLC that owns the Saint Mary’s Center for Health, in connection with the purchase of a 75% non-controllinginterest in the LLC (which was fully repaid during 2005); • $680,000 advance made to Desert Samaritan Hospital MOBs, an existing LLC which we have a 76% non-controlling equity interest (which wasfully repaid during 2005); • $425,000 advance made to Edwards Medical Plaza, an existing LLC in which we have a 90% non-controlling equity interest; • $1.3 million advance made (which was repaid to us during 2006) to Suburban Medical Plaza II, an existing LLC in which we have a 33% non-controlling equity interest, and; • $85,000 advance made to Rio Rancho Medical Center, an existing LLC in which we have a 80% non-controlling equity interest (subsequent toDecember 31, 2006, the real estate assets of this LLC were sold). We received $9.6 million of repayments of advances from the following LLCs: • $6.5 million received as repayments of advances provided to a LLC that owns the 700 Shadow Lane & Goldring MOBs located in Las Vegas,Nevada, in which we have a 98% non-controlling equity interest; • $2.5 million received as repayments of advances provided to a LLC that owns the Saint Mary’s Center for Health located in Reno, Nevada, inwhich we have a 75% non-controlling equity interest, and; • $680,000 received as repayments of advances provided to a LLC that owns the Desert Samaritan Hospital MOBs located in Mesa, Arizona, inwhich we have a 76% non-controlling equity interest. During the fourth quarter of 2005, we sold our non-controlling equity interest in West Highland Holdings, a LLC which owned the St. Jude HeritageHealth Complex, located in California, in exchange for a $3.1 million note receivable which was collateralized by the entire ownership interest of the LLC.This transaction resulted in a deferred gain of $1.9 million which was recognized as income during 2006 when the cash proceeds to repay the note receivablewere received by us. 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. Thetransaction resulted in a gain of approximately $1.0 million which is included in our results of operations for 2005. 74Table of Contents2004 — We invested $2.8 million in the following 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 Medical OfficeBuilding located in Las Vegas, Nevada (the LLC also obtained a $4.0 million third-party mortgage that is non-recourse to us), and; • $700,000 of additional investments in various LLCs in which we own a non-controlling equity interest. We advanced $1.4 million to the following LLCs: • $830,000 additional net loan funded (which was repaid to us during 2005) 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 thatconstructed and owns the St. Mary’s Center for Health located in Reno, Nevada, which opened in the first quarter of 2005 (the LLC also obtained a$29 million third-party mortgage that is non-recourse to us), and; • $600,000 additional net loan funded (which was repaid to us during 2005) in connection with the purchase of a 98% non-controlling equity interestin a LLC that simultaneously purchased three medical office buildings on the campus of Valley Hospital Medical Center in Las Vegas, Nevada. During the fourth quarter of 2004, we committed to invest a total of up to $3.5 million in exchange for a 95% non-controlling interest in a LLC that willdeveloped, constructed, owns and operates the Sierra San Antonio Medical Plaza located in Fontana, California. This LLC, which was completed and openedduring the first quarter of 2006, also obtained a $7.5 million third-party construction loan. 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, a LLC in which we had a 60% non-controlling equity interest, sold the real property of ParkvaleMedical Building which is located in Phoenix, Arizona. Our share of the net sale proceeds resulting from this transaction was $950,000 which is included asa gain on sale of real property in our results of operations for 2004, since the carrying value of this investment was reduced to zero in a prior year. (4)LEASES All of our leases are classified as operating leases with initial terms ranging from 3 to 20 years with up to four additional, five-year renewal options.Under the terms of the leases, we earn fixed monthly base rents and pursuant to the leases with subsidiaries of UHS, we may earn periodic bonus rents (seenote 1). The bonus rents from the subsidiaries of UHS, which are based upon each facility’s net revenue in excess of base amounts, are computed and paidon a quarterly basis based upon a computation that compares current quarter revenue to the corresponding quarter in the base year. 75Table 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): 2007 $21,9842008 20,9832009 20,1552010 17,3452011 15,219Thereafter 5,011 Total minimum base rents $100,697 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, from time to time, management enters into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. Theseswaps change the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest rate swaps, we receive variableinterest rate payments and make fixed interest rate payments, thereby creating the equivalent of fixed-rate debt. At December 31, 2006, we had no outstandingswap agreements. Changes in the fair value of interest rate swap designated as a hedging instrument 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, 2006, 2005 and 2004, we recorded additional interestexpense of $62,000, $431,000 and $1,106,000, respectively, as a result of our hedging activity. During 2005, based on revised borrowing forecasts, one of our interest rate swap agreements was deemed to be ineffective. In connection with thisineffective interest rate swap agreement, we recorded a net loss of $252,000 which was included in interest expense during 2005 and consisted of the following:(i) a loss of $515,000 representing the amount recorded in accumulated other comprehensive income (“AOCI”) as of January 1, 2005, and; (ii) a gain of$263,000 to recognize the change in fair value of this derivative during 2005. This swap was terminated during 2005 and a termination fee of $319,000 waspaid. Operating results for the years ended December 31, 2005 and 2004 include net losses/(gains) of $252,000 and ($124,000), respectively. The $252,000loss recorded during 2005 was in connection with the terminated swap, as discussed above. The gain recorded during 2004 represents cash flow hedgeineffectiveness arising from differences between the critical terms of the interest rate swap and the hedged debt obligation when it affects earnings. (6)DEBT In January 2007, we entered into a new unsecured $100 million revolving credit agreement (the “Agreement”) which expires on January 19, 2012. Wehave a one time option, which can be exercised at any time, subject to bank approval, to increase the amount by $50 million for a total commitment of $150million. The Agreement provides for interest at our option, at the Eurodollar rate plus .75% to 1.125%, or the prime rate 76Table of Contentsplus zero to .125%. A fee of .15% to .225% is paid on the unused portion of the commitment. The margins over the Eurodollar, prime rate and commitmentfee are based upon our debt to total capital ratio as defined by the Agreement. As of January 19, 2007, the applicable margin over the Eurodollar rate was.75%, the prime rate was zero, and the commitment fee was .15% At December 31, 2006, we had $13.6 million of outstanding borrowings under our then existing revolving credit agreement and $18.9 million ofoutstanding letters of credit. After giving effect to the increased borrowing capacity in the Agreement entered into in January of 2007, we had $67.5 million ofavailable borrowing capacity, net of the outstanding borrowings and letters of credit outstanding as of December 31, 2006. There are no compensating balancerequirements. The Agreement contains a provision whereby the commitments will be reduced by 50% of the proceeds generated from any new equity offering.The average amounts outstanding under our revolving credit agreement were $11.9 million in 2006, $12.0 million in 2005, and $26.4 million in 2004 withcorresponding effective interest rates, including commitment fees and interest rate swap expense, of 7.9% in 2006, 9.0% in 2005, and 7.0% in 2004. Thecarrying value of the amounts borrowed approximates fair market value. 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, 2006. We have two mortgages, which are non-recourse to us, included on our consolidated balance sheet as of December 31, 2006, with a combinedoutstanding balance of $12.7 million. Both mortgages carry an interest rate of 8.3% and both have maturity dates in 2010. The mortgages are secured by thereal property of the buildings as well as property leases and rents. These two mortgages have a combined fair value of approximately $13.7 million as ofDecember 31, 2006. Changes in market rates on our fixed rate debt impacts the fair value of debt, but it has no impact on interest incurred or cash flow. The following table summarizes our outstanding mortgages at December 31, 2006 (amounts in thousands): Facility Name / Secured by OutstandingBalance(in thousands) InterestRate MaturityDateMedical Center of Western Connecticut $3,849 8.3% 2010Summerlin Hospital MOB II 8,888 8.3% 2010 Total $12,737 As of December 31, 2006, our aggregate consolidated scheduled debt repayments (including mortgages) are as follows (amounts in thousands): 2007 $3322008 3612009 3942010 11,6502011 — Later(a) 13,600 Total $26,337 (a)Consists of borrowings outstanding under the terms of our new $100 million revolving credit agreement entered into in January of 2007. 77Table of Contents(7)DIVIDENDS Dividends of $2.260 per share were declared and paid in 2006, of which $1.831 per share was ordinary income, $0.160 per share was a capital gaindistribution and $0.269 per share was a return of capital distribution. Dividends of $2.175 per share were declared and paid in 2005, of which $1.754 pershare was ordinary income, $0.093 per share was a capital gain distribution and $0.328 per share was a return of capital distribution. Dividends of $2.000per share were declared and paid in 2004, of which $1.753 per share was ordinary income and $0.247 per share was a capital gain distribution. (8)INCENTIVE PLANS ` As discussed in note 1, effective January 1, 2006, we adopted SFAS No. 123R and related interpretations and began expensing the grant-date fair valueof stock options. Prior to January 1, 2006, we accounted for these plans under the recognition and measurement principles of APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no compensation expense was reflected in net income for stock optiongrants, as all options granted under the plan had an original exercise price equal to the market value of the underlying shares on the date of grant. As a result ofadopting SFAS No. 123R, during 2006 we recognized compensation cost in our financial statements on the unvested portion of existing options that weregranted prior to the effective date and the cost of stock options granted after the effective date based on the fair value of the stock options at grant date. 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, 2006, there have been 137,000 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 $195,000 in 2006, $227,000 in 2005 and $192,000 in 2004. As ofDecember 31, 2006, there were 94,750 options exercisable under The Plan with an average exercise price of $19.62 per share (average exercise price, adjustedto give effect to the dividend equivalent rights is $4.29 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 31,2006, no shares have been issued under this plan. Compensation cost related to stock options is recognized under the straight-line method over the stated vesting period of the award. The fair value of eachoption grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for the oneoption grant that occurred in 2004, and the two option grants that occurred in 2005; the 2006 weighted average assumption ranges were based upon the sevenoption grants that occurred between 2002 and 2006 that were granted or vesting on or after January 1, 2006: Year Ended December 31, 2006 2005 2004 Volatility 17% 18% - 19% 18%Interest rate 4% 4% 3%Expected life (years) 9.2 9.2 9.2 Forfeiture rate 2% 3% 0%Dividend yield(a.) 0% 6.5% 6.5%(a.)Fair value calculated at 0% expected dividend yield to provide for effect of DERs. 78Table 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 NumberofShares ExerciseWeighted-Average Price Grant Price Range(High-Low)Balance, January 1, 2004 95,500 $18.92 $29.44/$14.75Granted 5,000 $34.07 $34.07/$34.07 Balance, January 1, 2005 100,500 $19.67 $34.07/$14.75Granted 14,000 $34.55 $34.90/$30.06Exercised (4,500) $20.13 $34.07/$14.75Cancelled (1,000) $32.47 $34.07/$27.65 Balance, January 1, 2006 109,000 $21.45 $34.90/$14.75 Balance, December 31, 2006 109,000 $21.45 $34.90/$14.75 There were no options granted, exercised or cancelled during 2006. The following table provides information about options outstanding and exercisable options at December 31, 2006: OptionsOutstanding OptionsExercisableNumber 109,000 94,750Weighted average exercise price $21.45 $19.62Aggregate intrinsic value $1,911,000 $1,835,000Weighted average remaining contractual life 3.1 2.3 The weighted average remaining contractual life and weighted average exercise price for options outstanding and the weighted average exercise prices pershare for exercisable and expected to vest options at December 31, 2006 were as follows: Options Outstanding ExercisableOptions Expected to VestOptions (a.)Exercise Price Shares WeightedAverageExercisePrice PerShare WeightedAverageRemainingContractualLife (inYears) Shares WeightedAverageExercisePrice PerShare Shares WeightedAverageExercisePrice PerShare$14.75 - $14.75 24,000 $14.75 3.2 24,000 $14.75 N/A N/A$18.625 - $19.625 52,500 18.67 .5 52,500 18.67 N/A N/A$21.4375 - $26.25 7,500 24.62 4.5 6,500 24.37 983 $26.25$27.65 - $29.44 7,000 28.42 6.2 6,250 28.29 737 29.44$30.06 - $34.90 18,000 34.45 8.5 5,500 34.38 12,285 34.48 Total 109,000 $21.45 3.1 94,750 $19.62 14,005 $33.63 (a.)Assumes a weighted average forfeiture rate of 1.7% (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 79Table of Contentsaccount for our unconsolidated investments in LLCs which we do not control using the equity method of accounting. The third-party members in theseinvestments have equal voting rights with regards to issues such as, but not limited to: (i) divestiture of property; (ii) annual budget approval, and; (iii)financing commitments. These investments, which represent 33% to 99% non-controlling ownership interests, are recorded initially at our cost andsubsequently adjusted for our net equity in the net income, cash contributions to, and distributions from, the investments. Pursuant to certain agreements,allocations of profits and losses of some of the LLC investments may be allocated disproportionately as compared to ownership interests after specifiedpreferred return rate thresholds have been satisfied. In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. ThisInterpretation, as revised (“FIN 46R”), addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation. As aresult of our related party relationship with UHS, and certain master lease, lease assurance or lease guarantee arrangements between UHS and variousproperties owned by three LLCs in which we own non-controlling ownership interests ranging from 95% to 99%, these LLCs were considered to be variableinterest entities (see note 9). In addition, we were the primary beneficiary of these LLC investments. Upon the adoption of FIN 46R on March 31, 2004, webegan consolidating the results of operations of these three LLC investments in our consolidated financial statements. As a result of the expiration of the master lease arrangements between subsidiaries of UHS and two of these three LLCs, during the fourth quarter of2006, we began recording the financial results of two LLCs on an unconsolidated basis in our consolidated financial statements. Commencing in the fourthquarter of 2006, the revenues and expenses of these two LLCs are no longer included in our consolidated revenues and expenses; instead, the net incomegenerated from each of these LLCs is included in our consolidated statements of income as “Equity in income of unconsolidated LLCs”. The revenues andexpenses for these LLCs related to the periods prior to the fourth quarter are included in our revenues and expenses in our consolidated statements of income.There was no impact on our net income as a result of recording of the financial results of these LLCs on a consolidated or an unconsolidated basis. The otherLLCs in which we hold various non-controlling ownership interests are not variable interest entities and therefore are not subject to the consolidationrequirements of FIN 46R. Rental income is recorded by our consolidated and unconsolidated MOBs relating to leases in excess of one year in length using the straight-line methodunder which contractual rents are recognized evenly over the lease term regardless of when payments are due. The amount of rental revenue resulting fromstraight-line rent adjustments is dependent on many factors, including the nature and amount of any rental concessions granted to new tenants, scheduled rentincreases under existing leases, 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-line adjustments to rental revenue may vary from period-to-period. Pursuant to certain agreements, allocations of profits and losses of some of theLLC investments may be allocated disproportionately as compared to ownership interest after specified preferred return rate thresholds have been satisfied. Since January 1, 1995 through December 31, 2006, we have invested $61.9 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, 2006, short-term unsecured advances aggregated $7.2 million due from six LLCs. Including the cumulative adjustmentsfor our share of equity in the net income of the LLCs and cash contributions to and distributions from these investments, our net investment in LLCs was$47.2 million, (including the investments in two LLCs that were consolidated prior to the fourth quarter of 2006, as discussed above), as reflected on ourconsolidated balance sheet as of December 31, 2006. As of December 31, 2006, we had investments or commitments to invest in twenty-five LLCs. Three of these LLCs were consolidated into the results ofoperations through the third quarter of 2006. During the fourth quarter of 2006, as discussed above, we began recording the financial results of two LLCs onan unconsolidated basis, and continued accounting for one LLC on a consolidated basis. The following tables represent summarized 80Table of Contentsfinancial and other information related to the twenty-four LLCs which were accounted for under the equity method as of December 31, 2006: Name of LLC Ownership Property Owned by LLCDSMB Properties 76% Desert Samaritan Hospital MOBsDVMC Properties(f.) 90% 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(f.) 90% Edwards Medical PlazaRioMed Investments(k.) 80% Rio Rancho Medical CenterSanta Fe Scottsdale(f.) 90% Santa Fe Professional Plaza575 Hardy Investors(f.) 90% 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(a.) 98% 700 Shadow Lane & Goldring MOBsArlington Medical Properties(b.) 75% Saint Mary’s Professional Office BuildingApaMed Properties 85% Apache Junction Medical PlazaSpring Valley Medical Properties(a.) 95% Spring Valley Medical Office BuildingSierra Medical Properties(c.) 95% Sierra San Antonio Medical PlazaSpring Valley Medical Properties II(d.) 95% Spring Valley Medical Office Building IIPCH Southern Properties(e.) 95% Phoenix Children’s East Valley Care CenterCentennial Medical Properties(g.) 95% Centennial Hills Medical Office Building ICanyon Healthcare Properties(h.) 95% Canyon Springs Medical PlazaPalmdale Medical Properties(i.) 95% Palmdale Medical Plaza653 Town Center Drive(j.) 95% Summerlin Hospital Medical Office BuildingDesMed(l.) 99% Desert Springs Medical Plaza(a.)Tenants of this medical office building include subsidiaries of UHS.(b.)We have committed to invest a total of up to $8.0 million in equity, of which $5.2 million has been funded in exchange for a 75% non-controllinginterest in a LLC that constructed and owns the Saint Mary’s Professional Office Building located in Reno, Nevada. As of December 31, 2006, the LLChas an outstanding mortgage balance of $28.4 million from a third party, which is non-recourse to us. This medical office building opened in March of2005.(c.)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, 2006, we have invested $2.6 million inequity and $485,000 in debt financing in connection with this project. The LLC has a $7.5 million total construction loan commitment from a third-party, which is non-recourse to us. This project was completed and opened during the first quarter of 2006.(d.)We have committed to invest a total of up to $12.3 million ($3.4 million in equity, $79,000 of which was funded as of December 31, 2006, and $8.9million in debt financing, of which $5.3 million has been funded as of December 31, 2006) in exchange for a 95% non-controlling interest in a LLCthat will develop, construct, own and operate the Spring Valley Hospital Medical Office Building II, located in Las Vegas, Nevada on the campus of aUHS facility. This project, tenants of which may include subsidiaries of UHS, is scheduled to be completed and opened during the second quarter of2007.(e.)We have committed to invest up to $3.5 million in equity, of which $1.5 million has been funded as of December 31, 2006; additionally, $363,000 indebt financing has been funded as of December 31, 2006, in exchange for a 95% non-controlling ownership interest in a LLC that will develop,construct, own and operate the Phoenix Children’s East Valley Care Center located in Gilbert, Arizona. The LLC has a $6.8 million total constructionloan commitment from a third-party, which is non-recourse to us. This project is scheduled to be completed and opened during the fourth quarter of2007. 81Table of Contents(f.)The membership interests of this entity are held by a master LLC in which we hold a 90% non-controlling ownership interest.(g.)We have committed to invest up to $6.6 million ($250,000 in equity, $53,000 of which has been funded as of December 31, 2006 and $6.3 million indebt financing or equity, none of which has been funded as of December 31, 2006) in exchange for a 95% non-controlling interest in a LLC that willdevelop, construct, operate and own the Centennial Hills Medical Office Building I, located in Las Vegas, Nevada. The LLC has a $15.7 millionconstruction loan agreement with a third party, which is non-recourse to us, under which $2.8 million has been drawn as of December 31, 2006. Thisproject is scheduled to be completed and opened during the third quarter of 2007.(h.)We have committed to invest up to $6.0 million ($5.5 million in equity, $67,000 of which has been funded as of December 31, 2006, and $500,000 ineither equity and/or debt financing, none of which has been funded as of December 31, 2006) in exchange for a 95% non-controlling equity interest in aLLC that will develop, construct, own and operate the Canyon Springs Medical Plaza in Gilbert, Arizona. The LLC has a $14.2 million constructionloan agreement with a third party, which is non-recourse to us, under which $2.9 million has been drawn as of December 31, 2006. This project isscheduled to be completed and opened during the third quarter of 2007.(i.)We have committed to invest up to $4.3 million in equity of which $86,000 has been funded as of December 31, 2006 in exchange for a 95% non-controlling interest in a LLC that will develop, construct, own, and operate the Palmdale Medical Plaza in Palmdale, California. The LLC has a $9.9million construction loan agreement with a third party, which is non-recourse to us, under which $1.6 million has been drawn as of December 31,2006. This project, tenants of which may include subsidiaries of UHS, is scheduled to be completed and opened during the fourth quarter of 2007.(j.)Tenants of these medical office buildings include subsidiaries of UHS. As discussed above, we began recording these LLCs on an unconsolidated basisduring the fourth quarter of 2006.(k.)Subsequent to December 31, 2006, the real estate assets of this LLC were sold.(l.)The membership interest of this entity is held by a master LLC in which we hold a 95% non-controlling ownership interest. During the fourth quarter of 2005, we sold our non-controlling equity interest in West Highland Holdings, a LLC which owned the St. Jude HeritageHealth Complex, located in California, in exchange for a $3.1 million note receivable which was collateralized by the entire ownership interest of the LLC.This transaction resulted in a deferred gain of $1.9 million which we recognized as income during 2006 when the cash proceeds to repay the note receivablewere received by us. 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, located in Mesa, Arizona. Our share of the net sale proceeds resulting from this transaction was $2.9 million. The transactionresulted in a gain of approximately $1.0 million, which is included in our results of operations for 2005. 82Table of ContentsBelow are the combined statements of income for the LLCs accounted for under the equity method: For the Year Ended December 31, 2006 2005 2004 (amounts in thousands)Revenues $34,524 $31,689 $28,961Operating expenses 14,853 13,993 12,069Depreciation and amortization 6,213 5,484 5,006Interest, net 10,021 9,033 7,600 Net income before gain 3,437 3,179 4,286Gains on sales — 1,693 1,192 Net income $3,437 $4,872 $5,478 Our share of net income before gains on sales(a.) $2,381 $3,559 $3,958Our share of gains on sales 1,860(a.) 1,043 1,009 Our share of net income $4,241 $4,602 $4,967 (a.)Consists of a previously deferred gain of $1.9 million resulting from the sale of our interest in an unconsolidated LLC during the fourth quarter of2005. Included in the 2006 information presented above was the combined income statement information for two above-mentioned LLCs that we beganaccounting for on an unconsolidated basis during the fourth quarter of 2006, pursuant to the provisions of FIN 46R. The combined revenue amounts includedin the table above for the fourth quarter of 2006 for these two properties were $834,000, the combined operating expenses were $377,000, the combineddepreciation and amortization expenses were $172,000 and the combined net interest expense was $192,000. For the year ended December 31, 2006, theamount of combined revenue reflected on our consolidated income statement for these two LLCs while accounted for on a consolidated basis, and therefore notincluded in the table above, totaled $3.8 million, the amount of combined operating expenses were $1.6 million, the combined depreciation and amortizationexpenses were $736,000 and the combined net interest expense was $715,000. There was no impact on our net income as a result of recording these two LLCson an unconsolidated basis. Included in the information presented above for the three months ended March 31, 2004 was the combined income statement information for three LLCsthat we began including in our consolidated statements of income on April 1, 2004, pursuant to the provisions of FIN 46R. For the nine month period fromApril 1, 2004 to December 31, 2004, these three LLCs had combined revenues of $4.8 million, operating expenses of $1.7 million, depreciation andamortization expense of $900,000 and interest expense of $1.3 million. During the three month period ended March 31, 2004, these properties generatedapproximately $1.6 million of revenue, $300,000 of depreciation and amortization expense, $500,000 of other operating expenses and $400,000 of interestexpense. There was no impact on our net income 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, 2006(a.) 2005 (amounts in thousands)Net property, including CIP $210,241 $163,942Other assets 16,840 19,685 Total assets $227,081 $183,627 Liabilities $3,930 $6,086Mortgage notes payable, non-recourse to us 180,928 152,301Notes payable to us 7,238 1,859Equity 34,985 23,381 Total liabilities and equity $227,081 $183,627 Our share of equity and notes receivable from LLCs $47,223 $29,572 83Table of Contents(a.)Includes the assets, liabilities and equity related to the two LLCs discussed above which we began accounting for on an unconsolidated basis during thefourth quarter of 2006. As of December 31, 2006, 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): 2007 $18,2992008 24,0772009 9,6882010 23,2162011 11,245Later 94,403 Total $180,928 Pursuant to the operating agreements of the LLCs, the third-party member 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. On May 1, 2005, we entered into an agreement with the unrelated third-party member to twenty-five of the LLCs in which we hold various ownershipinterests, whereby we agreed to restructure our ownership interests in five existing LLCs with the third-party member. During the second quarter of 2005, wepaid approximately $2.5 million in cash to the third-party member as net consideration for these transactions based on an agreed upon fair market valuationfor the properties. In connection with this agreement, we also established two master limited liability companies to hold certain of the jointly-owned LLCs andentered into a new ventures agreement that will govern all our future joint investments with this third-party member. The LLCs in which we have invested maintain property insurance on all properties. Although we believe that generally our properties are adequatelyinsured, two of the LLCs in which we own various non-controlling equity interests, own properties in California that are located in earthquake zones. Theseproperties, in which we have invested a total of $5.6 million, are no longer covered by earthquake insurance since earthquake insurance is no longer availableat rates which are economical in relation to the risks covered. (10)SEGMENT REPORTING Our primary business is investing in and leasing healthcare and human service facilities through direct ownership or through joint ventures, whichaggregate into a single reportable segment under SFAS 131. We actively manage our portfolio of healthcare and human service facilities and may from time totime make decisions to sell lower performing properties not meeting our long-term investment objectives. The proceeds of sales are typically reinvested in newdevelopments or acquisitions, which we believe will meet our planned rate of return. It is our intent that all healthcare and human service facilities will beowned or developed for investment purposes. Our revenue and net income are generated from the operation of our investment portfolio. Our portfolio is located throughout the United States; however, we do not distinguish or group our operations on a geographical basis for purposes ofallocating resources or measuring performance. We review 84Table of Contentsoperating and financial data for each property on an individual basis, therefore we define an operating segment as our individual properties. Individualproperties have been aggregated into one reportable segment based upon their similarities with regard to both the nature and economics of the facilities, tenantsand operational processes, as well as long-term average financial performance. (11)QUARTERLY RESULTS (unaudited) 2006 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $8,359 $8,328 $8,395 $7,427 $32,509 Net Income $4,948 $6,892 $15,725 $7,132 $34,697 Total basic earnings per share $0.42 $0.58 $1.33 $0.60 $2.94 Total diluted earnings per share $0.42 $0.58 $1.32 $0.60 $2.92 Included in net income during the third and fourth quarters of 2006 are gains on the asset exchange and substitution agreement with UHS of $11.3million and $2.7 million, respectively. Revenues during the fourth quarter of 2006 exclude the $834,000 of combined revenues generated by two LLCs that webegan recording on an unconsolidated basis during the fourth quarter of 2006. 2005 FirstQuarter SecondQuarter ThirdQuarter FourthQuarter Total (amounts in thousands, except per share amounts)Revenues $8,491 $8,345 $8,217 $8,285 $33,338 Net Income $7,580 $6,205 $6,408 $5,230 $25,423 Total basic earnings per share $0.64 $0.53 $0.54 $0.44 $2.16 Total diluted earnings per share $0.64 $0.52 $0.54 $0.44 $2.15 Included in net income during the first quarter of 2005 is a gain on the sale of real property by a LLC of $1.0 million, or $.09 per diluted share.Included in net income during all four quarters of 2005 is $1.5 million, $1.2 million, $1.2 million and $750,000, respectively, related to the recovery ofreplacement costs of real estate assets at Wellington Regional Medical Center that were damaged by hurricanes during 2004. 85Table of ContentsSchedule IIIUniversal Health Realty Income TrustReal Estate and Accumulated Depreciation—December 31, 2006(amounts in thousands) Initial Cost toUniversal HealthRealty IncomeTrust Net costcapitalized/divestedsubsequentto acquisition Gross amount atwhich carriedat close of period AccumulatedDepreciationas of Dec. 31,2006 Date ofconstruction,acquisitionor mostrecentsignificantexpansion orrenovation DateAcquired AverageDepreciableLifeDescription Land Building& Improv. Amount Land Building &Improvements CIP Total Inland Valley Regional Medical CenterWildomar, California $2,050 $10,701 $12,088(c.) $2,050 $13,569 $9,220 $24,839 $5,704 2006 1986 43 YearsMcAllen Medical CenterMcAllen, Texas 4,720 31,442 10,188 6,281 40,069 46,350 16,823 1994 1986 42 YearsWellington Regional Medical CenterWest Palm Beach, Florida 1,190 14,652 17,370(c.) 1,663 31,549 33,212 7,652(a.) 2006 1986 42 YearsThe BridgewayNorth Little Rock, Arkansas 150 5,395 4,571(c.) 150 9,966 10,116 3,419 2006 1986 35 YearsTri-State Rehabilitation HospitalEvansville, Indiana 500 6,945 1,062 500 8,007 8,507 3,444 1993 1989 40 YearsKindred Hospital Chicago CentralChicago, Illinois 158 6,404 1,837 158 8,241 8,399 6,309 1993 1986 25 YearsFresno-Herndon Medical PlazaFresno, California 1,073 5,266 95 1,073 5,361 6,434 1,438 1992 1994 45 YearsFamily Doctor's Medical Office BuildingShreveport, Louisiana 54 1,526 494 54 2,020 2,074 521 1991 1995 45 YearsKelsey-Seybold Clinic at King's Crossing 439 1,618 232 439 1,850 2,289 444 1995 1995 45 YearsProfessional Center at King's CrossingKingwood, Texas 439 1,837 93 439 1,930 2,369 478 1995 1995 45 YearsChesterbrook AcademyAudubon, Pennsylvania 307 996 — 307 996 1,303 236 1996 1996 45 YearsChesterbrook AcademyNew Britain, Pennsylvania 250 744 — 250 744 994 176 1991 1996 45 YearsChesterbrook AcademyUwchlan, Pennsylvania 180 815 — 180 815 995 193 1992 1996 45 YearsChesterbrook AcademyNewtown, Pennsylvania 195 749 — 195 749 944 178 1992 1996 45 YearsThe Southern Crescent Center 1,130 5,092 173 1,130 5,265 6,395 1,232 1994 1996 45 YearsThe Southern Crescent Center IIRiverdale, Georgia — — 5,095 806 4,289 5,095 800 2000 1998 35 YearsThe Cypresswood Professional CenterSpring ,Texas 573 3,842 197 573 4,039 4,612 1,097 1997 1997 35 YearsOrthopaedic Specialists of Nevada BuildingLas Vegas, Nevada — 1,579 — — 1,579 1,579 458 1999 1999 25 YearsSheffield Medical Building Atlanta, Georgia 1,760 9,766 1,663 1,760 11,429 13,189 3,121 1999 1999 25 YearsMedical Center of Western Connecticut—Bldg. 73 (a.)Danbury, Connecticut 1,151 5,176 190 1,151 5,366 6,517 1,235 2000 2000 30 YearsSummerlin Hospital MOB II (b.)Las Vegas, Nevada 158 13,073 855 158 13,928 14,086 1,977 2000 2000 40 Years TOTALS $16,477 $127,618 $56,203 $19,317 $171,761 $9,220 $200,298 $56,935 a.At December 31, 2006 this property had an outstanding mortgage balance of $3.8 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.b.At December 31, 2006 this property had an outstanding mortgage balance of $8.9 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.c.Includes Asset Exchange and Substitution Agreement transaction completed during the third quarter of 2006. 86Table of ContentsUNIVERSAL HEALTH REALTY INCOME TRUST NOTES TO SCHEDULE IIIDECEMBER 31, 2006(amounts in thousands) (1)RECONCILIATION OF REAL ESTATE PROPERTIES The following table reconciles the Real Estate Properties from January 1, 2004 to December 31, 2006: 2006 2005 2004 Balance at January 1, $210,594 $214,254 $182,417 Initial consolidation of variable interest entities — — 43,592 Impact of deconsolidating two LLCs (31,804) — — Property write-down due to hurricane damage — (10,621) (2,931)Sale of real property — — (11,215)Construction in progress 9,220 — 1,863 Other — (123) — Additions(a.) 12,288 7,084 528 Balance at December 31, $200,298 $210,594 $214,254 (2)RECONCILIATION OF ACCUMULATED DEPRECIATION The following table reconciles the Accumulated Depreciation from January 1, 2004 to December 31, 2006: 2006 2005 2004 Balance at January 1, $57,729 $56,609 $52,075 Initial consolidation of variable interest entities — — 5,292 Impact of deconsolidating two LLCs (6,232) — — Property write-down due to hurricane damage — (4,362) (1,068)Sale of real property — — (4,728)Other — (21) — Current year depreciation expense 5,438 5,503 5,038 Balance at December 31, $56,935 $57,729 $56,609 (a.)2006 and 2005 amounts include replacement property recovered from UHS. 87Table of ContentsExhibit Index Exhibit No. Exhibit 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 RegistrationStatement 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 incorporated herein by reference.10.1 Advisory Agreement, dated as of December 24, 1986, between UHS of Delaware, Inc. and the Trust, previously filed as Exhibit10.2 to the Trust’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference.10.2 Agreement dated December 29, 2006, to renew Advisory Agreement dated as of December 24, 1986 between Universal HealthRealty Income Trust and 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 filed as Exhibit 10.2 to Amendment No. 3 of the Registration Statement on Form S-11 and S-2 of Universal HealthServices, Inc. and the Trust (File No. 33-7872), is incorporated herein by reference.10.4 Form of Leases, including Form of Master Lease Document Leases, between certain subsidiaries of Universal Health Services, Inc.and the Trust, previously filed as Exhibit 10.3 to Amendment No. 3 of the Registration Statement on Form S-11 and Form S-2 ofUniversal Health Services, Inc. and the Trust (File No. 33-7872), is incorporated herein by reference.10.5 Corporate Guaranty of Obligations of Subsidiaries Pursuant to Leases and Contract of Acquisition, dated December 1986, issuedby Universal Health Services, Inc. in favor of the Trust, previously filed as Exhibit 10.5 to the Trust’s Current Report on Form 8-K dated December 24, 1986, is incorporated herein by reference.10.6* Share Compensation Plan for Outside Trustees, previously filed as Exhibit 10.12 to the Trust’s Annual Report on Form 10-K forthe year ended December 31, 1991, is incorporated herein by reference.10.7 Lease, dated December 22, 1993, between the Trust and THC-Chicago, Inc., as lessee, previously filed as Exhibit 10.14 to theTrust’s Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.10.8* Universal Health Realty Income Trust 1997 Incentive Plan, previously filed as Exhibit 10.1 to the Trust’s Form 10-Q for thequarter ended September 30, 1997, is incorporated herein by reference.10.9 Credit Agreement, dated as of January 19, 2007, by and among the Trust, the financial institutions from time to time party theretoand Wachovia Bank, National Association, as Administrative Agent, previously filed as Exhibit 10.1 to the Trust’s Current Reporton Form 8-K dated January 24, 2007, is incorporated herein by reference.10.10 Dividend Reinvestment and Share Purchase Plan included in the Trust’s Registration Statement Form S-3 (Registration No. 333-81763) filed on June 28, 1999, is incorporated herein by reference.10.11 Asset Exchange and Substitution Agreement, dated as of April 24, 2006, by and among the Trust and Universal Health Services,Inc. and certain of its subsidiaries, previously filed as Exhibit 10.1 to the Trust’s Current Report on Form 8-K dated April 25,2006, is incorporated herein by reference. 88Table of ContentsExhibit No. Exhibit10.12 Amendment No. 1 to the Master Lease Document, between certain subsidiaries of Universal Health Services, Inc. and the Trust,previously filed as Exhibit 10.2 to the Trust’s Current Report on Form 8-K dated April 25, 2006, is incorporated herein byreference.11 Statement re computation of per share earnings is set forth on the Consolidated Statements of Income.21 Subsidiaries of Registrant.23.1 Consent of Independent Registered Public Accounting Firm.31.1 Certification from the Trust’s Chief Executive Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of1934.31.2 Certification from the Trust’s Chief Financial Officer Pursuant to Rule 13a-14(a)/15(d)-14(a) of the Securities Exchange Act of1934.32.1 Certification from the Trust’s Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted pursuant to Section 906 ofthe 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 ofthe Sarbanes-Oxley Act of 2002.*Management contract or compensatory plan or arrangement. 89Exhibit 10.2December 29, 2006Mr. Alan B. MillerPresidentUHS of Delaware, Inc.367 South Gulph RoadKing of Prussia, PA 19406Dear Alan:The Board of Trustees of Universal Health Realty Income Trust, at their December 1, 2006 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, 2007, 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 andChief Financial Officer cc:Warren J. Nimetz, Esq. Cheryl K. Ramagano Agreed to and Accepted:UHS OF DELAWARE, INC.By: /s/ Alan B. Miller PresidentExhibit 21Subsidiaries of RegistrantJurisdiction 73 Medical Building, LLC ConnecticutCypresswood Investments, L.P GeorgiaRiverdale Realty, L.L.C. GeorgiaSheffield Properties, L.L.C. GeorgiaEXHIBIT 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMThe 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 14, 2007, with respect to the consolidatedbalance sheets of Universal Health Realty Income Trust as of December 31, 2006 and 2005, 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, 2006, and the related financial statement schedule, management’sassessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financialreporting as of December 31, 2006, which reports appear in the December 31, 2006 annual report on Form 10-K of Universal Health Realty Income Trust./s/ KPMG LLPPhiladelphia, PennsylvaniaMarch 14, 2007Exhibit 31.1CERTIFICATION - Chief Executive OfficerI, 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 officer 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 control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theregistrant 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 control over financial reporting, or caused such internal control 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; andd) 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; and5. The registrant’s other certifying officer 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; andb) 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, 2007 /s/ Alan B. MillerPresident and ChiefExecutive OfficerExhibit 31.2CERTIFICATION-Chief Financial OfficerI, 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 officer 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 control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theregistrant 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 control over financial reporting, or caused such internal control 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; andd) 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; and5. The registrant’s other certifying officer 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; andb) 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, 2007 /s/ Charles F. BoyleVice President andChief Financial OfficerEXHIBIT 32.1CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Universal Health Realty Income Trust (the “Trust”) on Form 10-K for the year ended December 31, 2006 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, 2007A 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 32.2CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Universal Health Realty Income Trust (the “Trust”) on Form 10-K for the year ended December 31, 2006, 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, 2007A 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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