Good day, ladies and gentlemen, and welcome to the Diversified Healthcare Trust Second Quarter 2021 Earnings Conference Call. . I would now like to turn the conference over to Michael Kodesch, Director of Investor Relations. Please go ahead.

Good morning, and welcome to Diversified Healthcare Trust call covering the second quarter 2021 results. Joining me on today's call are Jennifer Francis, President and Chief Executive Officer; and Rick Siedel, Chief Financial Officer and Treasurer. Today's call includes a presentation by management followed by a question-and-answer session. I would like to note that the transcription, recording and retransmission of today's conference call are strictly prohibited without the prior written consent of Diversified Healthcare Trust or DHC. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based upon DHC's present beliefs and expectations as of today, Thursday, August 5, 2021. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission, or SEC. In addition, this call may contain non-GAAP numbers, including normalized funds from operations or normalized FFO, EBITDA, net operating income or NOI, and cash basis net operating income or cash basis NOI. Reconciliations of net income or loss attributable to common shareholders to these non-GAAP figures and the components to calculate AFFO, CAD or FAD are available in our supplemental operating and financial data package found on our website at www.dhcreit.com. Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our filings with the SEC. Investors are cautioned not to place undue reliance upon any forward-looking statements. Now I'd like to turn the call over to Jennifer.

Thank you, Michael. Welcome to our second quarter 2021 earnings call, and good morning, everyone. To begin today's company overview, I'll provide an update on the recent actions we've taken with regard to our strategic shift within our SHOP segment, followed by additional commentary surrounding our portfolio in the context of the current operating environment. Subsequent to quarter end, we were excited to announce our progress in our plan to transition close to 50% of our SHOP communities to new operators as we entered into 4 new management agreements for a total of 76 communities in this portfolio. These agreements represent approximately 70% of the transitioning communities, and we look forward to, in some cases, the start of and in others, the continuation of successful relationships with these operators. Given the makeup of our transitioning portfolio, which consists primarily of communities with smaller unit counts and higher acuity business lines, mostly located in secondary markets. We believe that each of these operators is the best regional choice to execute on our business plans that will optimize performance and create the best experience for the residents and team members in these communities. The first agreement we signed was with Charter Senior Living, who will manage communities for us in Florida, Maryland, Tennessee and Virginia. Keven and Jayne at Charter believe in creating culture by having the company's senior leaders spend frequent hands-on time in their communities, which allows them to quickly identify and deal with operational issues, but also it allows them to personally recognize and reward employees that excel. The company's strong close-knit culture has become a key differentiator for them in the markets they serve. We next reached agreement with Phoenix Senior Living. Jesse and his leadership team encourage a culture that supports communities with a hands-on regional model…

Thanks, Jennifer, and good morning, everyone. In the second quarter, we reported normalized FFO attributable to common shareholders of $0.05 per share and adjusted EBITDA of $87.8 million. Looking at our sequential Office Portfolio results, same-property cash basis NOI was up 10 basis points. With the utilization of our assets increasing, we've seen a resulting increase in parking revenues, which helped offset the decreased occupancy Jennifer mentioned. Rent collections have remained strong in this portfolio, with nearly 100% of contractual rents due being collected during the second quarter and for the month of July. In our SHOP segment, sequentially, same property cash basis NOI for our 228 community portfolio was up $6.9 million from the first quarter. Same-property revenues in the SHOP segment decreased $15.9 million or 6.1% from the first quarter, primarily due to the closure of approximately 1,500 skilled nursing units in the portfolio that Five Star will continue to manage for us. Same-property expenses in the SHOP segment decreased 8.9% from the first quarter or approximately $22.7 million, also primarily as a result of the skilled nursing closures. Related to the skilled nursing unit closures, we recently completed the first sale of skilled bed licenses. We plan to sell over 500 in total, and believe we can generate proceeds of over $10 million that we will reinvest into our communities. During the quarter, we recognized approximately $15.7 million of CARES Act funds. As a reminder, these funds are included in interest and other income, but excluded from our reported NOI results. Interest expense was $67.7 million for the second quarter of 2021, an increase of $7.6 million compared to the first quarter due to drawing $800 million on our revolving credit facility at the end of the first quarter. In June, we redeemed $300 million of our 6.75% senior notes using a portion of the proceeds from our February issuance of senior notes. Following this June 2021 redemption, our next senior notes maturity is not until May of 2024. At the end of the second quarter, we had $849 million of unrestricted cash on hand as well as $59 million of restricted cash, much of which can be used to fund budgeted expenditures. In the second quarter, we spent $48.8 million on capital improvements, bringing year-to-date CapEx to just over $100 million. We remain committed to investing capital into our portfolio to improve our future results, and these plans are largely unaffected by the senior living operator transitions we have scheduled. I'll now turn it back over to Jennifer for closing remarks.

Thanks, Rick. We're pleased with the progress we've made in the transition of our SHOP communities to new operators. We remain confident in both the recovery and long-term prospects of senior living and health care real estate in general due to the aging of the U.S. population. Additionally, as we continue to increase the long-term value of our buildings through capital investment, we believe that we are best positioning our portfolio to capitalize on this strong supply-demand dynamic. That concludes our prepared remarks. Operator, please open the line for questions.

. Our first question today will come from Bryan Maher with B. Riley Securities.

Can we drill down a little bit on that SNF license sales? I just want to make sure I got the numbers correctly. Did you say that of the 1,500, you're going to sell 500 or you've already sold 500 for $10 million?

We're marketing them for sale. We've sold 10, and we're marketing the balance.

And why wouldn't you sell all 1,500? Maybe I'm just naive there.

Yes. No, it's dependent on where it's allowed, in what states allow the sale of the bed licenses.

So of the 1,500, really, there's only 500 to be sold.

That's correct.

Great. And then as far as the CARES Act money that was received in the quarter, was that actually received in the quarter? Or was it received prior and you just took the credit during 2Q? And do you expect to get any more?

Good question, Bryan. Much of it was received in the second quarter. There might have been a little bit that had been received in the first quarter, but you don't recognize it until you've met all the requirements and the team has been pretty diligent about going through and making sure that by the time we recognize it, we're confident we fulfilled all the obligations. So yes, $15.7 million this quarter was recognized. We certainly hope there's more. There has been some recent talk about possibly a fourth phase in the Provider Relief Fund. So we are, like many other players in the senior living industry, hoping that there is some more to offset some of the damage that COVID-19 has really done in the business. But it's - again, it's not something we would put in the model at this point.

Great. And then I think earlier or maybe last quarter, you said that you were thinking about $250 million of CapEx for the year with maybe $150 million for SHOP and I think $100 million for MOB life science. Is that still the plan now that you've gotten through half of the year? And I think you said you spent about $100 million so far.

It is certainly still the plan. I guess there is a little bit of question about timing and whether we can - with labor shortages and things physically get it all done this year. There's a chance some of it will slip into early 2022, but we are still very much moving forward with all those projects, the folks in the communities and - at our properties are excited to see the investments. And frankly, we're excited about what it will do for our future cash flow.

Great. And just one last for me and then I'll hop back in the queue. On the SHOP occupancy, I think we've heard dialogue from a couple of companies about the expectation for a post-Labor Day bump. Are you still thinking that, that's going to be the case when people head back to work and school?

We are. As we've talked about before, there are a lot of people who are home and are caring for mom or dad because they're working from home. So as kids return to school and adults return to work, we think there will be a need to move those - that parent or parents into senior living communities.

Our next question will come from Jason Idoine with RBC Capital Markets.

I just had a question on the SNF closure. So I understand that a lot of the change from sequential change in revenues and expenses were driven by the SNF closures. But just wondering if you could put maybe a more specific value on like how much of that change was driven by that specifically.

Jason, this is Rick. That's a - it's a good question. It's one we've dug into a bit. And the challenge is that at many of the communities where you have multiple business lines, skilled nursing, assisted living, there are a lot of shared functions, right? Like your dietary team is generally consistent. Your cleaning staff is the same. So it's really hard to bifurcate it by business line when we're really managing it more by function. So what we see in our retained - the Five Star retained portfolio that we've closed the 1,500 SNF units in, we've seen revenue decreased but that expenses have decreased more as compared to the transitioning properties where we're leaving the skilled nursing units open for the most part. We've seen labor pressure related to costs and things like that. So it's interesting to really see the results that even this quarter, where we did have some SNF operations for a period, the cost savings outweighed the revenue loss. So we're - I think that just further validates that it was probably the right decision, and the teams are actively working to repurpose those SNFs and develop the plans. In a lot of cases, it will likely be higher acuity memory care type product. But all the other business lines are less expensive to operate and less regulated than the skilled nursing space is. So we - again, we're pleased to see that reduction and expect it to continue in the future.

Okay. Yes, that's helpful. And then the 76 communities that are transitioned, I guess, when are you guys expecting to start receiving NOI from those properties? And I assume the remaining transitions are still expected to be completed by year-end, but would you also be expecting to collecting or be collecting rents at that period of time as well?

These are - they're in our SHOP portfolio. So these are managed communities. And just - I want to just be clear, we've had agreements signed for 76 communities, 41 have transitioned to date. And so the transition will continue to happen. They're staggered over the next couple of months. But yes, we're expecting that these operators will grow occupancy and it's competitive across all senior living. So they will also be providing concessions in order to grow occupancies. But yes, we're hoping that we'll see certainly increased NOI as a result of their growth in occupancy.

Okay. And then I guess just following up on that a little bit. How should we think about the impact to the transitions we'll have on occupancy and RevPOR given the competitive dynamics with building that occupancy? I guess how are you guys thinking about that?

I think it's important to keep in mind that the transitioning properties do have, a little bit more of the mix of the units is a little bit more towards the needs-based product versus the properties where we're keeping Five Star as the manager have a higher concentration of assisted - sorry, independent living, which is more choice based. So I do think we'll see the benefit of that needs-based product right now. That's usually in the senior living cycles, that's usually the one that comes back first. I don't think there's any reason to expect that to be different this time around.

Yes. And just to build on what Rick just said, we currently are very much in a needs-based market. The industry is working hard with all of the news of the residents being vaccinated and the vaccine mandates for employees. And so therefore, the growth in employees that have been vaccinated, building consumer confidence to bring the IL residents back is very important. The vaccinations are certainly helping with that. But as Rick said, because it's a needs-based market, these smaller, higher acuity communities should benefit from that.

. Our next question will come from Vikram Malhotra with Morgan Stanley.

Maybe just to clarify on that transition versus non-transition. Can you just give us some color how pre this transition, which I guess all of them have occurred in July onward, how have the 2 buckets performed relative, say, in the first and second quarter?

Sure. I can take that. So the Five Star retained portfolio, the 120 assets, occupancy was up about 170 basis points from the first quarter to the second quarter. And again, we saw revenues decrease $16.7 million, as a result of the SNF closures, and we saw expenses decrease $18.6 million. So it's pretty consistent across the board as a result of those skilled nursing unit shutdowns. On the transition communities, we did see an occupancy increase despite the news of the announcement and the fact that we were touring our asset management folks, we're touring through with prospective operators. We still saw occupancy increase 90 basis points. And I think that even more positive note, we saw revenues increase in that portfolio, about $800,000 from Q1 to Q2. And we were actually able to bring expenses down $4.1 million. So combined, NOI in the transition portfolio is up $4.9 million. And we're confident that our team got out, met with the staff at these transitioning communities to assure them that we're still committed to the buildings in the space and that we're hopeful for the future. And again, I think there's still a lot of work to do, but we are really much more optimistic than we've been in quite some time.

Great. And then can you remind me the specific for both the transition and retained with Five Star? Can you remind me sort of your CapEx outlay specifically? If you can give us a sense of over the next 2 or 3 years, what's budgeted, that would be helpful.

Yes. So Bryan had mentioned last quarter, we kind of talked about a range of probably $250 million to $290 million in total CapEx. I still think that is probably appropriate again. The big question mark is whether we can physically get it done due to contractor availability and some labor shortages and things like that. But we are - for the most part now that the vaccines are in place and the communities are open and we can get people in, we are excited to do that. The development team is also doing a great job moving things forward with the redevelopments we have on the office side. So again, there is a...

But the $250 million to the $290 million is just for senior housing or is that total?

No, that's the whole portfolio.

And roughly, how much is for senior housing?

It's roughly 55% for senior housing.

Got it. Okay. And then just last question, just on the covenant waivers, which I think, correct me if I'm wrong, run through June '22. First, can you just remind us of the specific covenant or covenants that you're monitoring, what that metric is? And then second, if I remember correctly, there are sort of 3 levers you're looking at in terms of compliance or recompliance: one is just the organic growth; two is reducing high-cost debt; and third, I think, is the potential asset sales. I'm specifically interested on the organic side. In your confidence around meeting those covenants, can you give us a sense of what are you expecting for organic growth in SHOP?

I mean, this quarter, the consolidated same-property NOI was up 10% from the first quarter. So we do think things are going in the right direction. We'd like to continue that progress, and we are confident that we're - that we've got the right operators at all of our communities to get that done. There is still some work to do. So there may be some disruptions from headlines about the Delta variant and things like that. But we are still very optimistic about the organic growth story and that these communities have really suffered during the pandemic, and we will return. I think investing capital at the same time is helpful. So we are confident that, that first leg as far as levers you mentioned, getting organic growth back, restoring EBITDA to where it used to be, will certainly help quite a bit. The second one you mentioned was refinancing the high-cost debt, and that's still very much on the table. The one covenant that I think has gotten the most attention so far is the - it's one of our incurrence tests under our public debt covenants. So the idea there is that you're - we're not allowed to issue new debt until our consolidated income available for debt service ratio is above 1.5. The number we printed in the supplemental this quarter is 1.3. But it is important to remember that, that incurrence test is done on a pro forma basis. So when the $1 billion of 9.75% notes are callable and we look to refinance that with lower-cost debt, you do that calculation on a pro forma basis, you go back to the beginning of the period for both. So it's a time where our numerator, the EBITDA, is growing and the denominator, the debt service, should be shrinking. So again, we remain confident that by the middle of next year when our waiver period runs through that we'll be well positioned. And as you said, the third lever that can be pulled is asset sales or potentially JVs or any number of other things that don't involve issuing debt until we're - until we've got the balance sheet back where we believe it should be.

That's really helpful. Just to clarify on - you said on a pro forma basis, so that - but that does not include the refi of the high-cost debt, correct?

It can. It very much can.

Sorry, I just meant the - like today is like the 1.3 that you reported.

No, that's as is. We just reported as for informational purposes. That test really only applies if we were trying to issue new debt, but we think it's a helpful metric to have. And it has to be taken together with all of the other metrics that we report, including our GAAP financial statements. But again, we're trying to be really transparent about where we are in the process.

Our next question will come from Bryan Maher with B. Riley Securities.

Just a follow-up on Vikram's question. Isn't that a little bit of a chicken and the egg thing with - if it's pro forma and you're going to refinance the high-cost debt, how does that work? I mean if you come to the market, let's just say, with $1 billion at 4.5%, do they consider the success of that transaction in allowing the ability to actually do the transaction and issue more debt?

The short answer is yes. You pro-forma, you go back to the beginning of the 4-quarter period as if it happened at the beginning of the test period, including the application of proceeds. So yes.

Without actually knowing exactly what your interest rate will be until you complete the deal, I guess, you kind of have an idea where it's going to price out and so they allow it. Is that the right way to think about it?

I think so, yes.

Okay. And then just one more question for me. We noticed that you sold some MOB life science properties in the quarter, I think it was $95 million. Can you give us a little color on those assets? And is there any more that we should be thinking about in the back half of this year?

So those assets that we sold, those are - it was a great sale. Those were properties that we had in an agreement as part of our previously stated disposition program. Those were a $30 million gain. So it was a good sale for us. We have some senior living communities where we had the operator vacate the residents in those communities. And so we have a handful of those or so that are being marketed for sale. But other than that, we're just focused on our strategy of repositioning this portfolio, the senior living portfolio now. And so we have no further dispositions planned at this point.

Right. And seeing that we have a little bit of time, let me just ask you maybe a big picture question. The Vertex Pharmaceutical headquarters and let's just say, Cedars-Sinai Medical Center Towers in L.A. I mean they're a big part of your NOI at this point, and those are just whale of assets. And what do you think the Street is missing when they look at the portfolio? It seems like there's so much noise related to the SHOP component of the business that it seems like the Street and investors are maybe not giving you credit for kind of the supertankers in their portfolio. How do you think about that when talking to investors and trying to convey the story?

It's a really good point, Bryan. I spend a lot of time trying to talk about our MOB and life sciences portfolio. And while you talk about those 2 assets which, obviously, are premier assets, really well located, great tenant base in those. The rest of our portfolio is also very strong. We've been consistently over 92% occupied in our same-store portfolio. We've got Torrey Pines. We've got assets in - life sciences assets in Boston and San Francisco and San Diego. It's a strong portfolio. I don't know what people are missing. And it's why I try to spend a lot of time talking about that portfolio. Senior living is the topic of choice, certainly, but we'll continue to get out and try to convey the strength of that portfolio.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Jennifer Francis for any closing remarks.

Thank you, and thank you all for joining our call today. Operator, that concludes our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.