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Edited Transcript of DVCR earnings conference call or presentation 5-Aug-19 9:00pm GMT

Q2 2019 Diversicare Healthcare Services Inc Earnings Call

BRENTWOOD Aug 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Diversicare Healthcare Services Inc earnings conference call or presentation Monday, August 5, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James Reed McKnight

Diversicare Healthcare Services, Inc. - President, CEO & Director

* Kerry D. Massey

Diversicare Healthcare Services, Inc. - Executive VP & CFO

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Diversicare Healthcare Services 2019 Second Quarter Conference Call. Today's call is being recorded.

I would now like to remind everyone that in addition to historical information, certain comments made during this conference will be forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. And these statements involve risks and uncertainties, may cause actual events, results and/or performance to differ materially from those indicated by such statements. You are encouraged to review the risk factors and forward-looking statement disclosures the company has provided in its annual report on Form 10-K for the fiscal year ended December 31, 2018, and today's Form 10-Q as well as its other public filings with the Securities and Exchange Commission. During today's call, references may be made to non-GAAP financial measures. Investors are encouraged to review those non-GAAP financial measures and the reconciliation of those measures to the comparable GAAP results in our press release furnished under Form 8-K.

I would now like to turn the call over to Jay McKnight, the President and Chief Executive Officer.

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [2]

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Thank you, Josh. Good afternoon, and thank you for joining Diversicare's 2019 Second Quarter Earnings Call. I want to apologize for moving the call from last Thursday to this afternoon. As the requirements to being a publicly traded company and the accounting standards get more and more complex, it's gotten significantly more difficult for our lean corporate team to complete all that must be completed and review it all with our auditors under a compressed time frame at the end of the quarters. Our quarterly earnings calls have been scheduled roughly a month after quarter end for years now, but we're evaluating adding a few days to the process by moving our call back as we did this quarter.

As you saw in our release and filings today, we have a material update on our outstanding government investigation. As we've noted before and as is the case with others in our industry, we're subject to unresolved governmental investigations into our therapy practices, our practices relating to the preadmission evaluation forms required by TennCare and the PASRR forms required by the Medicare program. We share in today's press release and Form 10-Q that we've reached an agreement in principle with the government to settle the ongoing DOJ investigation and recorded an additional $3.1 million of expense in the quarter, bringing our total accrual to $9.5 million.

This tentative settlement calls for a payment plan over 5 years, with an initial payment of $500,000 to be made when the agreement is finalized. It's expected that we'll be subject to a corporate integrity agreement for the same 5-year period. To provide some context on this matter, less than a year after our COO Leslie Cunningham Campbell and I joined the company, we were informed that the government had opened its investigation going back to 2010. For 6 years, we've had this open investigation, but we are now closer to having certainty on the matter, and we'll be able to better work on the strategic planning for the company. We'll provide updates on the settlement process as we have been. We ask that you please see our updated disclosures and risk factors in today's 10-Q and other filings with the SEC.

As we shared before, we continue to have a substantial presence in certain jurisdictions that have some of the highest professional liability cost per bed in the country. These factors and other challenges facing our industry have been taken into consideration in developing our operating and strategic direction.

We've made significant progress on our Kentucky exit during the second quarter and expect that transaction to be finalized during the third quarter. Due to the planned exit, we were required to change the depreciation schedule for our assets in Kentucky to be fully depreciated by the exit date. Kerry Massey, our CFO, will have more detail on the transition accounting, but this accounted for an extra $671,000 of depreciation expense for the quarter. We also had $100,000 of disposition cost this quarter that were recorded as G&A expense. We expect to wind down our cost -- our wind-down of cost to continue through this calendar year. After our exit, we'll provide pro forma financials that will better reflect our book of business going forward. Kerry will provide more detail on that as well.

As we mentioned on our last call, we've enrolled in the Texas Quality Incentive Payment Program, or QIPP, for 12 of our 13 centers in that state. We provided some specific information on the program in the 10-Q today and urge you to review that language. The program requires certain quality metric targets to be attained for reimbursement add-ons to be earned. We believe that we will qualify for over $2.1 million of revenue add-ons for the period from September 2019 through August 2020, which is the program year, all while continuing to invest in patient care. As we shared in the past, the Medicaid rates in Texas are on the lower end of the spectrum, and we believe this program will be of use to our centers there.

We also mentioned on our last call that year-to-date, we've removed 10% of our noncenter positions. After the exit from Kentucky, we expect that this -- that number to be just over 25% of those noncenter positions. This is very much in line with our efforts to drive new efficiency into our operating platform. In our industry, it's often seen as difficult to be financially sound and be an innovator due to the constant pressure on reimbursement. Our team has taken specific steps recently that we believe will assist us financially and will also allow us to continue to have a best-in-class platform. We look forward to sharing more about this in the future.

For the second quarter, we realized a net loss of $24.6 million compared to a net loss of $311,000 for the year ago quarter. Adjusted EBITDAR for the quarter was $16.4 million. During the second quarter, we recorded a noncash tax expense of $20 million to increase the valuation allowance against our deferred tax assets. Accounting rules require that when you meet certain requirements, you must perform further evaluation work on this type of asset. Because of our settlement with the government, we met those requirements in the second quarter and have recorded this allowance as necessary. Kerry will provide more details about the quarter results and the impact of these accounting -- those accounting matters in his comments.

Our revenue for the quarter was $135.4 million compared to $141.1 million for the year ago quarter. The revenue decrease was primarily related to the sale of 3 Kentucky centers and a decrease in Medicare patients served at our same-store centers. After this quarter, we expect that all of our Kentucky operations for all periods presented will be classified as discontinued operations, making revenue comparisons more straightforward. Our same-store revenue decreased from $136.5 million to $135.4 million from the year ago quarter, mostly as a result of decreased occupancy and shorter length of stay for our skilled patients.

Year-over-year, total occupancy for available beds was down from 84.5% to 82.2%, with skilled mix also down slightly from 14.8% to 14.3%. Our quarterly Medicare and Medicaid rates increased year-over-year by $3.04 and $3.84, respectively, while Managed Care rates decreased by $3.68.

The PDPM payment system for Medicare goes into effect on October 1, and we're happy to report that our team is ready. We expect that our revenue will increase slightly because of this change, and our team has actively worked to prepare for the changeover. As with any major change, there will be bumps, but we will work swiftly to move past them. Our overall philosophy of delivering care to the needs of our patients and residents is very much in line with the PDPM methodology.

The next Medicare market basket increase also goes into effect on October 1. The net market basket is 2.4% as finalized by CMS last week. However, our actual increase will be calculated using value-based purchasing and geographic influences. Our Medicare increases have historically been less than the market basket adjustments.

With that, I'll turn the call over to Kerry for some specific remarks on our financial statements.

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Kerry D. Massey, Diversicare Healthcare Services, Inc. - Executive VP & CFO [3]

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Thank you, Jay. As Jay referenced earlier, we announced in May our planned exit from Kentucky through an agreement with Omega to terminate the lease of our remaining 10 centers in Kentucky and transfer operations to an operator selected by Omega. We expect to complete this transaction during the third quarter, and we'll file pro forma financial statements as part of an 8-K shortly after closing the transaction. The pro forma financial statements will present our operating results and balance sheets, giving effect to disposition of these 10 Kentucky centers in addition to the 3 Kentucky centers that we sold during December of 2018. We have concluded that these centers will meet the accounting criteria to be reported as discontinued operations during the third quarter.

As we wind down the operations for the Kentucky centers, pre-close accounts receivable liabilities for these centers will be presented in discontinued operations until fully liquidated. Also as Jay mentioned, we accelerated depreciation for the leasehold improvements that we expect to abandon in connection with this transaction, such that these assets will be fully depreciated upon our exit. The acceleration resulted in $671,000 of additional depreciation for the second quarter. As a reminder of the information shared with you in our Q1 call, we adopted the new lease accounting standard at the beginning of 2019. The standard required us to initially record on the balance sheet right-of-use operating lease assets and lease liabilities. Reflective of year-to-date amortization to rent expense, operating lease assets reduced to $371.3 million at the end of Q2, while total lease liabilities reduced to $379.1 million for year-to-date payments.

Let me now turn to the detailed quarterly results. Our reported revenue for the quarter was $135.4 million, representing a decrease of $5.7 million from the prior year quarter. The primary driver of the decrease was the sale of the 3 Kentucky centers during the fourth quarter of 2018. Those centers represented $4.5 million of the year-over-year revenue decrease. Same-store revenue decreased by $1.2 million primarily due to a decrease in Medicare skilled census as we continue to experience compression on the average length of stay for those patients. A year-over-year increase in our Medicaid rates helps mitigate these unfavorable impacts.

Total operating expenses for the quarter were $108.6 million, representing a $2.8 million decrease from the prior year quarter. Again, the decrease was driven primarily by the sale of the 3 Kentucky centers during the fourth quarter of '18. As a percentage of revenue, Q2 operating expenses increased to 80.3% from 79% for the prior year quarter. While we successfully scaled our labor and nursing and ancillary costs to our census levels, we have been challenged by increased health insurance cost for our team members, which led to the overall increase in the percentage.

General and administrative expenses for Q2 of $7.6 million were $1.7 million lower than the prior year quarter. As a percentage of revenue, G&A expenses decreased from 6.6% to 5.6% year-over-year. The decrease was driven by lower salaries and taxes in addition to $1.2 million of executive severance expenses that were recorded in the prior year quarter. Our professional liability expense for Q2 of $3 million or 2.2% of revenue decreased from the prior year quarter of $3.2 million or 2.3% of revenue.

As referenced in the previous 2 quarters, we are in the early years of our master lease agreements with Omega and Golden Living. As a result, our GAAP rent expense for these operating leases is significantly outpacing the actual cash rent that we pay. Our lease expense for the quarter of $15.8 million or 11.7% of revenue was $2.1 million higher than the prior year quarter of $13.7 million or 9.7% of revenue. This increase was driven primarily by a $1.7 million quarter-over-quarter increase in noncash straight-line rent expense. The impact of noncash straight-line rent expense will continue to be a significant factor for us throughout the remainder of 2019 as well as the upcoming years.

Our adjusted EBITDA for the quarter was $0.6 million. Considering an adjustment for GAAP rent expense of $15.8 million, adjusted EBITDAR for the quarter was $16.4 million. Adjusted EBITDA for the quarter was 4 point -- for the prior year quarter was $4.6 million, and GAAP rent expense was $13.7 million. The primary drivers of the year-over-year decrease in adjusted EBITDA were the sale of the 3 Kentucky centers during the fourth quarter of '18, the decrease in Medicare census, the increase in health insurance cost and the impact of straight-line rent expense.

In addition to these factors, our Q2 net loss attributable to shareholders of $24.6 million was driven largely by the $3.1 million additional loss contingency expense and the $20 million noncash charge to income tax expense that resulted from an increase in the valuation allowance against our deferred tax assets. In determining the need to book this valuation allowance, we considered our recent cumulative operating results and performed a thorough assessment of the expected realizability of our deferred tax assets. We conservatively booked a full valuation allowance against these assets during Q2. The evaluation of these factors and conditions affecting the realizability of deferred tax assets is a highly subjective process, and future events could result in a change in judgment. Future changes in the valuation of our deferred tax assets may decrease or increase our income tax expense and our net deferred tax assets. We will continue to routinely assess each quarter the realizability of these assets. That concludes our discussion of the Q1 financial -- Q2 financial results.

I will now turn the call back over to Jay for some closing remarks.

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [4]

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Before moving to questions, I'd like to talk about the delisting notice that we received from NASDAQ in December 2018. We've appealed that determination and are awaiting our hearing later this month. If we're not successful in the appeal, our trading will transition to the over-the-counter exchange. We have already applied to and have been accepted by the OTC exchange.

It's not often that you have the opportunity to do a near-complete reset in a public company. In the last year, we've made significant changes that we believe will improve our outlook and puts us well on our way to accomplishing a reset of our company. Last fall, we renegotiated our master lease with Omega. And shortly thereafter, we realized a significant gain on the sale of our owned assets in Kentucky. We've positioned ourselves to complete our exit from Kentucky in the third quarter of this year, after which we'll see the benefit of streamlining processes and procedures through expense reductions along with an improvement to our overall risk profile. We have enrolled in the Texas QIPP program, as discussed. And on October 1, we'll see the implementation of PDPM and the market basket increase for our Medicare room and board reimbursement. The settlement in principle of our open government investigation clarifies a very large unknown item for us. Our industry continues to change, and we believe that we're now well positioned for what's next.

As is our custom, we'd like to conclude this call by reminding you of our mission statement: to improve every life we touch by providing exceptional health care and exceeding expectations. We'd also like to recognize all of our Diversicare Healthcare team members for their passion and relentless pursuit of our mission and achievement of our goal to be a recognized industry leader. This concludes our prepared remarks for today.

We'll now open the call for questions. Please remember, we'll be unable to discuss more than what's been shared in today's 10-Q filing related to the government investigation.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from [Peter Lucks], private investor.

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Unidentified Participant, [2]

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So Jay, was this -- you mentioned that this was not company-specific but industry-specific. Have there been settlements by other similar companies?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [3]

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[Peter], yes, there has been other settlements like this with other companies that obviously I don't have any insight into all the specifics around those, so I can't comment on them. But yes, it's something that we've seen in our industry and in the broader health care sector.

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Unidentified Participant, [4]

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Do you -- were you impacted, in your opinion, on a greater percentage than some of these other thing -- other companies even though you haven't seen their settlements?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [5]

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[Peter], I really can't comment on that. I'm sorry. We're in a position where we've got a settlement in principle that's being documented and finalized. I really -- I think that's about all we can say. We've disclosed what the payment plan looks like in our 10-Q, and I just have to refer you there for specific questions.

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Unidentified Participant, [6]

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What do -- how do your lenders feel about this whole settlement?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [7]

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I can't speak -- I cannot speak for our lenders. We do have enjoyed a very long history with our syndicate, and they've been a very supportive group. And they're obviously extremely up to date on where we are as a company.

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Unidentified Participant, [8]

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Where was the Audit Committee when all of these was going on?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [9]

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[Peter], I can't really get into Board specifics. We have an active Audit Committee and an active Board.

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Unidentified Participant, [10]

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Okay. So let me ask you a question, and this is also -- are you guys really fighting for survivability in your opinion?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [11]

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Wow. That's a really big question. I just mentioned all the positive things that we've worked through and what we've done to reset the company. I mean we've got a new reimbursement opportunity through Texas QIPP that we think is going to be more than $2.1 million of upside. We've really been honed in and focused on getting our expense structure modified, streamlined to be in line with where we think the industry is going and preparing ourselves for what we look like after our Kentucky exit. The Kentucky exit, as I mentioned before, is a collaborative decision between us and Omega about reducing the risk profile for both entities. So yes, I think we've been pushing the reset button, and we're looking forward to the future.

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Unidentified Participant, [12]

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I thought I heard that you said that based on the way you're going to do PM, whatever that is, perhaps you wouldn't get the full 2.4% flow-through from CMS. Did you say that?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [13]

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Yes. That's a great point. I'll clarify that. So there's 2 things happening on October 1. One is the RUG system goes away, and they start -- the Medicare starts paying under PDPM. Separate from that is the annual market basket increase, which is the annual escalator that is applied to Medicare rates. So the 2 are divorced from one another. They just happen to go in on the same day. So on the market basket side, it's a 2.4% max market basket. It's actually bigger than that, but then it's net adjusted for cost. So that 2.4% is then affected by our geography. And as you know, because we've talked about this in the past, we have quite a few rural centers. So the rural centers are reimbursed a little differently. You don't get quite as much in the market basket. And then the other piece of it is related to value-based purchasing. And that's a program that the government goes through, and they work with their providers. And they kind of come back and say, it's a max 2.4%, but this is what you actually get. And so our number historically has been less than the full market basket, which I think if you were to go and read public filings about other companies, you would see that that's pretty consistent.

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Unidentified Participant, [14]

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To make it clear, so you're going to pay against this indebtedness $500,000 per year going forward until you -- this debt is washed off. Is that basically what you said?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [15]

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No. We're going to pay over 5 years.

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Unidentified Participant, [16]

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5 years. Okay.

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [17]

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The first payment is due whenever we reach a documented -- a final settlement under this proposed structure. Remember, it's a settlement in principle. So the first, the $500,000 is whenever we get it all inked and done-done. And then we'll pay the balance over...

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Unidentified Participant, [18]

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Over 5 years. Is that what it is, a 5-year payout?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [19]

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Yes. I don't know the schedule. I don't remember the schedule off the top of my head, but it's in the 10-Q. You can see it in the paragraph right below the commitments and contingencies table.

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Unidentified Participant, [20]

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And finally, what are you guys going to do because ultimately the business is the business? And how do we get the occupancy up?

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [21]

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That's a great question. So we have a very motivated team in our centers. I wish I had some -- a little bit more information on my fingertips. We've actually seen our admissions go up year over year over year, but the length of stay is compressing. So as patients move from Medicare over to Managed Care, Managed Care affects the amount of care that we get to provide in a little bit different way, by the way, they work through their case management program. So we're changing some of our care coordination to be able to respond to that, that we think is going to help position us to work on length of stay, work on our reimbursement, making sure that we're keeping the patient at the center of everything we're doing. So all of our centers have sales function within them. We have regional sales function that supports them obviously then it's all led by our corporate sales function here. So as we look across the industry, the industry has really suffered from an occupancy perspective. Our numbers have held up against that average. The problem is that the whole industry is seeing that shrink.

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Unidentified Participant, [22]

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Yes. We've had that conversation.

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Operator [23]

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And I am not showing any further questions at this time. I would now like to turn the call back over to Jay McKnight for any further remarks.

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James Reed McKnight, Diversicare Healthcare Services, Inc. - President, CEO & Director [24]

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Yes. Thanks, everybody, for joining our call. We really appreciate your interest in Diversicare and look forward to sharing our results with you in the future. Thank you.

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Operator [25]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.