ADVOCAT INC, 10-K405, 2000-03-30

ADVOCAT INC
10-K405, 2000-03-30
SKILLED NURSING CARE FACILITIES

Previous: MCLEODUSA INC, 10-K, 2000-03-30

Next: NTL TRIANGLE LLC, 10-K405, 2000-03-30

<PAGE> 1
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(MARK ONE)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]

For the fiscal year ended DECEMBER 31, 1999

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT
OF 1934 [NO FEE REQUIRED]

For the transition period from ______ to _____.

Commission file number 1-12996

ADVOCAT INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

DELAWARE 62-1559667
------------------------------ -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

277 Mallory Station Road, Suite 130, Franklin, TN 37067
- ------------------------------------------------- ----------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (615) 771-7575

Securities registered pursuant to Section 12(b) of the Act:

Name of Each Exchange On
Title of Each Class Which Registered
------------------- ------------------------
Common Stock, par value $0.01 per share NASD OTC
Toronto Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None.

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to the
filing requirements for the past 90 days. Yes [X] 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
best of 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
Form 10-K. [X]

The aggregate market value of Common Stock held by non-affiliates on March 23,
2000 (based on the closing price of such shares on the NASD OTC Market) was
$1,176,309. For purposes of the foregoing calculation only, all directors,
named executive officers and persons known to the Registrant to be holders of 5%
or more of the Registrant's Common Stock have been deemed affiliates of the
Registrant.

On March 23, 2000, 5,491,693 shares of the registrant's $0.01 par value Common
Stock were outstanding.

Documents Incorporated by Reference:

The following documents are incorporated by reference into Part III, Items 10,
11, 12, and 13 of this Form 10-K: The Registrant's definitive proxy materials
for its 2000 annual meeting of stockholders.

<PAGE> 2

PART I

ITEM 1. BUSINESS

FORWARD-LOOKING STATEMENTS.

Certain statements made by or on behalf of Advocat Inc. (together with its
subsidiaries, "Advocat" or the "Company"), including those contained in this
Annual Report on Form 10-K and elsewhere, are forward-looking statements as
defined in the Private Securities Litigation Reform Act of 1995. These
statements involve risks and uncertainties, including, but not limited to,
changes in governmental reimbursement, government regulation and health care
reforms, ability to expand operations through acquisition activities, both in
finding suitable acquisitions and financing therefor, changing economic and
market conditions and others. Actual results may differ materially from that
expressed or implied in such forward-looking statements. See "Item 1 - Business
- - Risk Factors." Such cautionary statements identify important factors that
could cause the Company's actual results to materially differ from those
projected in forward-looking statements.

INTRODUCTORY SUMMARY.

The Company provides long-term care services to nursing home patients and
residents of assisted living facilities in 12 states, primarily in the
Southeast, and three Canadian provinces. The Company completed its initial
public offering in May 1994; however, its operational history can be traced to
February 1980 through common senior management who were involved in different
organizational structures.

The Company's objective is to become the provider of choice of health care and
related services to the elderly in the communities in which it operates. Advocat
will continue to implement its operating strategy of (i) providing a broad range
of cost-effective senior care services; (ii) forming strategic alliances with
other health care providers to expand the Company's continuum of care; (iii)
clustering its operations on a regional basis; and (iv) targeting non-urban
markets, which management believes are under-served by long-term care providers.
Key elements of the Company's growth strategy are to maximize revenue and
profitability at existing facilities, make selective acquisitions of assisted
living facilities generally located in smaller rural and secondary markets in
the southeast United States and in Canada, and pursue additional management
opportunities.

The Company's principal executive offices are located at 277 Mallory Station
Road, Suite 130, Franklin, Tennessee 37067. The Company's telephone number at
that address is (615) 771-7575, and its facsimile number is (615) 771-7409.

2
<PAGE> 3

MATERIAL CORPORATE DEVELOPMENTS.

OPERATING LOSSES

The Company has incurred losses during 1999 and 1998 and expects to continue to
incur losses during 2000. The Company has a working capital deficit of $56.7
million as of December 31, 1999. Also, the Company has limited resources
available to meet its operating, capital expenditure and debt service
requirements during 2000. Given the events of default under the Company's
working capital line of credit, there can be no assurance that the respective
lender will continue to provide working capital advances.

CURRENT DEBT MATURITIES AND FINANCIAL COVENANT NON-COMPLIANCE

Certain of the Company's loan agreements contain various financial covenants,
the most restrictive of which relate to net worth, cash flow, debt-to-equity
ratio requirements, and limits on the payment of dividends to shareholders. As
of December 31, 1999, the Company was not in compliance with the covenants.
Cross-default or material adverse change provisions contained in the agreements
allow the holders of substantially all of the Company's debt to demand immediate
repayment. Although the non-compliance and resulting actions have not been
formally or informally declared by lenders, the Company has not obtained waivers
of the non-compliance. Based on regularly scheduled debt service requirements,
the Company has a total of $27,195,000 of debt that must be repaid or refinanced
within the next 12 months. However, as a result of the covenant noncompliance
and other cross-default provisions, the Company has classified a total of
$53,098,000 of debt as current liabilities as of December 31, 1999. The Company
would not be able to repay the total amount of its indebtedness outstanding if
the applicable lenders forced immediate repayment.

At December 31, 1999, the Company had total debt outstanding of $60,925,000, of
which $34,950,000 was principally mortgage debt bearing interest, generally at
floating rates ranging from 6.3% to 8.6%. The Company also had outstanding a
promissory note (the "Promissory Note") in the amount of $9,412,000 and a
reducing demand loan to a Canadian bank in the amount of $1,038,000. The
Company's remaining debt of $15,524,000 was drawn under the Company's lines of
credit, consisting of a working capital line of credit and an acquisition line
of credit. Most of the Company's debt is at floating interest rates, generally
at a spread above the London Interbank Offered Rate ("LIBOR"). As of December
31, 1999, the Company's weighted average interest rate was 9.1%.

On June 4, 1999, the Company obtained two loans totaling $25,250,000 (the "NC
Loans"). The NC Loans are secured by the 13 owned assisted living facilities the
Company operates in the state of North Carolina. The NC Loans mature in June
2002, bear interest at LIBOR plus 2.35%, and provide for principal amortization
under a 25-year amortization schedule. The net proceeds available at closing,
$24,688,000, was applied against the Company's indebtedness under the Promissory
Note. As of December 31, 1999, the outstanding indebtedness under the NC Loans
was $25,080,000 and the interest rate was 8.2%.

The Promissory Note had an original indebtedness of $34,100,000. It was used to
fund the purchase of the Company's North Carolina assisted living operations,
which purchase closed on September 30, 1997. With the application of the net
proceeds from the NC Loans, the balance of the Promissory Note was reduced to
$9,412,000. Prior to the principal reduction, the Promissory Note had a maturity
date of July 1, 1999, carried interest at LIBOR plus 3.0% and had a restriction
against pledging the North Carolina assets as collateral with any other lender.
With the reduction in the principal balance, the Company and its lenders agreed
to modify the terms of the Promissory Note by extending the stated maturity date
increasing the interest rate to 12.0% fixed and providing certain security
interests to the lenders. The security interests include two non-operating
properties

3
<PAGE> 4

in North Carolina and the Company's limited partnership interests in Texas
Diversicare Limited Partnership ("TDLP"). The Company has agreed to apply
against the Promissory Note indebtedness any net proceeds realized from the
sale of the collateral comprising the additional security interests. The
Promissory Note was due February 28, 2000, and has not been not called. The
Company and its lender are currently in negotiations with respect to the status
of the Promissory Note.

As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of
letters of credit outstanding, and had $1,929,000 remaining borrowing
capability under its working capital line of credit. The interest rate
applicable at December 31, 1999, was 8.97%. The working capital line of credit
matured February 28, 2000, and has not been called. A further extension of the
existing agreement or a replacement working capital line of credit is currently
being negotiated with the existing bank.

Since early 1998, the Company's bank has provided additional line of credit
availability (the "Overline"). Availability under the Overline began at
$1,250,000 and was increased over time to a maximum level of $4,000,000.
Subsequently, it was reduced to its current level of $3,500,000. Since April
14, 1999, the Overline has carried interest at 14.0% but was otherwise subject
to the same terms and conditions as the Company's working capital line of
credit. Maturity of the Overline had been scheduled for July 1, 1999. However,
coincident with the changes with respect to the Promissory Note, the lender
agreed to revised terms with respect to the Overline. These revisions,
including availability reduction, extended the maturity date, provided for
increased reporting responsibility to the lender and cooperation in the
completion of an audit of the Company's accounts receivable if requested by the
lender. In addition, the Company has provided, with respect to certain
available assets, first and second collateral positions in favor of the lender.
The Company's negotiations with its bank lender include the status of the
Overline, which carried a formal maturity of February 28, 2000. The Overline
has not been called by the respective lender.

The acquisition line of credit of $40,000,000, less outstanding borrowings, was
available to fund approved acquisitions through October 1999. The Company's
obligations under the acquisition line are secured by the assets acquired with
the draws under the acquisition line. Advances under the acquisition line bear
interest, payable monthly, at LIBOR plus a defined spread with respect to each
facility based upon its loan-to-value ratio and debt service coverage.
Individual advances made under the acquisition line are due three years from the
date of initial funding. As of December 31, 1999, the Company had $11,100,000
outstanding under the acquisition line, which amount was secured by four nursing
homes. No further draws are available under the acquisition line of credit.
Amounts outstanding under the acquisition line of credit had a scheduled
maturity date of December 1, 1999; however, the lender has extended the maturity
date to April 30, 2000. The Company and the lender are negotiating replacement
long-term financing.

In late 1999, the Company secured a credit agreement with a bank in support of
its Canadian operations. The Company received a $1,038,000 ($1,500,000 Canadian)
loan. This loan is a reducing demand loan with scheduled monthly payments
aggregating $208,000 ($300,000 Canadian) annually. The loan carries interest at
the lending bank's prime rate plus 0.25% and is secured by a general security
agreement with respect to the Company's Canadian operations. The loan agreement
includes a second facility for working capital loans up to $692,000 ($1,000,000
Canadian). The Company had no working capital draws outstanding under this
facility at December 31, 1999.

4
<PAGE> 5

Based on demand status or regularly scheduled debt service requirements (i.e.,
excluding any potential acceleration due to formal declaration of default by one
or more of the Company's lenders), as of December 31, 1999, $27,195,000 of the
Company's total debt $60,925,000 must be repaid or refinanced during the next 12
months. These scheduled maturities are as follows: $924,000 under the working
capital line of credit, $3,500,000 under the Overline, and $9,412,000 under the
Promissory Note, all three of which are currently due; $11,100,000 under the
acquisition line of credit, which has been extended to April 30, 2000, as
described above; $1,038,000 reducing demand loan to a Canadian Bank ($208,000 of
which is scheduled in the absence of demand); and miscellaneous scheduled
maturities over the next 12 months of $1,220,000. With respect to the Promissory
Note, the working capital line of credit, and the Overline, the Company is
currently negotiating with the existing lender to further restructure the terms,
including further extension of their maturity dates. The Company expects to
repay a portion of this debt through various means such as the sale of certain
assets, refinancing mortgage debt, securing additional equity investment or
through cash generated from operations. The Company expects to repay the
reducing demand loan and miscellaneous current maturities of $1,220,000 with
cash generated from operations. Management is hopeful that it will be successful
in restructuring the Company's debt as described. However, there can be no
assurance that the Company's restructuring efforts will be successful. The
degree to which the Company is unsuccessful increases the likelihood of having
to seek relief through other means including the possibility of relief under the
United States Bankruptcy Code.

At December 31, 1999, the classification of certain debt instruments as current
liabilities, based upon their contractual maturities in 1999, results in
negative working capital of $(56.7) million. As discussed above, management is
pursuing various alternatives to extend or potentially refinance these debt
instruments on a non-current basis. See also Notes 2 and 9 of the Company's
Consolidated Financial Statements.

Of the Company's 63 leased facilities, 30 are covered by a Master Lease and
other leases with Omega Healthcare Investors, Inc. ("Omega"). Under the terms of
the Master Lease, the Company must comply with certain covenants based on total
shareholders' equity of the Company as defined. The Company was not in
compliance with these covenants as of December 31, 1999. As a result of the
non-compliance, Omega has the right to terminate all of its leases with the
Company and seek recovery of any related financial losses, as well as other
miscellaneous remedies. The Company has not obtained waivers of the
non-compliance. The Company and Omega are currently in negotiations with respect
to modification of the existing lease agreements.

OPERATING LEASE NON-COMPLIANCE

The Company is not in compliance with the financial covenants applicable to the
lease agreements covering a majority of its United States nursing facilities.
Under the agreements, the lessor has the right to terminate the lease
agreements and seek recovery of any related financial losses as well as other
remedies. The Company is currently in discussions with the respective lessor
regarding a restructuring of the leases.

HEALTH CARE INDUSTRY

The health care industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
health care program participation requirements, reimbursement for patient
services and Medicare and Medicaid fraud and abuse. Health care law is a dynamic
and rapidly evolving area of the law, and it has been the subject of increased
legislative and regulatory scrutiny in recent years. Changes in these laws and
regulations, such as reimbursement policies of Medicare and Medicaid programs as
a result of budget cuts by federal and state governments or other legislative
and regulatory actions, could have a material adverse effect on the Company's
consolidated financial position, results of operations and cash flows. Future
federal budget legislation and federal and state regulatory changes may
negatively impact the Company.

5
<PAGE> 6

adequacy and condition of the equipment used therein, the quality and adequacy
of personnel, and the quality of medical care. Such requirements are subject to
change. There can be no assurance that, in the future, the Company will be able
to maintain such licenses for its facilities or that the Company will not be
required to expend significant sums in order to do so.

Recently, government activity has increased with respect to investigations and
allegations concerning possible violations by health care providers of fraud and
abuse statutes and regulations. Violations of these laws and regulations could
result in expulsion from government health care programs together with the
imposition of significant fines and penalties, as well as significant repayments
for patient services previously billed. Management believes that the Company is
in substantial compliance with fraud and abuse laws and regulations as well as
other applicable government laws and regulations. However, compliance with such
laws and regulations can be subject to future government review and
interpretation as well as regulatory actions unknown or unasserted at this time.

During 1997, the Company received separate notifications from the state of
Alabama that, as a result of certain deficiencies noted upon periodic surveys of
its two facilities in Mobile, the facilities would be decertified from
participation in the Medicare and Medicaid programs and that licensure
revocation could be pursued. The facilities were decertified for 69 and 91 days,
respectively, before resurveys found them to be in compliance. Both of the
facilities were recertified in 1998 for participation in the Medicare and
Medicaid programs.

During the latter half of 1998, the Company experienced further regulatory
issues with respect to certain facilities. One of the Company's facilities in
Arkansas was decertified from the Medicare and Medicaid programs. The facility
was recertified for Medicaid participation before the decertification had a
negative financial impact on operations; the Company is currently engaged in the
application process to be recertified for Medicare participation. The State of
Florida imposed a moratorium on new admissions as well as civil monetary
penalties upon a facility during the last quarter of 1998. Additionally, the
State required that the facility increase its staffing during the last half of
1998. The Company is appealing the civil monetary penalties. The moratorium on
admissions was lifted at the end of January 1999.

During 1999, the Company did not experience any facility decertifications.
However, the Company did experience the increased regulatory scrutiny that has
been exerted on the industry in the form of increased fines and penalties.

MEDICARE REIMBURSEMENT CHANGES

In 1999, the Company has continued to experience the impact of Medicare payment
limitations imposed by the Health Care Finance Administration upon all providers
of nursing home Medicare services, including implementation of a prospective
payment system ("PPS"). The three-year phase-in of PPS began for all providers
at some point during the year ending June 30, 1999. In general, PPS provides a
standard payment for Medicare Part A services to all providers regardless of
their current costs. PPS creates an incentive for providers to reduce their
costs, and management has reduced operating expenses in 1999 in an effort to
offset the revenue reductions resulting from PPS.

6
<PAGE> 7
However, the Company's Medicare census has declined significantly as an indirect
result of PPS and other reimbursement changes, which has resulted in a reduction
in the amount of the Company's overhead absorbed by the Company's Medicare
operations. Since PPS is still an evolving process, its ultimate impact cannot
be known with certainty at this time.

Cost restrictions placed on the provision of rehabilitation (ancillary) services
have been significant. Beginning in January 1998, the allowable costs for cost
reimbursement components of Medicare Part B services became subject to a
limitation factor of 90.0% of actual cost. In 1999, the cost reimbursement
system for rehabilitation services has been replaced by a system of fee screens
that effectively limit reimbursement and place caps on the maximum fees that may
be charged for therapy services. Historically, the Company subcontracted the
provision of these therapy services. However, in response to the deep cuts in
fees for service, the Company's therapy subcontractor exited the business. In
June 1999, the Company began providing such services in house. The Company
anticipates that this will further negatively impact operations, although the
ultimate effect cannot yet be reasonably estimated. These changes with respect
to Part B reimbursement have combined to cause a dramatic decrease in the
Company's ancillary revenues and expenses.

During 1997, the Federal government enacted the Balanced Budget Act of 1997
("BBA"), which contains numerous Medicare and Medicaid cost-saving measures. The
BBA requires that nursing homes transition to a prospective payment system
("PPS") under the Medicare program during a three-year "transition period,"
commencing with the first cost reporting period beginning on or after July 1,
1998. The BBA also contains certain measures that have and could lead to further
future reductions in Medicare therapy reimbursement and Medicaid payment rates.
To date, the major impact on the Company from PPS and other reimbursement
changes has been systemic occupancy declines, which have reduced the amount of
overhead absorbed under the Company's Medicare operations. These occupancy
declines have resulted in part from the imposition of more conservative
admission criteria and reductions in the average length of stay by patients.
Both revenues and expenses have been reduced significantly from the levels prior
to PPS. With respect to Medicare therapy allowable cost and fee reductions, the
Company estimates that net operations was negatively impacted in both 1998 and
1999 and will continue to be negatively impacted beyond 1999 as a result of the
changes brought about under BBA.

These changes have affected the entire long-term care industry. They have
resulted pursuant to the administrative implementation of the guidelines
contained in the BBA. Under the BBA, Medicare expenditures by the Federal
government have been cut approximately 20.0%. This has been a sudden, drastic
blow to the industry. Other providers who relied more heavily on the provision
of services to higher acuity patients have been impacted more severely than the
Company. There have already been several major bankruptcy filings by nursing
home companies. Without remediation, the long-term effect of the BBA on the
industry is expected to be catastrophic. As the impact of these changes upon
both providers and beneficiaries has become known, there has been growing

7
<PAGE> 8

political awareness of a need to re-examine the drastic cuts that have been
implemented. On November 29, 1999, President Clinton signed into law a budget
agreement that restores over three years $2.7 billion in Medicare funding. The
bill contains several components that become effective at various times over the
three year period. As a result of the legislation, individual nursing facilities
now have the option, for cost reporting years beginning after December 29, 1999,
of continuing under the current PPS transition formula or adopting the full
federal PPS per diem. In addition, the measure provides a two-year moratorium on
the Part B therapy caps beginning January 1, 2000, and it also provides
increases in the per diem rates for the care of certain groups of patients. The
Company is continuing to evaluate the impact of the legislation on its
operations. However, the ultimate impact on the Company's operations cannot be
determined at this time.

There are also ongoing discussions within Congress that may result in further
legislative relief or the institution of administrative changes that would
restore additional revenues to the U.S. nursing home industry. While such
activity is positive, there is no expectation by management that the current
round of legislative and administrative relief under consideration is sufficient
to restore the economic viability that the industry needs. Current levels of or
further reductions in government spending for long-term health care would
continue to have an adverse effect on the operating results and cash flows of
the Company. The Company will attempt to maximize the revenues available to it
from governmental sources within the changes that have occurred and will
continue to occur under the BBA. In addition, the Company will attempt to
increase revenues from non-governmental sources, including expansion of its
assisted living and Canadian operations to the extent capital is available to do
so, if at all.

BUSINESS.

Advocat provides a broad range of long-term care services to the elderly
including assisted living, skilled nursing and ancillary health care services.
As of December 31, 1999, Advocat's portfolio includes 119 facilities composed of
65 nursing homes containing 7,307 licensed beds and 54 assisted living
facilities containing 5,215 units. In comparison, at December 31, 1998, the
Company operated 115 facilities composed of 63 nursing homes containing 7,182
licensed beds and 52 assisted living facilities containing 4,755 units. Within
the current portfolio, 35 facilities are managed on behalf of other owners, 29
of which are on behalf of unrelated owners and six in which the Company holds a
minority equity interest. The remaining facilities, consisting of 61 leased and
23 owned facilities, are operated for the Company's own account. In the United
States, the Company operates 51 nursing homes and 33 assisted living facilities,
and in Canada, the Company operates 14 nursing homes and 21 assisted living
facilities.

The Company's facilities provide a range of health care services to its
residents. In addition to the nursing and social services usually provided in
long-term care facilities, the Company offers a variety of rehabilitative,
nutritional, respiratory, and other specialized ancillary services. As of
December 31, 1999, the Company operates facilities in Alabama, Arkansas,
Florida, Georgia, Kentucky, North Carolina, Ohio, South Carolina, Tennessee,
Texas, Virginia, West Virginia, and the Canadian provinces of Ontario, British
Columbia and Alberta. In January 2000, the Company began managing an assisted
living facility in Nova Scotia in which it holds a minority equity interest.

8
<PAGE> 9

The Company, in its role as owner, lessee, or manager, is responsible for the
day-to-day operation of all operated facilities. These responsibilities include
recruiting, hiring, and training all nursing and other personnel, and providing
resident care, nutrition services, marketing, quality improvement, accounting,
and data processing services for each facility. The lease agreements pertaining
to the Company's 61 leased facilities are, in all but two cases, "triple net"
leases, requiring the Company to maintain the premises, pay taxes and pay for
all utilities. The leases typically provide for an initial term of 10 to 15
years with renewal options up to 10 years. The average remaining term of the
Company's lease agreements, including renewal options, is approximately 14
years.

As compensation for providing management services, the Company earns a
management fee, which in 1999 averaged approximately 3.7% of the facilities' net
patient revenues. Management fees with respect to four United States facilities
were reduced in 1999 because of the failure to meet defined operational
thresholds. Of the Company's 35 management agreements, 20 have more than five
years remaining on their current terms, 12 have from one to three years
remaining on their current terms and three have a current term expiring within
one year, with an average remaining life of approximately five years for all
contracts.

INDUSTRY BACKGROUND.

The long-term care industry encompasses a broad range of accommodations and
health care and related services that are provided primarily to the elderly. As
the need for assistance increases, the elderly can benefit from an assisted
living facility, where nutritional, housekeeping and modest nursing or medical
needs can be met. For those elderly in need of specialized support,
rehabilitative, nutritional, respiratory or other treatments, nursing home
health care is often required. The Company, through its assisted living
facilities and nursing homes, is actively involved in the continuum of care and
believes that it has, through its history of operating such facilities,
developed the expertise required to serve the varied needs of its elderly
residents.

Since the enactment of the BBA in 1997, numerous changes affecting government
funding levels of the nursing home industry have resulted. See "Item 1 -
Material Corporate Developments - Medicare Reimbursement Changes." While the
ultimate impact of the BBA is presently unknown, management believes there are a
number of significant trends that will support the continued growth of the
assisted living and nursing home segments of the long-term care industry,
including:

DEMOGRAPHIC TRENDS. The primary market for the Company's long-term
health care services is comprised of persons aged 75 and older. This age
group is one of the fastest growing segments of the United States
population. According to United States Census Bureau information, this
population segment will increase approximately 28.0% over the next 20
years. The population of seniors aged 85 and over is expected to increase
approximately 68.0% over the next 20 years. As the number of persons aged
75 and over continues to grow, the Company believes that there will be
corresponding increases in the number of persons who need skilled nursing
care or who want to reside in an assisted living facility for assistance
with activities of daily living. According to the United States General
Accounting Office, there are approximately 6.5 million people aged 65 and
older in the United States who needed assistance with daily activities, and
the number of people needing such assistance is expected to double by the
year 2020.

9
<PAGE> 10

COST CONTAINMENT PRESSURES. In response to rapidly rising health care
costs, governmental and other third-party payors have adopted
cost-containment measures to reduce admissions and encourage reduced
lengths of stays in hospitals and other acute care settings. The federal
government had previously acted to curtail increases in health care costs
under Medicare by limiting acute care hospital reimbursement for specific
services to pre-established fixed amounts. Other third-party payors have
begun to limit reimbursement for medical services in general to
predetermined reasonable charges, and managed care organizations (such as
health maintenance organizations) are attempting to limit hospitalization
costs by negotiating for discounted rates for hospital and acute care
services and by monitoring and reducing hospital use. In response,
hospitals are discharging patients earlier and referring elderly patients,
who may be too sick or frail to manage their lives without assistance, to
nursing homes and assisted living facilities where the cost of providing
care is typically lower than hospital care. In addition, third-party payors
are increasingly becoming involved in determining the appropriate health
care settings for their insureds or clients based primarily on cost and
quality of care.

INDUSTRY CONSOLIDATION. Although the long-term care market continues
to be extremely fragmented, consolidations have occurred recently within
the industry, driven in part by opportunities to leverage corporate
overhead, expand into new markets or to enhance development pipelines
through strategic acquisitions, with some companies attempting to achieve a
critical mass and market concentration in order to provide leverage in
dealing with managed-care companies that provide medical insurance for the
elderly. Competitors of the Company desiring to provide more comprehensive
care for the elderly are diversifying into home health care,
rehabilitation, adult day care and assisted living services to provide the
senior population with some measure of independence but with support for
activities of daily living, often achieving this diversification through
acquisitions of existing providers.

LIMITED SUPPLY OF FACILITIES. Because of the aging of the population
and limitations on the granting of Certificates of Need ("CONs") for new
skilled nursing facilities, management believes that there will be a
continuing demand for skilled nursing beds in the markets in which the
Company competes. A majority of states in the United States have adopted
CON or similar statutes generally requiring that, prior to the addition of
new beds, the addition of new services, or the making of certain capital
expenditures, a state agency must determine that a need exists for the new
beds or the proposed activities. The Company believes that this CON process
tends to restrict the supply and availability of licensed nursing facility
beds. High construction costs, limitations on government reimbursement for
the full costs of construction, and start-up expenses also act to constrain
growth in the supply of such facilities. At the same time, nursing facility
operators are continuing to focus on improving occupancy and expanding
services to subacute patients requiring significantly higher levels of
nursing care. As a result, the Company believes that there has been a
decrease in the number of skilled nursing beds available to patients with
lower acuity levels, as opposed to patients with physical or more acute
disabilities, and that this trend should increase the demand for the
Company's assisted living facilities. Management also believes there is
currently a limited supply of assisted living units relative to the growing
need for assisted living services in rural and secondary markets. Although
states generally do not require CONs for assisted living facilities, some
states may impose additional limitations on the supply of facilities. For
example, North Carolina has imposed a moratorium on the addition of new
beds unless the vacancy rate of the county is less than 15.0%.

10
<PAGE> 11

REDUCED RELIANCE ON FAMILY CARE. Historically, the family has been the
primary provider of care for seniors. Management of the Company believes
that the increase in the percentage of women in the work force, the
reduction of average family size, and the increased mobility in society
will reduce the role of the family as the traditional care-giver for aging
parents. Management believes that this trend will make it necessary for
many seniors to look outside the family for assistance as they age.

NURSING HOME AND ASSISTED LIVING FACILITY SERVICES.

OPERATIONS. As of December 31, 1999, the Company operates 65 nursing homes with
7,307 licensed beds and 54 assisted living facilities with 5,215 units as set
forth below:

<TABLE>
<CAPTION>
United States Canada
--------------------------- ----------------------------
Facilities Licensed Beds Facilities Licensed Beds
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Nursing Homes:
Owned ........................ 5 562 2 144
Leased ....................... 36 4,007 0 0
Managed ...................... 10 867 12 1,727
----- ----- ----- -----
Total ............... 51 5,436 14 1,871
===== ===== ===== =====

</TABLE>

Assisted Living Facilities(1): Facilities Units Facilities Units
---------- ------------- ---------- -------------
<S> <C> <C> <C> <C>
Owned ....................... 13 971 3 218
Leased ...................... 20 1,611 5 489
Joint Venture Managed ....... 0 0 6 865
Managed ..................... 0 0 7 1,061
----- ----- ----- -----
Total .............. 33 2,582 21 2,633
===== ===== ===== =====

</TABLE>

(1) Facilities that provide both nursing care and assisted living services are
counted as nursing homes although their units are classified as either
nursing home beds or assisted living units. The Company operates three such
facilities in the United States.

For the year ended December 31, 1999, the Company's net patient and resident
revenues were $178.9 million, or 98.2% of total net revenues. For the year ended
December 31, 1999, the Company's net revenues from the provision of management
services were $3.0 million, or 1.7% of the total net revenues. See Note 14 of
the Company's Consolidated Financial Statements for more information on the
Company's operating segments.

NURSING HOME SERVICES. The nursing homes operated by the Company provide basic
health care services, including room and board, nutrition services, recreational
therapy, social services, housekeeping and laundry services and nursing
services. In addition, the nursing homes dispense medications and otherwise
follow care plans prescribed by the patients' physicians. In an effort to
increase revenues by attracting patients with more complex health care needs,
the Company also provides for the delivery of ancillary medical services at the
nursing homes it operates. These specialty services include rehabilitation
therapy services, such as speech pathology, audiology, and occupational,
hospital-based respiratory, and physical therapies, which are provided through
licensed

11
<PAGE> 12

therapists and registered nurses, and the provision of medical supplies,
nutritional support, infusion therapies, and related clinical services. The
Company has historically contracted with third parties for a fee to assist in
the provision of various ancillary services to the Company's patients. The
Company owns an ancillary service supply business through which it provides
medical supplies and enteral nutritional support services directly to patients.
In 1998, the Company entered into a joint venture to provide institutional
pharmacy services to certain of the Company's facilities as well as facilities
owned by others. The Company continues to explore opportunities to broaden its
ancillary services. The Company's nursing homes range in size from 48 to 247
licensed beds.

ASSISTED LIVING FACILITY SERVICES. Services and accommodations at assisted
living facilities include central dining facilities, recreational areas, social
programs, housekeeping, laundry and maintenance service, emergency call systems,
special features for handicapped persons and transportation to shopping and
special events. The Company believes that assisted living services will continue
to increase as an attractive alternative to nursing home care because a variety
of supportive services and supervision can be obtained in a far more independent
and less institutional setting. Generally, basic care and support services can
be offered cheaper in an assisted living facility than either in a nursing home
or through home health care assistance. On average, the Company provides 30 to
60 minutes of nursing care per resident per day in its Canadian assisted living
facilities. The Company believes that the availability of health care services
is an additional factor that makes assisted living an attractive alternative in
Canada. The Company's assisted living facilities range in size from 12 to 323
units.

OPERATING AND GROWTH STRATEGY.

The Company's objective is to become the provider of choice of health care and
related services to the elderly in the communities in which it operates. The
Company intends to achieve this objective by seeking to:

PROVIDE A BROAD RANGE OF COST-EFFECTIVE SERVICES. The Company's
objective is to provide a variety of services in a broad continuum of care
which will meet the ever changing needs of the elderly. The Company's
expanded service offering currently includes assisted living, skilled
nursing, comprehensive rehabilitation services and medical supply and
nutritional support services. In addition, the Company is considering
adding new services as appropriate including adult day care, medical
equipment rental, and specialized recreational programs. By addressing
varying levels of acuity, the Company is able to meet the needs of the
elderly population it serves for a longer period of time and can establish
a reputation as the provider of choice in a particular market. Furthermore,
the Company believes it is able to deliver quality services
cost-effectively, thereby expanding the elderly population base that can
benefit from the Company's services, including those not otherwise able to
afford private-pay assisted living services.

FORM STRATEGIC ALLIANCES OR JOINT VENTURES WITH OTHER HEALTH CARE
PROVIDERS. Through strategic alliances or joint ventures with other health
care providers, the Company is able to offer additional services to its
customers in a cost-effective, specialized manner. By entering into such
agreements for services such as rehabilitation, the Company believes that
it can continue to leverage the expertise of other providers in order to
expand its continuum of care on a cost-

12
<PAGE> 13

effective basis. In 1998, the Company entered into a joint venture to
provide institutional pharmacy services with NCS HealthCare, a leading
long-term care pharmacy services company. The Company expects to expand
into other service areas as appropriate by establishing additional
strategic alliances or joint ventures in the future.

CLUSTER OPERATIONS ON A REGIONAL BASIS. The Company has developed
regional concentrations of operations in order to achieve operating
efficiencies, generate economies of scale and capitalize on marketing
opportunities created by having multiple operations in a regional market
area.

Key elements of the Company's growth strategy are to:

INCREASE REVENUES AND PROFITABILITY AT EXISTING FACILITIES. The
Company's strategy includes increasing facility revenues and profitability
levels through increasing occupancy levels and containing costs. The
Company directs its marketing efforts locally in order to promote higher
occupancy levels and improved payor and case mixes at its nursing homes and
assisted living facilities.

EMPHASIZE DEVELOPMENT JOINT VENTURES IN CANADA. During 1999 and 1998,
the Company entered into five Canadian joint ventures, each of which has
developed a new assisted living facility. The Company has a minority equity
interest in each development and has received a long-term contract to
manage each facility. Four of these facilities opened during 1999 and the
fifth began operations in January 2000.

MAKE SELECTIVE ACQUISITIONS. The Company's senior management will
continue to evaluate selected acquisitions primarily through the lease of
additional assisted living facilities, concentrating on rural and secondary
markets in the southeast United States and Canada. Management believes that
such markets are often under served by long-term care facilities and offer
lower labor costs. The Company's goal is to use its expertise in operating
long-term care facilities to increase the occupancy rates and lower the
costs of these acquired facilities. In addition, where market conditions
permit, the Company intends to expand the operations of acquired facilities
by offering more services, in an effort to increase their profitability.

PURSUE ADDITIONAL OPPORTUNITIES FOR MANAGEMENT AGREEMENTS. Management
believes that the Company can attract additional management agreements in
Canada. Further, it is management's belief that the Company is a recognized
provider of quality care in Canada and has established financial and
operational control systems, extensive reimbursement expertise, and access
to purchasing economies. The Company has the ability to provide an array of
services ranging from total operational management for passive investors in
nursing homes and assisted living facilities to the provision of unbundled
consulting services. In certain cases, the Company has the opportunity to
share in the profits of a managed facility and/or has a right of first
refusal or an option to purchase the managed facility.

The Company has established a task force to address the continuing impact
of the BBA. The task force will evaluate changes in the funding environment for
long-term care as these changes become known. The Company will attempt to
maximize the revenues available to it from governmental sources within the
changes that occur under the BBA.

13
<PAGE> 14

MARKETING.

At a local level, the Company's sales and marketing efforts are designed to
promote higher occupancy levels and optimal payor mix. Management believes that
the long-term care industry is fundamentally a local industry in which both
patients and residents and the referral sources for them are based in the
immediate geographic area in which the facility is located. The Company's
marketing plan emphasizes the role and performance of the administrator and
social services director of each nursing home and the administrator of each
assisted living facility, all of whom are responsible for contacting various
referral sources such as doctors, hospitals, hospital discharge planners,
churches, and various community organizations. Administrators are evaluated
based on their ability to meet specific goals and performance standards that are
tied to compensation incentives. The Company's regional managers and corporate
staff assist local marketing personnel and administrators in establishing
relationships and follow-up procedures with such referral sources. In addition
to soliciting admissions from these sources, management emphasizes involvement
in community affairs in order to promote a public awareness of the Company's
nursing homes and assisted living facilities and their services. The Company
also promotes effective customer relations and seeks feedback through family and
employee surveys.

The Company has an internally-developed marketing program that focuses on the
identification and provision of services needed by the community. The program
assists each facility administrator in analysis of local demographics and
competition with a view toward complementary service development. The Company
believes that the primary referral area in the long-term care industry generally
lies within a five-to-fifteen-mile radius of each facility depending on
population density; consequently, local marketing efforts are more beneficial
than broad-based advertising techniques.

DESCRIPTION OF MANAGEMENT SERVICES AND AGREEMENTS.

Of the Company's 119 facilities, 35 are operated as managed facilities, where
the Company's responsibilities include recruiting, hiring and training all
nursing and other personnel, and providing quality assurance, resident care,
nutrition services, marketing, accounting and data processing services. Services
performed at the corporate level include group contract purchasing, employee
training and development, quality assurance oversight, human resource
management, assistance in obtaining third-party reimbursement, financial and
accounting functions, policy and procedure development, system design and
development and marketing support. The Company's financial reporting system
monitors certain key data for each managed facility, such as payroll, admissions
and discharges, cash collections, net patient care revenues, rental revenues,
staffing trend analysis and measurement of operational data on a per patient
basis.

The Company's management fee is subordinated to debt payments at 17 facilities.
The Company has the potential to earn incentive management fees over its base
management fees at 26 facilities and is obligated to provide cash flow support
at eight facilities. The Company receives a base management fee for the
management of long-term care facilities ranging generally from 3.5% to 6.0% of
the net revenues of each facility. Total management fees as a percentage of
revenues were 3.9% in 1999. Management fees with respect to four United States
facilities were reduced in 1999 because of the failure to meet defined
operational thresholds. Other than certain corporate and regional overhead
costs, the services provided at the facility are the facility owner's expense.
The facility owner also is obligated to pay for all required capital
expenditures. The Company generally is not required to advance funds to the
owner. However, with respect to one management agreement covering two

14
<PAGE> 15

facilities, the Company has advanced approximately $929,000; this advance
carries 8.0% interest and is being repaid over the remaining life of the
management agreement through December 2005. Additionally, the Company guarantees
the cash flow of a second limited partnership that the Company manages. See
Notes 6 and 16 of the Company's Consolidated Financial Statements for more
information on these advances.

In years prior to 1999, the Company has had several contracts to manage
facilities during Canadian receivership or insolvency proceedings. Although
these contracts are generally month-to-month, it has been the Company's
experience that the duration of a receivership or insolvency management
appointment typically ranges from six to twenty-four months. The number of such
management appointments fluctuates as troubled facilities are added or are
removed due to the disposition of the property by the receiver or owner. Such
management contracts are generally for a base fee with no profit participation,
no subordination to debt, no purchase options and no guarantees of debt.

Based upon the initial term and any renewal terms over which the Company holds
the option, the remaining Company's management contracts expire in the following
years:

Number of Facilities 1999
-------------------------- Management
Year U.S. Canada Fees
---- -------- --------- ---------
<S> <C> <C> <C>
2000 ................... 0 3 264,000
2001 ................... 6(1) 1 48,000(1)
2002 ................... 0 3 293,000
2003 ................... 0 2 82,000
2004 ................... 0 14 1,423,000
2005 ................... 0 2 551,000
2015 ................... 4(2) 0 154,000
----- ---------
Total ......... 10 25
===== =========

</TABLE>

- ----------

(1) The operations of the six facilities of Texas Diversicare Limited
Partnership ("TDLP") are included in the Company's consolidated operations.
Accordingly, no management fees are recognized with respect to TDLP. See
Note 6 of the Company's Consolidated Financial Statements for more
information with respect to the Company's relationship with TDLP.
(2) The management fees with respect to these facilities are subject to
reduction because of the failure to meet defined operational thresholds.
The Company's 1999 management fees were reduced $618,000 due to the
operational results of these facilities.

The Company currently anticipates that most of the management agreements coming
due for renewal in 2000 will be renewed. However, there can be no assurance that
any of these agreements will be renewed.

15
<PAGE> 16

The following table summarizes the Company's net revenues derived from
management services and the net revenues of the managed facilities during the
years indicated (in thousands):

<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Management Fees $ 2,932 $ 3,627 $ 3,886
============= ============= =============

Net Revenues of Managed Facilities $ 75,675 $ 71,670 $ 75,043
============= ============= =============

Management Fees as a Percentage
of Net Facility Revenues 3.9%(1) 5.1% 5.2%
============= ============= =============

</TABLE>
- ---------------
(1) In 1999, management fees were reduced due to the failure of four facilities
to reach certain operational thresholds. Had these revenues been earned,
the 1999 percentage would have been 4.5%.

DESCRIPTION OF LEASE AGREEMENTS.

The Company leases 61 nursing homes and assisted living facilities, including 30
owned by Omega, 11 owned by Counsel Corporation ("Counsel") (which owned or
controlled the Company's predecessor operations), 13 owned by members or
affiliates of Pierce and seven owned by others, three of which were added in
1999. All but two of the Company's leases are "triple-net," requiring the
Company to maintain the premises, pay taxes, and pay for all utilities. The
Company typically grants its lessor a security interest in the Company's
personal property located at each leased facility to secure the Company's
performance under the lease. The leases contain customary default and covenant
provisions, generally requiring the Company to maintain a minimum net worth,
expend specified sums per bed for capital expenditures, maintain certain
financial and coverage ratios and prohibit the Company from operating any
additional facilities within a certain radius of each leased facility. In
addition, the Company is generally required to maintain comprehensive insurance
covering the facilities it leases as well as personal and real property damage
insurance and professional malpractice insurance. In all cases where mortgage
indebtedness exists with respect to a leased facility, the Company's interest in
the premises is subordinated to that of the lessor's mortgage lenders.

OMEGA LEASES. The Company has a master lease with Omega Healthcare Investors
Inc. ("Omega") covering 21 facilities (the "Master Lease"), which provides for
an initial term of ten years through August 2002 and allows the Company one
ten-year renewal option. The Master Lease provides for annual increases in the
rent based upon inflation or a percentage of the increase in the net revenues of
the facilities, whichever results in the greater increase in rent, up to a
maximum increase equal to 5.0% of the prior year's rent. The Company entered
into a series of agreements with Omega in 1994 that ultimately resulted in the
Company leasing a total of nine additional facilities (the "1994 Omega Leases").
The 1994 Omega Leases provide for an initial term of ten and one-half years
expiring in May 2005 and allow the Company two five-year renewal options. The
rent with respect to these facilities is subject to increases under a formula
similar to that of the Master Lease up to a maximum increase of

16
<PAGE> 17

3.9% of the prior year's rent. During the year ended December 31, 1999, the
patient and resident revenues from the Omega leased facilities were $69.6
million. A default with respect to any one facility would constitute a default
with respect to all the facilities covered by the Master Lease or the 1994 Omega
Leases, as applicable.

The Company is currently not in compliance with the financial covenants
applicable to the Master Lease and the 1994 Omega Leases. Under the agreements,
Omega has the right to terminate the agreements and seek recovery of any related
financial losses as well as other miscellaneous remedies. To date, Omega has not
asserted any of its rights arising from the non-compliance. The Company is
currently negotiating amendments to its agreements with Omega.

COUNSEL LEASES. The Company leases five facilities from Counsel with a remaining
term of approximately four years through April 2004. The Company leases three
additional facilities from Counsel with an initial term of ten years through
April 2004 and one ten-year renewal option. With respect to these eight
facilities, the Company has the right of first refusal and a purchase option at
the end of the respective lease terms. Additionally, the rent is fixed
throughout the current terms. The Company leases three additional facilities
from Counsel with a lease term through August 2002. These facilities are subject
to a participating mortgage from Counsel in favor of Omega. At the end of the
lease term, the Company has the right to purchase these facilities. In addition,
the Company can require Counsel to transfer these facilities to Omega, at which
time the Company has the right to lease these facilities from Omega in
accordance with the terms of the Master Lease. Rent increases with respect to
these three facilities are calculated under the same terms as applicable in the
Omega Master Lease. During the year ended December 31, 1999, the patient and
resident revenues from the Counsel leased facilities were $17.0 million. The
Counsel leases provide that a default under any one of the leases constitutes a
default under all of the leases.

PIERCE LEASES. Effective October 1, 1997, the Company acquired leases with
respect to 14 facilities from Pierce Management Group ("Pierce"). Of these
leases, 12 are with the former principal owners of Pierce and have an initial
term of 15 years and two five-year renewal options. Beginning at the third
anniversary, annual rent increases are to be applied equal to the rate of
inflation up to a maximum of 3.0%. Beginning at the fifth anniversary, the
Company has a right to purchase all 12 facilities as a group for their fair
market value. An additional lease, which expires in 2003, is with an affiliate
of Pierce who is a current employee of the Company. The remaining lease is a
sublease that expires in 2017. The Company has no purchase option with respect
to either the 2003 lease or the sublease. During the period ended December 31,
1999, the resident revenues from the Pierce leased facilities were $14.1
million.

17
<PAGE> 18

FACILITIES.

The following table summarizes certain information with respect to the nursing
homes and assisted living facilities owned, leased and managed by the Company as
of December 31, 1999:

<TABLE>
<CAPTION>
Assisted Living
Nursing Homes Facilities
-------------------------- ------------------------
Number Licensed Beds Number(1) Units
----- ------------- --------- -----
<S> <C> <C> <C> <C>
OPERATING LOCATIONS:
Alabama .................. 6 711 -0- 52
Arkansas ................. 13 1,411 2 24
Florida .................. 8 800 -0- -0-
Georgia .................. -0- -0- 1 52
Kentucky ................. 6 474 -0- 4
North Carolina ........... -0- -0- 28 2,241
Ohio ..................... 1 151 -0- -0-
South Carolina ........... -0- -0- 1 99
Tennessee ................ 5 617 -0- -0-
Texas .................... 10 1,092 -0- -0-
Virginia ................. -0- -0- 1 110
West Virginia ............ 2 180 -0- -0-
Ontario .................. 14 1,871 15 1,775
British Columbia ......... -0- -0- 5 688
Alberta .................. -0- -0- 1 170
----- ----- ----- -----
65 7,307 54 5,215
===== ===== ===== =====

CLASSIFICATION:
Owned .................... 7 706 16 1,216
Leased ................... 36 4,007 25 2,073
Joint Venture Managed .... -0- -0- 6 865
Managed .................. 22 2,594 7 1,061
----- ----- ----- -----
Total ........... 65 7,307 54 5,215
===== ===== ===== =====

</TABLE>

- ----------
(1) Facilities that provide both nursing care and assisted living services are
counted as nursing homes. The Company operates two such facilities in
Alabama and one in Kentucky.

18
<PAGE> 19

ORGANIZATION.

The Company's long-term care facilities are currently organized into nine
regions, seven in the United States and two in Canada, each of which is
supervised by a regional vice president or manager. The regional vice president
or manager is supported by nursing and human resource personnel, education
coordinators and clerical personnel, all of whom are employed by the Company.
The day-to-day operations of each owned, leased or managed nursing home is
supervised by an on-site, licensed administrator. The administrator of each
nursing home is supported by other professional personnel, including a medical
director, who assists in the medical management of the facility, and a director
of nursing, who supervises a staff of registered nurses, licensed practical
nurses, and nurses aides. Other personnel include dietary staff, activities and
social service staff, housekeeping, laundry and maintenance staff, and a
business office staff. Each assisted living facility owned, leased or managed by
the Company is supervised by an on-site administrator, who is supported by a
director of resident care, a director of food services, a director of
maintenance, an activities coordinator, dietary staff and housekeeping, laundry
and maintenance staff. With respect to the managed facilities, the majority of
the administrators are employed by the Company, and the Company is reimbursed
for their salaries and benefits by the respective facilities. All other
personnel at managed facilities are employed and paid by the owner of the
nursing home or assisted living facility, not by the Company. All personnel at
the leased or owned facilities, including the administrators, are employed by
the Company.

The Company has in place a Continuous Quality Improvement ("CQI") program, which
is focused on training direct care givers. The Company conducts monthly audits
to monitor adherence to the standards of care established by the CQI program at
each facility which it owns, leases or manages. The facility administrator, with
assistance from regional nursing personnel, is primarily responsible for
adherence to the Company's quality improvement standards. In that regard, the
annual operational objectives established by each facility administrator include
specific objectives with respect to quality of care. Performance of these
objectives is evaluated quarterly by the regional vice president or manager, and
each facility administrator's incentive compensation is based, in part, on the
achievement of the specified quality objectives. Issues regarding quality of
care and resident care outcomes are addressed monthly by senior management. The
Company also has established a quality improvement committee consisting of
nursing representatives from each region. This committee periodically reviews
the Company's quality improvement programs and, if so directed, conducts
facility audits as required by the Company's executive committee. The Company
and its predecessor have operated a medical advisory committee in Ontario for
more than 13 years and has developed similar committees in some of the other
jurisdictions in which it operates. It is the Company's view that these
committees provide a vehicle for ensuring greater physician involvement in the
operations of each facility with resulting improved focus on CQI and resident
care plans. In addition, the Company has provided membership for all of its
medical directors in the American Medical Directors Association. All of the
nursing homes operated by the Company in Ontario have been accredited by the
Canadian Council on Health Facilities Accreditation. The CQI program used at all
locations was designed to meet accreditation standards and to exceed state and
federal government regulations.

19
<PAGE> 20

COMPETITION.

The long-term care business is highly competitive. The Company faces direct
competition for additional facilities and management agreements, and the
facilities operated by the Company face competition for employees, patients, and
residents. The Company plans to expand its business through the acquisition of
additional leased long-term care facilities and through additional management
agreements. The Company competes with a variety of other companies to acquire
such facilities and to provide contract management services. Some of the
Company's present and potential competitors for acquisitions and management
agreements are significantly larger and have or may obtain greater financial and
marketing resources. Competing companies may offer new or more modern facilities
or new or different services that may be more attractive to patients, residents
or facility owners than the services offered by the Company.

The nursing homes and assisted living facilities that the Company operates
compete with other facilities in their respective markets, including
rehabilitation hospitals, other "skilled" or "intermediate" nursing homes and
personal care residential facilities. In the few urban markets in which the
Company operates, some of the long-term care providers with which the Company's
operated facilities compete are significantly larger and have or may obtain
greater financial and marketing resources than the Company's operated
facilities. Some of these providers are not-for-profit organizations with access
to sources of funds not available to the facilities operated by the Company.
Construction of new long-term care facilities near the Company's existing
operated facilities could adversely affect the Company's business. Management
believes that the most important competitive factors in the long-term care
business are: a facility's local reputation with referral sources, such as acute
care hospitals, physicians, religious groups, other community organizations,
managed care organizations, and a patient's family and friends; physical plant
condition; the ability to identify and meet particular care needs in the
community; the availability of qualified personnel to provide the requisite
care; and the rates charged for services. There is limited, if any, price
competition with respect to Medicaid and Medicare patients, since revenues for
services to such patients are strictly controlled and are based on fixed rates
and cost reimbursement principles. Although the degree of success with which the
Company's operated facilities compete varies from location to location,
management believes that its operated facilities generally compete effectively
with respect to these factors.

GOVERNMENT REGULATION AND REIMBURSEMENT.

The Company's facilities are subject to compliance with numerous federal, state
and local health care statutes and regulations. All nursing homes must be
licensed by the states in which they operate and must meet the certification
requirements of government-sponsored health insurance programs such as Medicare
and Medicaid, in order to receive reimbursement from these programs. The
Company's assisted living facilities in North Carolina are subject to similar
state and local licensing requirements.

REIMBURSEMENT. A significant portion of the Company's revenues is derived from
government-sponsored health insurance programs. The nursing homes operated by
the Company derive revenues under Medicaid, Medicare, the Ontario Government
Operating Subsidy program and private pay sources. The United States assisted
living facilities located in North Carolina derive revenues from Medicaid and
similar programs as well as from private pay sources. Assisted living facilities
in Canada derive virtually

20
<PAGE> 21
all of their revenues from private pay sources. The Company employs specialists
in reimbursement at the corporate level to monitor regulatory developments, to
comply with all reporting requirements, and to maximize payments to its operated
nursing homes. It is generally recognized that all government-funded programs
have been and will continue to be under cost containment pressures, but the
extent to which these pressures will affect the Company's future operations is
unclear.

MEDICARE AND MEDICAID. Medicare is a federally-funded and administered health
insurance program for the aged and for certain chronically disabled individuals.
Part A of the Medicare program covers inpatient hospital services and certain
services furnished by other institutional providers such as skilled nursing
facilities. Part B covers the services of doctors, suppliers of medical items,
various types of outpatient services, and certain ancillary services of the type
provided by long term and acute care facilities. Medicare payments under Part A
and Part B are subject to certain caps and limitations, as provided in Medicare
regulations. Medicare benefits are not available for intermediate and custodial
levels of nursing home care, nor for a stay in an assisted living facility.

Medicaid is a medical assistance program for the indigent, operated by
individual states with financial participation by the federal government.
Criteria for medical indigence vary somewhat from state to state, subject to
federal guidelines. Available Medicaid benefits and rates of payment vary
somewhat from state to state, subject to certain federal requirements. Basic
long-term care services are provided to Medicaid beneficiaries, including
nursing, dietary, housekeeping and laundry and restorative health care services,
room and board, and medications. Previously, under legislation known as the
Boren Amendment, federal law required that Medicaid programs pay to nursing home
providers amounts adequate to enable them to meet government quality and safety
standards. However, the Balanced Budget Act signed into law by President Clinton
on August 5, 1997 (the "BBA"), repealed the Boren Amendment, and the BBA
requires only that, for services and items furnished on or after October 1,
1997, a state Medicaid program must provide for a public process for
determination of Medicaid rates of payment for nursing facility services. Under
this process, proposed rates, the methodologies underlying the establishment of
such rates and the justification for the proposed rates are published. This
public process gives providers, beneficiaries and concerned state residents a
reasonable opportunity for review and comment. At least four of the eight states
in which the Company now operates are actively seeking ways to reduce Medicaid
spending for nursing home care by such methods as capitated payments and
substantial reductions in reimbursement rates.

The BBA also requires that nursing homes transition to a prospective payment
system ("PPS") under the Medicare program during a three-year transition period
that began with the first cost reporting period beginning on or after July 1,
1998, and creates a managed care Medicare program called "Medicare + Choice."
Medicare + Choice allows beneficiaries to participate either in the original
Medicare fee-for-service program or to enroll in a managed care plan such as a
health maintenance organization ("HMO"). Such managed care plans would allow the
HMOs to enter into risk-based contracts with the Medicare program, and the
Medicare HMOs could then contract with providers such as the Company for the
provision of nursing home services. No assurance can be given that the Company's
facilities will be successful in negotiating favorable contracts with Medicare
HMOs.

21
<PAGE> 22

Management estimates that the ultimate impact of PPS on Company revenues will be
a reduction of $16.0 to $17.0 million per year. The Company's Medicare census
has declined significantly as an indirect result of PPS and other reimbursement
changes, which has resulted in a reduction in the amount of the Company's
overhead absorbed by the Company's Medicare operations. Since PPS is still an
evolving process, its ultimate impact cannot be known with certainty at this
time.

Reduction in health care spending has become a national priority in the United
States, and the field of health care regulation and reimbursement is a rapidly
evolving one. For the fiscal year ended December 31, 1999, the Company derived
14.2% and 66.3% of its total patient and resident revenues from the Medicare and
Medicaid programs, respectively. Any health care reforms that significantly
limit rates of reimbursement under these programs could, therefore, have a
material adverse effect on the Company's profitability. The Company is unable to
predict which reform proposals or reimbursement limitations will be adopted in
the future or the effect such changes would have on its operations. In addition,
private payors, including managed care payors, are increasingly demanding that
providers accept discounted fees or assume all or a portion of the financial
risk for the delivery of health care services. Such measures may include
capitated payments, which can result in significant losses to health care
providers if patients require expensive treatment not adequately covered by the
capitated rate.

ONTARIO GOVERNMENT OPERATING SUBSIDY PROGRAM. The Ontario Government Operating
Subsidy program ("OGOS") regulates both the total charges allowed to be levied
by a licensed nursing home and the maximum amount that the OGOS program will pay
on behalf of nursing home residents. The maximum amounts that can be charged to
residents for ward, semi-private and private accommodation are established each
year by the Ontario Ministry of Health. Regardless of actual accommodation, at
least 40% of the beds in each home must be filled at the ward rate. Generally,
amounts received from residents should be sufficient to cover the accommodation
costs of a nursing home, including food, laundry, housekeeping, property costs
and administration. In addition, the Ontario government partially subsidizes
each individual, and funds each nursing home for the approximate care
requirements of its residents. This funding is based upon an annual assessment
of the levels of care required in each home, from which "caps" are determined
and funding provided on a retrospective basis. The Ontario government funds from
35.0% to 70.0% of a resident's charges, depending on the individual resident's
income and type of accommodation. The Company receives payment directly from
OGOS by virtue of its ownership of two nursing homes in Canada. Additionally,
the Company earns management fees from Canadian nursing homes, which derive
significant portions of their revenues from OGOS.

SELF-REFERRAL AND ANTI-KICKBACK LEGISLATION. The health care industry is subject
to state and federal laws which regulate the relationships of providers of
health care services, physicians, and other clinicians. These laws impose
restrictions on physician referrals to any entity with which they have a
financial relationship. The Company believes that it is in compliance with these
laws. Failure to comply with self-referral laws could subject the Company to a
range of sanctions, including civil fines, possible exclusion from government
reimbursement programs, and criminal prosecution. There are also federal and
state laws making it illegal to offer anyone anything of value in return for
referral of patients. These laws, generally known as "anti-kickback" laws, are
broad and subject to varying interpretations. Given the lack

22
<PAGE> 23

of clarity of these laws, there can be no absolute assurance that any health
care provider, including the Company, will not be found in violation of the
anti-kickback laws in any given factual situation. Strict sanctions, including
exclusion from the Medicare and Medicaid programs and criminal penalties, may be
imposed for violation of the anti-kickback laws.

COMPLIANCE PROGRAM. During 1999, the Company instituted a formal compliance
program. The program exists to promote a high standard of ethics and to promote
adherence to a number of policies intended to avoid potential fraud and abuse. A
corporate compliance officer oversees the program, which requires that he submit
a formal report to the chief executive officer annually.

LICENSURE AND CERTIFICATION. All the Company's nursing homes must be licensed by
the state in which they are located in order to accept patients, regardless of
payor source. In most states, nursing homes are subject to certificate of need
laws, which require the Company to obtain government approval for the
construction of new nursing homes or the addition of new licensed beds to
existing homes. The Company's nursing homes must comply with detailed statutory
and regulatory requirements in order to qualify for licensure, as well as for
certification as a provider eligible to receive payments from the Medicare and
Medicaid programs. Generally, the requirements for licensure and
Medicare/Medicaid certification are similar and relate to quality and adequacy
of personnel, quality of medical care, record keeping, dietary services,
resident rights, and the physical condition of the facility and the adequacy of
the equipment used therein. Each facility is subject to periodic inspections,
known as "surveys" by health care regulators, to determine compliance with all
applicable licensure and certification standards. If the survey concludes that
there are deficiencies in compliance, the facility is subject to various
sanctions, including but not limited to monetary fines and penalties, suspension
of new admissions, and loss of licensure or certification. Generally, however,
once a facility receives written notice of any compliance deficiencies, it
submits a written plan of correction and is given a reasonable opportunity to
correct the deficiencies. However, one of the Company's facilities in Arkansas
was decertified from the Medicaid and Medicare programs in 1998. Although the
facility was recertified for participation in the Medicaid program within 30
days without significant adverse financial impact, it has not yet been
recertified to participate in Medicare and is not currently accepting Medicare
patients. However, the Company is actively engaged in the application process
for recertification. A second facility, located in Florida, was subject to a
government-imposed moratorium on admissions and civil monetary penalties during
the last quarter of 1998. The Company is appealing the civil monetary penalties
and has taken aggressive action, including increasing its staffing, to correct
the deficiencies on which the moratorium was based. The moratorium was lifted at
the end of January 1999. See "Item 1 - Material Corporate Developments Health
Care Industry."

Privately owned nursing homes in Ontario are licensed by the Ministry of Health
under the Ontario Nursing Homes Act. The legislation, together with program
manuals, establishes the minimum standards that are required to be provided to
the patients of the home, including staffing, space, nutrition and activities.
Patients can only be admitted and subsidized if they require at least 1.5 hours
per day of care, as determined by a physician. Retirement centers in Canada are
generally regulated at the municipal government level in the areas of fire
safety and public health and at the provincial level in the areas of employee
safety, pay equity, and, in Ontario, rent control.

Licensure and regulation of assisted living facilities varies considerably from
state to state, although the trend is toward increased regulation in the United
States. In North Carolina, the Company's facilities must pass annual surveys,
and the state has established base-level requirements that must be maintained.

23
<PAGE> 24

Such requirements include or relate to staffing ratios, space, food service,
activities, sanitation, proper medical oversight, fire safety, resident
assessments and employee training programs. In Canada, assisted living
facilities are generally not required to be licensed and are subject to only
minor regulations.

PAYOR SOURCES.

The Company classifies its revenues from patients and residents into three major
categories: Medicaid, Medicare and private pay. In addition to traditional
Medicaid revenues, the Company includes within the Medicaid classification
revenues from other programs established to provide benefits to those in need of
financial assistance in the securing of medical services. Examples include the
OGOS and North Carolina state and county special assistance programs. Medicare
revenues include revenues received under both Part A and Part B of the Medicare
program. The Company classifies payments from individuals who pay directly for
services without government assistance as private pay revenue. The private pay
classification also includes revenues from commercial insurers, HMOs, and other
charge-based payment sources. Veterans Administration payments are included in
private pay and are made pursuant to renewable contracts negotiated with these
payors.

The following table sets forth net patient and resident revenues by payor source
for the Company for the years presented:

<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------------------------------------------
(Dollars in thousands)
1999 1998 1997
-------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) ....... $118,571 66.3% $118,394 58.8% $ 99,396 55.8%
Medicare ........... 25,461 14.2 44,490 22.1 44,974 25.2
Private Pay (1) .... 34,895 19.5 38,449 19.1 33,829 19.0
-------- -------- -------- -------- -------- --------
Total ....... $178,927 100.0% $201,333 100.0% $178,199 100.0%
======== ======== ======== ======== ======== ========
</TABLE>

- ----------

(1) Includes assisted living facility revenues. The mix of Medicaid, Medicare
and private pay for nursing homes in 1999 was 70.0%, 16.9%, and 13.1%,
respectively.

Patient and residential service is generally provided and charged in daily
service units, commonly referred to as patient and resident days. The following
table sets forth patient and resident days by payor source for the Company for
the years presented:

<TABLE>
<CAPTION>
Year ended December 31,
----------------------------------------------------------------------------------------
1999 1998 1997
-------------------- --------------------- ---------------------
<S> <C> <C> <C> <C> <C> <C>
Medicaid (1) ....... 1,708,335 71.7% 1,747,844 72.1% 1,345,010 67.5%
Medicare ........... 82,571 3.5 110,178 4.5 120,583 6.1
Private Pay (1) .... 592,134 24.8 566,834 23.4 525,016 26.4
--------- -------- --------- -------- --------- --------
Total ....... 2,383,040 100.0% 2,424,856 100.0% 1,990,609 100.0%
========= ======== ========= ======== ========= ========
</TABLE>

- ----------

(1) Includes assisted living facility days. The mix of Medicaid, Medicare and
private pay for nursing homes in 1999 was 78.5%, 5.78%, and 15.8%,
respectively.

The above tables include net patient revenues and the patient days of the six
facilities comprising TDLP. See Note 6 of the Company's Consolidated Financial
Statements.

24
<PAGE> 25

Consistent with the nursing home industry in general, changes in the mix of a
facility's patient population among Medicaid, Medicare, and private pay can
significantly affect the profitability of the facility's operations.

For information about revenue, operating income (loss) and identifiable assets
attributable to the Company's United States and Canadian operations, see Note 14
of the Company's Consolidated Financial Statements.

SUPPLIES AND EQUIPMENT.

The Company purchases drugs, solutions and other materials and leases certain
equipment required in connection with the Company's business from many
suppliers. The Company has not experienced, and management does not anticipate
that the Company will experience, any significant difficulty in purchasing
supplies or leasing equipment from current suppliers. In the event that such
suppliers are unable or fail to sell supplies or lease equipment to the Company,
management believes that other suppliers are available to adequately meet the
Company's needs at comparable prices. National purchasing contracts are in place
for all major supplies, such as food, linens, and medical supplies. These
contracts assist in maintaining quality, consistency and efficient pricing.

INSURANCE.

The entire United States long-term care industry has seen a dramatic increase in
personal injury/wrongful death claims based on alleged negligence by nursing
homes and their employees in providing care to patients and residents. As a
result, the Company has numerous liability claims and disputes outstanding for
professional liability and other related issues. Professional liability
insurance up to certain limits is carried by the Company and its subsidiaries
for coverage of such claims. However, due to the increasing number of claims
against the Company and throughout the long-term care industry, the Company's
professional liability insurance premiums and deductible amounts have increased
substantially during 1998 and 1999. Additional increases in premiums and
deductibles will also occur for the policy year 2000.

All of the Company's professional liability policies are currently on a claims
made basis and are renewable annually. Prior to March 9, 2000, all of these
policies were on an occurrence basis. The Company currently maintains general
and professional liability insurance with coverage limits of $1,000,000 per
medical incident, aggregate coverage limits of $3,000,000 per location and total
aggregate policy coverage limits of $12,000,000 for its long-term care services.
Through December 31, 1997, with respect to a majority of its United States
nursing homes, the Company was self-insured for the first $25,000 per occurrence
and $500,000 in the aggregate. Effective January 1, 1998, the Company
substantially increased the self-insurance portion of its liability with respect
to its United States nursing home operations up to $250,000 per occurrence and
$2,500,000 in the aggregate per year. Effective February 1, 1999, all United
States nursing homes became part of the $250,000/$2,500,000 deductible program,
including the six TDLP facilities. For 1999 and 1998, the Company expects to
ultimately fully incur the aggregate deductible amount. A reserve has been
established in anticipation of the settlement of the 1999 and 1998 claims, which
may take up to four years from the date of the injury event to reach final
settlement.

25
<PAGE> 26

Effective March 9, 2000, the self-insured per claim amount for all United States
nursing homes increased to $500,000 per claim with no aggregate limit. The
Company also maintains umbrella liability coverage of $15,000,000 per occurrence
for all United States facilities.

The assisted living operations acquired in the Pierce transaction are
self-insured, with respect to each location, for the first $5,000 per occurrence
and $25,000 in the aggregate. The Company also maintains a $10,000,000 aggregate
umbrella liability policy for claims in excess of the foregoing limits for these
assisted living operations.

The Canadian facilities owned or leased by the Company maintain general and
professional liability insurance with per claim coverage limits of up to
$3,462,000 ($5,000,000 Canadian). The Company also maintains an aggregate
umbrella policy for claims in excess of the above limit for these facilities.

The ultimate results of the Company's professional liability claims and disputes
are unknown at the present time. However, management is currently of the opinion
that there would be no material amounts in excess of liability coverage and
established reserves.

The Company utilizes risk management consultants in the evaluation of its
insurance programs, and management believes its current insurance coverage level
is consistent with industry standards and is appropriate for the risk
environment. The Company has established reserves that management believes are
adequate to cover the self-insured risks of its insurance programs. There can be
no assurance that the Company's insurance and reserves will be sufficient to
cover any judgements, settlements or costs relating to any pending or future
claims or legal proceedings (including any related judgements, settlements or
costs) or that any such insurance will be available to the Company in the future
on satisfactory terms, if at all. If the insurance and reserves carried by the
Company are not sufficient to cover any judgements, settlements or costs
relating to pending or future claims or legal proceedings, the Company's
business and financial condition could be materially adversely affected.

EMPLOYEES.

As of February 15, 2000, the Company employed a total of approximately 5,150
individuals. Management believes that the Company's employee relations are good.
Approximately 190 of the Company's United States employees are represented by a
labor union and approximately 320 of the Company's Canadian employees are
represented by various unions. With the exception of some administrators of
managed facilities (whose salaries are reimbursed by the owners), the staff of
the managed nursing homes and assisted living facilities are not employees of
the Company. The Company's managed facilities employ approximately 3,160
individuals, approximately 2,130 of whom are Canadians represented by various
unions.

A major component of the Company's CQI program includes an employee empowerment
selection, retention and recognition program. Administrators and managers of the
Company include employee retention and turnover goals in the annual facility,
regional and personal objectives.

Although the Company believes it is able to employ sufficient nurses and
therapists to provide its services, a shortage of health care professional
personnel in any of the geographic areas in which the Company operates could
affect the ability of the Company to recruit and retain qualified employees and
could increase its operating costs. The Company competes with other health care
providers for both professional and non-professional employees and with
non-health care providers for non-professional employees. During 1999, the
Company faced increased competition for workers due to tight labor markets in
most of the areas in which the Company operates in the United States.

26
<PAGE> 27

RISK FACTORS.

This section summarizes certain risks, among others, that should be considered
by stockholders and prospective investors in the Company.

NON-COMPLIANCE WITH DEBT INSTRUMENTS AND LEASE AGREEMENTS. At December 31, 1999,
the Company is in default of certain financial covenants under certain of its
loan and lease agreements. Cross-default or material adverse change provisions
contained in the agreements allow the holders of substantially all of the
Company's debt and leases to demand immediate repayment or termination of the
lease. The Company has not obtained waivers with respect to such defaults. As of
December 31, 1999, the Company's total indebtedness was $60,925,000. The Company
is currently in discussions with its senior bank lenders and its primary
landlord with respect to their response to the foregoing. There can be no
assurance that the bank lenders will not call the loans in default and demand
the full repayment of the loans or that the landlords will not terminate one or
more leases. If the credit agreements are called, the Company does not have
sufficient assets to repay the entire outstanding balance under the credit
agreements.

In addition, the defaults under the credit and lease agreements may impair the
Company's ability to finance, through its own cash flow or from additional
financing, its future operations or pursue its business strategy and could make
the Company more vulnerable to economic downturns, competitive and payor pricing
pressures and adverse changes in government regulation. There can be no
assurance that future cash flow from operations will be sufficient to cover debt
obligations. Additional sources of funds may be required and there can be no
assurance the Company will be able to obtain additional funds on acceptable
terms, if at all. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources."

CROSS DEFAULTS UNDER CREDIT FACILITIES, LEASE AGREEMENTS, MANAGEMENT AGREEMENTS
AND PARTICIPATING MORTGAGE. The Company's credit facility provides that a
default under any of the Company's leases or management agreements constitutes a
default under the credit facility unless waived by the Lender. Nineteen nursing
homes and two assisted living facilities are leased by the Company pursuant to
the Omega Master Lease agreement and an additional nine facilities under the
1994 Omega Leases, the terms of which provide that a default with respect to one
facility is a default not only with respect to the entire Master Lease, the 1994
Omega Leases and each facility covered thereby, but also with respect to a
participating mortgage secured by three additional nursing homes. The Company
leases these nursing homes that are subject to the participating mortgage from
Counsel Corporation ("Counsel"), a publicly-owned Canadian corporation. Counsel
has agreed to indemnify Advocat in the event of a default by Counsel under such
participating mortgage, except in the case where such default was caused by
Advocat. A default under such participating mortgage or related documents is a
default under the Master Lease. In addition to the three nursing homes
previously discussed that the Company leases from Counsel, the Company leases
eight facilities and manages eight facilities owned by Counsel or affiliates of
Counsel. A default under any of the agreements with Counsel or its affiliates
constitutes a default under all of the leases and management agreements with
Counsel. Finally, four management contracts that cover two, four, six and seven
nursing homes, respectively, provide that a default with respect to any facility
under any one of the management contracts is a default with respect to all
facilities under such management contract.

27
<PAGE> 28

NO ASSURANCE OF GROWTH. The Company reported a net loss of $21.7 million for the
year ended December 31, 1999 and a working capital deficit of $56.7 million at
December 31, 1999. No assurance can be given that the Company will achieve
profitable operations in the near term. There can be no assurance that the
Company can increase growth in net revenues. The Company cannot assure that
internally generated cash flows from earnings and existing cash balances will be
sufficient to fund existing debt obligations or future capital and working
capital requirements through fiscal year 2000. The price of the Company's Common
Stock may fluctuate in response to quarterly variations in the Company's
operating and financial results, announcements by the Company or other
developments affecting the Company, as well as general economic and other
external factors.

THIRD-PARTY INDEBTEDNESS SECURED BY ASSETS LEASED OR MANAGED BY COMPANY. The
Company, through leases and management agreements, operates facilities that
secure the indebtedness of the owners of the facilities. As a result, the
Company's leases at such facilities are subject to cancellation upon the default
of these third-party owners under their credit agreements. In addition, the
payment of management fees to the Company at these facilities is subordinated to
the payment of the owners' debt obligations. To the extent that the owners of
the Company's managed facilities experience financial difficulty or otherwise
are unable to meet their obligations, the ability of the Company to receive
management fees or continue as manager of such facility is jeopardized.

DEPENDENCE ON REIMBURSEMENT BY THIRD-PARTY PAYORS. Government at both the
federal and state levels has continued in its efforts to reduce, or at least
limit the growth of, spending for health care services, including services
provided by the Company. In August 5, 1997, President Clinton signed into law
The Balanced Budget Act of 1997, which has negatively impacted the Company's net
operations. Any additional reduction in either Medicare or Medicaid payments
could adversely affect the Company. In addition, private payors, including
managed care payors, increasingly are demanding that providers accept discounted
fees or assume all or a portion of the financial risk for the delivery of health
care services. Such measures may include capitated payments whereby the Company
is responsible for providing, for a fixed fee, all services needed by certain
patients. Capitated or flat-rate payments can result in significant losses if
patients require expensive treatment not adequately covered by the payment rate.
PPS is a flat-rate payment system as are the Medicaid programs of Arkansas,
Texas and Kentucky. Substantially all of the Company's nursing home revenues,
including management fees, are directly or indirectly dependent upon
reimbursement from third-party payors, including the Medicare and Medicaid
programs, the Ontario Government Operating Subsidy program, and private
insurers. For the period ended December 31, 1999, approximately 66.3%, 14.2%,
and 19.5% of the Company's patient and resident revenues were derived from
Medicaid, Medicare and private pay sources. The net revenues and profitability
of the Company are affected by the continuing efforts of all payors to contain
or reduce the costs of health care. Efforts to impose reduced payments, greater
discounts and more stringent cost controls by government and other payors are
expected to continue. Any changes in reimbursement levels under Medicare,
Medicaid or private pay programs and any changes in applicable government
regulations could have a material adverse effect on the Company's net revenues
and net income. The Company is unable to predict what reform proposals or
reimbursement limitations will be adopted in the future or the effect such
changes will have on its operations. No assurance can be given that such reforms
will not have a material adverse effect on the Company. Changes in the mix of
the Company's patients among Medicare, Medicaid and private pay categories and
among different types of private pay sources may also affect the Company's net
revenues and profitability. There can be no assurance that the Company will
improve or continue to maintain its current payor or revenue mix.

28
<PAGE> 29

GOVERNMENT REGULATION. The United States government, the Canadian government,
and all states and provinces in which the Company operates regulate various
aspects of its business. Various federal, state and provincial laws regulate
relationships among providers of services, including employment or service
contracts and investment relationships. The operation of long-term care
facilities and the provision of services are also subject to extensive federal,
state, provincial and local laws relating to, among other things, the adequacy
of medical care, distribution of pharmaceuticals, equipment, personnel,
operating policies, environmental compliance, ADA compliance, fire prevention
and compliance with building codes. Long-term care facilities are also subject
to periodic inspection to assure continued compliance with various standards and
licensing requirements under state law, as well as with Medicare and Medicaid
standards. The failure to obtain or renew any required regulatory approvals or
licenses could adversely affect the Company's growth and could prevent it from
offering its existing or additional services. In addition, health care is an
area of extensive and frequent regulatory change. Changes in the laws or new
interpretations of existing laws can have a significant effect on methods and
costs of doing business and amounts of payments received from governmental and
other payors. The Company's operations could be adversely affected by, among
other things, regulatory developments such as mandatory increases in the scope
and quality of care to be afforded patients and revisions in licensing and
certification standards. The Company at all times attempts to comply with all
applicable laws; however, there can be no assurance that administrative or
judicial interpretation of existing laws or regulations will not have a material
adverse effect on the Company's operations or financial condition.

In order to receive Medicare and Medicaid reimbursement, the Company must be
certified by Medicare and Medicaid. In 1995, the Federal Government promulgated
new survey, certification and enforcement rules governing long-term care
facilities participating in the Medicare and Medicaid programs, which impose
significant new requirements on long-term care facilities. The breadth of the
rules has created uncertainty over the manner in which the rules are
implemented, the ability of any long-term care facility to comply with them and
the effect of the rules on the Company. Facilities that are found not to be in
compliance with the rules are subject to decertification from participating in
the Medicare/Medicaid programs; termination of provider agreement; temporary
management; denial of payment for new admissions; civil money penalties; closure
of the facility or transfer of patients or both; and on-site state monitoring.
In the ordinary course of its business, the Company receives notices of
deficiencies for failure to comply with various regulatory requirements. The
Company reviews such notices and takes appropriate corrective action. In most
cases, the Company and the reviewing agency will agree upon the measures to be
taken to bring the facility into compliance with regulatory requirements. During
1997 and 1998 certain of the Company's facilities in Alabama and Arkansas were
decertified from the Medicare and Medicaid programs. Since then, one facility
has been recertified, another is applying for recertification and the lease term
expired on the third facility. There can be no assurance that the Company will
not experience additional problems with maintaining the certification of its
facilities. Failure to obtain and maintain Medicare and Medicaid certification
at the Company's facilities will result in denial of Medicare and Medicaid
payments which could result in a significant loss of revenue to the Company.

SELF-REFERRAL AND ANTI-KICKBACK LEGISLATION. The health care industry is highly
regulated at the state, provincial and federal levels. In the United States,
various state and federal laws regulate the relationships between providers of
health care services, physicians, and other clinicians. These laws impose
restrictions on physician referrals for designated health services to entities
with which they have financial relationships. These laws also prohibit the
offering, payment, solicitation or receipt of any form of remuneration in return
for the referral of Medicare or state health care program patients or patient

29
<PAGE> 30

care opportunities for the purchase, lease or order of any item or service that
is covered by the Medicare and Medicaid programs. There can be no assurance the
Company's operations will not be subject to review, scrutiny, penalties or
enforcement actions under these laws, or that these laws will not change in the
future. Violations of these laws may result in substantial civil or criminal
penalties for individuals or entities, including large civil monetary penalties
and exclusion from participation in the Medicare or Medicaid programs. Such
exclusions or penalties, if applied to the Company, could have a material
adverse effect on the profitability of the Company.

RELATIONSHIPS BETWEEN LONG-TERM CARE FACILITIES AND OTHER PROVIDERS.
Relationships between long-term care facilities and other providers such as
providers of physical therapy and other ancillary service providers have come
under increased scrutiny by government and private payors. To the extent that
the Company, any facility with which it does business, or any of their owners or
directors have a financial relationship with each other or with other health
care entities providing services to long-term care patients, such relationships
could be subject to increased scrutiny. There can be no assurance that the
Company's business operations and agreements with other providers of health care
services will not be subject to change, review, penalties or enforcement actions
under state and federal laws regarding self-referrals or fraud and abuse, or
that these laws will not change in the future.

LIQUIDITY. Effective at the close of business on November 9, 1999, the New York
Stock Exchange de-listed the Company's Common Stock. As a result, beginning
November 10, 1999, trading of the Company's Common Stock is conducted on the
over-the-counter market ("OTC") or, on application by broker-dealers, in the
NASD's Electronic Bulletin Board using the Company's current trading symbol,
AVCA. In addition, in December 1999, the Company's market maker temporarily
suspended trading of the Company's Common Stock on the OTC pending the Company's
filing of certain amendments to the Company's quarterly reports on Form 10-Q.
Although trading on the OTC has resumed, no assurance can be given that the
Company's market maker will not suspend trading on the OTC again in the future,
which could make it difficult for investors to complete transactions in the
Company's Common Stock. As a result of the de-listing, the liquidity of the
Company's Common Stock and its price have been adversely affected, which may
limit the Company's ability to raise additional capital.

LIABILITY AND INSURANCE. The provision of health care services involves an
inherent risk of liability. In recent years, participants in the long-term care
industry have become subject to an increasing number of lawsuits alleging
malpractice or related legal theories, many of which involve large claims and
significant defense costs. It is expected that the Company from time to time
will be subject to such suits as a result of the nature of its business. The
Company currently maintains liability insurance intended to cover such claims,
however, it is self-insured with respect to the first $500,000 per occurrence
and no aggregate limit on such claims. In addition, there can be no assurance
that claims in excess of the Company's insurance coverage or claims not covered
by the Company's insurance coverage (e.g., claims for punitive damages) will not
arise. A successful claim against the Company in excess of the Company's
insurance coverage could have a material adverse effect upon the Company and its
financial condition. Claims against the Company, regardless of their merit or
eventual outcome, may also have a material adverse effect upon the Company's
ability to attract patients or residents or expand its business. In addition,
the Company's insurance policies must be renewed annually. There can be no
assurance that the Company will be able to obtain liability insurance coverage
in the future on acceptable terms, if at all.

30
<PAGE> 31

GUARANTEES AND OBLIGATIONS TO REDEEM CERTAIN PARTNERSHIP INTERESTS. A
subsidiary of the Company has provided guarantees of certain cash flow
deficiencies and quarterly return obligations of Diversicare VI Limited
Partnership ("Diversicare VI"), which may obligate the subsidiary to make
interest-free loans to Diversicare VI. Such cash flow obligations have never
been called upon. The Company has also provided a cash flow guarantee to TDLP,
which may obligate the Company to provide monthly interest-free loans to TDLP.
In addition, the limited partners of TDLP have the right to cause the Company
to repurchase up to 10.0% of their partnership units annually for five years
(up to a maximum of 50.0% of the total partnership units outstanding) beginning
in January 1996. To date, the Company has repurchased 22.6% of the partnership
units. No units were presented for repurchase in January, 2000. It is a virtual
certainty that the Company will be required to make additional loans to TDLP.
It is less certain whether the Company will be called upon to repurchase up to
10.0% of additional partnership units in January 2001. The Company has reserved
for these obligations, but there can be no assurance as to the aggregate dollar
amount of the Company's obligations under the guarantees and redemption
obligation, nor can there be any assurance that all or any portion of the loans
made to Diversicare VI or TDLP will be repaid.

COMPETITION. The long-term care industry generally, and the nursing home and
assisted living center businesses particularly, are highly competitive. The
Company faces direct competition for the acquisition or management of
facilities. In turn, its facilities face competition for employees, patients and
residents. Some of the Company's present and potential competitors are
significantly larger and have or may obtain greater financial and marketing
resources than those of the Company. Some hospitals that provide long-term care
services are also a potential source of competition to the Company. In addition,
the Company may encounter substantial competition from new market entrants.
Consequently, there can be no assurance that the Company will not encounter
increased competition in the future, which could limit its ability to attract
patients or residents or expand its business, and could materially and adversely
affect its business or decrease its market share.

ANTI-TAKEOVER CONSIDERATIONS. The Company is authorized to issue up to 1,000,000
shares of preferred stock, the rights of which may be fixed by the Board of
Directors without shareholder approval. In March 1995, the Board of Directors
approved the adoption of a Shareholder Rights Plan (the "Plan"). The Plan is
intended to encourage potential acquirors to negotiate with the Company's Board
of Directors and to discourage coercive, discriminatory and unfair proposals.
The Company's stock incentive plans provide for the acceleration of the vesting
of options in the event of certain changes in control (as defined in such
plans). The Company's Certificate of Incorporation (the "Certificate") provides
for the classification of its Board of Directors into three classes, with each
class of directors serving staggered terms of three years. The Company's
Certificate requires the approval of two-thirds of the outstanding shares to
amend certain provisions of the Certificate. Section 203 of the Delaware General
Corporate Law restricts the ability of a Delaware corporation to engage in any
business combination with an interested stockholder. Provisions in the executive
officers' employment agreements provide for post-termination compensation,
including payment of certain of the executive officers' salaries for up to 30
months, following certain changes in control. Certain changes in control of the
Company also constitutes an event of default under the Company's bank credit
facility. The foregoing matters and the Change in Control purchase feature of
the Debentures described above may, together or separately, have the effect of
discouraging or making more difficult an acquisition or change of control of the
Company.

31
<PAGE> 32

ITEM 2. PROPERTIES

The Company owns 23 and leases 61 long-term care facilities. See "Item 1 -
Description of Lease Agreements" and "- Facilities." The Company leases
approximately 19,000 square feet of office space in Franklin, Tennessee, that
houses the executive offices of the Company, centralized management support
functions, and the ancillary services supply operations. In addition, the
Company leases its regional office for Canadian operations with approximately
10,800 square feet of office space in Mississauga, Ontario, its regional office
with approximately 5,500 square feet of office space in Kernersville, North
Carolina, and its regional office with approximately 3,000 square feet of office
space in Ashland, Kentucky. Lease periods on these facilities generally range up
to seven years, although the Kernersville lease runs through 2022 including
renewal options. Regional executives for Alabama, Arkansas, Florida and Texas
work from offices of under 1,000 square feet each. Management believes that the
Company's leased properties are adequate for its present needs and that suitable
additional or replacement space will be available as required.

ITEM 3. LEGAL PROCEEDINGS

The provision of health care services entails an inherent risk of liability. In
recent years, participants in the health care industry have become subject to an
increasing number of lawsuits alleging malpractice, product liability, or
related legal theories, many of which involve large claims and significant
defense costs. It is expected that the Company from time to time will be subject
to such suits as a result of the nature of its business. Further, as with all
health care providers, the Company is potentially subject to the increased
scrutiny of regulators for issues related to compliance with health care fraud
and abuse laws. Although the Company is not a party to or subject to any
material pending legal proceedings and carries liability insurance that
Management believes meets industry standards, there can be no assurance that any
pending or future legal proceedings (including any related judgments,
settlements or costs) will not have a material adverse effect on the Company's
business, reputation, or financial condition. See "Item 1 - Insurance."

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There have been no matters submitted to a vote of security holders during the
fourth quarter (October 1, 1999 through December 31, 1999) of the fiscal year
covered by this Annual Report on Form 10-K.

32
<PAGE> 33

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS

The Common Stock of the Company was listed on the New York Stock Exchange under
the symbol "AVC" through November 9, 1999. Since that time, the Company's Common
Stock has been traded on NASD's OTC Bulletin Board under the symbol "AVCA." The
Company's Common Stock is also traded on the Toronto Stock Exchange under the
symbol "AVCU." The following table sets forth the high and low prices of the
common stock for each quarter in 1998 and 1999:

<TABLE>
<CAPTION>
Period High Low
---------------- -------- -------
<S> <C> <C>
1998 1st Quarter $10 3/16 $ 7 3/4
1998 2nd Quarter 10 5/16 6
1998 3rd Quarter 7 7/8 5 5/8
1998 4th Quarter 6 1/2 4 3/4
1999 1st Quarter 6 1/4 2 7/8
1999 2nd Quarter 2 5/16 1 3/8
1999 3rd Quarter 2 1/16 7/8
1999 4th Quarter 1 1/16 1/8

</TABLE>

The Company's Common Stock has been traded since May 10, 1994. On March 23,
2000, the closing price for the Common Stock was $0.22, as reported by
PCQuote.com.

On March 23, 2000, there were 340 holders of record of the common stock. Most
of the Company's shareholders have their holdings in the street name of their
broker/dealer.

The Company has not paid cash dividends on its Common Stock and anticipates
that, for the foreseeable future, any earnings will be retained for use in its
business and no cash dividends will be paid. The Company is currently prohibited
from issuing dividends under certain debt instruments.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected financial data of Advocat as of December 31, 1999, 1998, 1997,
1996 and 1995 and for the years ended December 31, 1999, 1998, 1997, 1996 and
1995 have been derived from the audited financial statements of Advocat.

33
<PAGE> 34

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands, except per share amounts)

<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:

REVENUES:
Patient revenues ............... $ 141,022 $ 166,529 $ 163,094 $ 153,582 $ 128,643
Resident revenues .............. 37,905 34,804 15,105 8,347 7,477
Management fees ................ 2,932 3,627 3,886 4,152 3,618
Interest ....................... 159 192 158 156 227
--------- --------- --------- --------- ---------
Net revenues ............. 182,018 205,152 182,243 166,237 139,965
--------- --------- --------- --------- ---------

EXPENSES:
Operating ...................... 152,557 164,769 146,555 131,966 109,458
Lease .......................... 20,375 19,109 15,850 14,441 13,518
General and administrative ..... 11,753 10,969 9,636 8,578 7,806
Depreciation and amortization .. 4,516 3,838 2,823 2,285 1,516
Non-recurring charges .......... 500 5,859 -0- -0- -0-
Interest ....................... 5,460 5,425 2,672 1,591 777
--------- --------- --------- --------- ---------
Total expenses ........... 195,812 209,969 177,536 158,861 133,075
--------- --------- --------- --------- ---------

INCOME (LOSS) BEFORE
INCOME TAXES ................... $ (13,794) $ (4,817) $ 4,707 $ 7,376 $ 6,890
========= ========= ========= ========= =========

NET INCOME (LOSS) ................. $ (21,676) $ (3,083) $ 3,013 $ 4,721 $ 4,410
========= ========= ========= ========= =========

EARNINGS (LOSS) PER SHARE:
Basic .......................... $ (3.98) $ (.57) $ .56 $ .89 $ .84
========= ========= ========= ========= =========
Diluted ........................ $ (3.98) $ (.57) $ .56 $ .89 $ .82
========= ========= ========= ========= =========

WEIGHTED AVERAGE SHARES:
Basic .......................... 5,445 5,388 5,339 5,270 5,270
========= ========= ========= ========= =========
Diluted .................. 5,445 5,388 5,373 5,381 5,381
========= ========= ========= ========= =========

</TABLE>

<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------
1999 1998 1997 1996 1995
--------- --------- --------- --------- ---------
(in thousands)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:

Working capital (deficit) ......... $ (56,699) $ 16,233 $ 14,389 $ 13,540 $ 6,726
========= ========= ========= ========= =========

Total assets ...................... $ 96,185 $ 121,294 $ 114,961 $ 74,908 $ 59,031
========= ========= ========= ========= =========

Long-term debt, excluding
current portion ............... $ 7,827(1) $ 33,514 $ 58,373 $ 23,254 $ 11,063
========= ========= ========= ========= =========

Shareholders' equity .............. $ 6,267 $ 27,561 $ 30,733 $ 27,348 $ 22,437
========= ========= ========= ========= =========

</TABLE>

- ----------

(1) Because of financial covenant non-compliance, the Company has classified as
current $25,903 of debt with scheduled maturities that actually begin in
2001. In the absence of the non-compliance issues, the Company's long-term
debt would have been $33,730. See "Item 1 - Material Corporate Developments
- Current Debt Maturities and Financial Covenant Non-Compliance."

34
<PAGE> 35

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

OVERVIEW

The Company's facilities provide a range of health care services to their
patients and residents. In addition to the nursing, personal care and social
services usually provided in long-term care facilities, the Company offers a
variety of comprehensive rehabilitation services as well as medical supply and
nutritional support services.

As of December 31, 1999, Advocat's portfolio includes 119 facilities composed of
65 nursing homes containing 7,307 licensed beds and 54 assisted living
facilities containing 5,215 units. In comparison, at December 31, 1998, the
Company operated 115 facilities composed of 63 nursing homes containing 7,182
licensed beds and 52 assisted living facilities containing 4,755 units. Within
the current portfolio, 35 facilities are managed on behalf of other owners, 29
of which are on behalf of unrelated owners and six in which the Company holds a
minority equity interest. The remaining facilities, consisting of 61 leased and
23 owned facilities are operated for the Company's own account. In the United
States, the Company operates 51 nursing homes and 33 assisted living facilities,
and in Canada, the Company operates 14 nursing homes and 21 assisted living
facilities.

BASIS OF FINANCIAL STATEMENTS. The Company's patient and resident revenues
consist of the fees charged for the care of patients in the nursing homes and
residents of the assisted living facilities leased and owned by the Company.
Management fee revenues consist of the fees charged to the owners of the
facilities managed by the Company. The management fee revenues are based on the
respective contractual terms of the Company's management agreements, which
generally provide for management fees ranging from 3.5% to 6.0% of the net
revenues of the managed facilities. As a result, the level of management fees is
affected positively or negatively by the increase or decrease in the average
occupancy level and the per diem rates of the managed facilities. The Company's
operating expenses include the costs, other than lease, depreciation,
amortization and interest expenses, incurred in the nursing homes and assisted
living facilities owned and leased by the Company. The Company's general and
administrative expenses consist of the costs of the corporate office and
regional support functions, including the costs incurred in providing management
services to other owners. The Company's depreciation, amortization and interest
expenses include all such expenses incurred across the range of the Company's
operations.

35
<PAGE> 36

OPERATING DATA

The following table presents the Advocat statements of operations for the years
ended December 31, 1999, 1998 and 1997, and sets forth this data as a percentage
of revenues for the same years.

<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------------
($ in thousands) 1999 1998 1997
----------------------- --------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Patient revenues .................... $ 141,022 77.5% $ 166,529 81.2% $ 163,094 89.5%
Resident revenues ................... 37,905 20.8 34,804 16.9 15,105 8.3
Management fees ..................... 2,932 1.6 3,627 1.8 3,886 2.1
Interest ............................ 159 0.1 192 0.1 158 0.1
--------- ------- --------- ------- --------- -------
Net revenues ...................... 182,018 100.0% 205,152 100.0% 182,243 100.0%
--------- ------- --------- ------- --------- -------
Expenses:
Operating ........................... 152,557 83.8 164,769 80.3 146,555 80.4
Lease ............................... 20,375 11.2 19,109 9.3 15,850 8.7
General and administrative .......... 11,753 6.5 10,969 5.3 9,636 5.3
Depreciation and amortization ....... 5,167 2.8 3,838 1.9 2,823 1.5
Non-recurring charges ............... 500 0.3 5,859 2.9 -0- 0.0
Interest ............................ 5,460 3.0 5,425 2.6 2,672 1.5
--------- ------- --------- ------- --------- -------
Total expenses .................... 195,812 107.6 209,969 102.3 177,536 97.4
--------- ------- --------- ------- --------- -------

Income (loss) before income taxes ..... (13,794) (7.6) (4,817) (2.3) 4,707 2.6
Provision (benefit) for income taxes .. 7,605 4.2 (1,734 (0.8) 1,694 0.9
--------- ------- --------- ------- --------- -------
Income (loss) before cumulative
effect of change in accounting
principle ........................... (21,399) (11.8) (3,083) (1.5) 3,013 1.7
Cumulative effect of change in
accounting principle, net of tax .... (277) (0.2) -0- 0.0 -0- 0.0
--------- ------- --------- ------- --------- -------
Net income (loss) ..................... $ (21,676) (11.9)% $ (3,083) (1.5)% $ 3,013 1.7%
========= ======= ========= ======= ========= =======

</TABLE>

The Company has incurred losses during 1999 and 1998 and expects to continue to
incur losses during 2000. The Company has a working capital deficit of $56.7
million as of December 31, 1999. Also, the Company has limited resources
available to meet its operating, capital expenditure and debt service
requirements during 2000. Given that events of default under the Company's
working capital line of credit, there can be no assurance that the respective
lender will continue to provide working capital advances.

36
<PAGE> 37

The following tables present data about the facilities operated by the Company
as of the dates or for the years indicated:

<TABLE>
<CAPTION>
December 31,
------------------------------
1999 1998 1997
------ ------ ------
<S> <C> <C> <C>
Licensed Nursing Home Beds:
Owned ...................... 706 706 706
Leased ..................... 4,007 4,158 4,158
Managed .................... 2,594 2,318 2,477
------ ------ ------
Total .................... 7,307 7,182 7,341
====== ====== ======
Assisted Living Units:
Owned ...................... 1,216 1,302 1,314
Leased ..................... 2,073 1,883 1,800
Managed(1) ................. 1,926 1,570 1,634
------ ------ ------
Total .................... 5,215 4,755 4,748
====== ====== ======
Total Beds/Units:
Owned ...................... 1,922 2,008 2,020
Leased ..................... 6,080 6,041 5,958
Managed(1) ................. 4,520 3,888 4,111
------ ------ ------
Total .................... 12,522 11,937 12,089
====== ====== ======
Facilities:
Owned ...................... 23 24 25
Leased ..................... 61 61 59
Managed(1) ................. 35 30 32
------ ------ ------
Total .................... 119 115 116
====== ====== ======

</TABLE>

- ----------

(1) Includes six assisted living facilities with 865 units in which the Company
holds a minority equity interest.

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Average Occupancy(1):
Leased/Owned(2) ..................... 76.0% 81.6% 83.0%
Managed ............................. 93.9 95.6 96.3
----- -------- --------
Total ............................. 81.7% 84.9% 86.7%
===== ======== ========

</TABLE>

- ----------

(1) Average occupancy excludes facilities under development or facilities
managed during receivership or insolvency proceedings.
(2) Includes the occupancy of the six facilities of TDLP, a limited partnership
managed by the Company.

37
<PAGE> 38

MEDICARE REIMBURSEMENT CHANGES

Cost restrictions placed on the provision of rehabilitation (ancillary) services
as a result of the BBA have also been significant. Beginning in January 1998,
the allowable costs for cost reimbursement components of Medicare Part B
services became subject to a limitation factor of 90.0% of actual cost. In 1999,
the cost reimbursement system for rehabilitation services has been replaced by a
system of fee screens that effectively limit reimbursement and place caps on the
maximum fees that may be charged for therapy services. Historically, the Company
subcontracted the provision of these therapy services. However, in response to
the deep cuts in fees for service, the Company's therapy subcontractor exited
the business. In June 1999, the Company began providing such services in house.
The Company anticipates that this will further negatively impact operations,
although the ultimate effect cannot yet be reasonably estimated. These changes
with respect to Part B reimbursement have combined to cause a dramatic decrease
in the Company's ancillary revenues and expenses.

To date, one of the major impacts on the Company from PPS and other BBA
reimbursement changes has been the indirect impact of Medicare occupancy
declines, which have reduced the amount of overhead absorbed under the Company's
Medicare operations. With respect to Medicare therapy allowable cost and fee
reductions, the Company estimates that net operations have been negatively
impacted in both 1998 and 1999 and will continue to be negatively impacted
beyond 1999 as a result of the changes brought about under BBA. However, since
PPS and other various changes brought about by the BBA are still an evolving
process, the ultimate impact of the BBA cannot be known with certainty at this
time.

These changes have affected the entire long-term care industry. They have
resulted pursuant to the administrative implementation of the guidelines
contained in the BBA. Under the BBA, Medicare expenditures by the Federal
government have been cut approximately 20.0%. This has been a sudden, drastic
blow to the industry. Other providers who relied more heavily on the provision
of services to higher acuity patients have been impacted more severely than the
Company. There have already been several major bankruptcy filings. Without
remediation, the long-term effect on the industry is expected to be
catastrophic.

As the impact of these changes upon both providers and beneficiaries has become
known, there has been growing political awareness of a need to re-examine the
drastic cuts that have been implemented. On November 29, 1999, President Clinton
signed into law a budget agreement that restores over three years $2.7 billion
in Medicare funding. The bill contains several components that become effective
at various times over the three-year period. As a result of the legislation,
individual nursing facilities now have the option, for cost reporting years
beginning after December 29, 1999, of continuing under the current PPS
transition formula or adopting the full federal PPS per diem. In addition, the
measure provides a two-year moratorium on the Part B therapy caps beginning
January 1, 2000, and it also provides increases in the per diem rates for the
care of certain groups of patients. The Company is continuing to evaluate the
impact of the legislation on its operations. However, there is no expectation by
management that the relief will be sufficient to restore the economic viability
the industry needs.

38
<PAGE> 39

While federal regulations do not provide states with grounds to curtail funding
of their Medicaid cost reimbursement programs due to state budget deficiencies,
states have nevertheless curtailed funding in such circumstances in the past. No
assurance can be given that states will not do so in the future or that the
future funding of Medicaid programs will remain at levels comparable to the
present levels. The United States Supreme Court ruled in 1990 that healthcare
providers could use the Boren Amendment to require states to comply with their
legal obligation to adequately fund Medicaid programs. The BBA repeals the Boren
Amendment and authorizes states to develop their own standards for setting
payment rates. It requires each state to use a public process for establishing
proposed rates whereby the methodologies and justifications used for setting
such rates are available for public review and comment. This requires facilities
to become more involved in the rate setting process since failure to do so may
interfere with a facility's ability to challenge rates later.

The Company will attempt to maximize the revenues available to it from
governmental sources within the changes that have occurred and will continue to
occur under the BBA. In addition, the Company will attempt to increase revenues
from non-governmental sources, including expansion of its assisted living and
Canadian operations to the extent capital is available to do so, if at all.
However, current levels of or further reductions in government spending for
long-term health care are expected to continue to have an adverse effect on the
operating results and cash flows of the Company.

NEW FACILITIES

Since its inception as a public company in 1994, Advocat has sought to expand
its operations through the acquisition of attractive properties via either
purchase or lease. Management has conscientiously evaluated the acquisition
opportunities that have been available to the Company in light of criteria that
were established to help insure the long-term value of the acquisitions that
have been completed.

Effective October 1, 1997, the Company completed its most significant
acquisition, 29 assisted living facilities from Pierce Management Group
("Pierce"). In the Pierce acquisition, the Company purchased 15 facilities
(including two non-operating facilities) and leased 14 others. The Company holds
the option to purchase 12 of the leased facilities for market value beginning at
the fifth anniversary. With the Pierce acquisition, the Company, which has long
been involved in the provision of assisted living services in its Canadian
operations, established a foundation from which it hopes to expand its presence
in the growing assisted living market in the United States.

The following table summarizes the Company's acquisitions for 1997 through 1999:

<TABLE>
<CAPTION>
Facilities Added
----------------------- Beds/Units
Purchase Lease Added
-------- ----- -----
<S> <C> <C> <C>
1999 0 3 324
1998 0 0 0
1997 15 15 2,344

</TABLE>

These facilities are hereafter referred to collectively or in part as the "New
Facilities." The contribution of the New Facilities to selected components of
operations is noted separately where such contribution is significant within
their first year of operations.

39
<PAGE> 40

NON-RECURRING CHARGES

In the third quarter of 1999, the Company recorded non-recurring charges of
$500,000. In addition, during the second and fourth quarters of 1998, the
Company recorded various non-recurring charges totaling $5.9 million. Summarized
information with respect to each non-recurring charge is presented below:

<TABLE>
<CAPTION>
1999 1998
----------- -----------
<S> <C> <C>
Impaired Assets ...................... $ 500,000 $ 2,858,000
MIS Conversion ....................... -0- 1,166,000
Legal and Contractual Settlements .... -0- 1,276,000
Termination of Proposed Financing
and Acquisition Transactions ..... -0- 559,000
----------- -----------
$ 500,000 $ 5,859,000
=========== ===========

</TABLE>

During the third quarter of 1999, the Company recorded a charge of $500,000 for
the estimated impairment of the Company's investment in TDLP. The Company is
obligated to support TDLP cash flow to defined levels through August 2001. The
$500,000 charge represents management's estimate of additional future cash flow
obligations beyond that which had been provided for in prior evaluations. During
the fourth quarter of 1998, the Company recorded a charge of $2.5 million for
the estimated impairment of the Company's investment in TDLP. Approximately $1.3
million of this charge represented a valuation allowance against advances made
in 1998 in excess of the estimated fair value of the Company's investment, while
the remaining $1.2 million represented management's estimate of additional
future required cash flow obligations. In addition, in the fourth quarter of
1998, management identified two locations for which leases will not be renewed
and wrote off the impairment of certain long-lived assets with respect to these
locations ($358,000).

During 1998, in connection with its decision to convert all management
information systems with respect to the Company's U.S. nursing homes, the
Company abandoned much of its existing software and eliminated much of its
regional infrastructure in favor of a more centralized accounting organization.
The related $1.2 million charge in 1998 represents the write-off of capitalized
software costs, costs associated with the closing of certain regional offices
and severance packages of affected personnel.

During 1998, the Company recorded costs related to certain legal matters and
contractual disputes that were settled, resulting in total charges of $1.3
million.

During 1998, the Company also wrote off costs associated with terminated
prospective financing and acquisition transactions.

40
<PAGE> 41

YEAR ENDED DECEMBER 31, 1999 COMPARED WITH YEAR ENDED DECEMBER 31, 1998

REVENUES. Net revenues decreased to $182.0 million in 1999 from $205.2 million
in 1998, a decrease of $23.2 million, or 11.3%. Resident revenues increased to
$37.9 million in 1999 from $34.8 million in 1998, an increase of $3.1 million,
or 8.9%. The increase in resident revenues is primarily attributable to three
facilities the Company began operating late in the second quarter of 1999.
Patient revenues decreased to $141.0 million in 1999 from $166.5 million in
1998, a decrease of $22.5 million, or 15.3%. This decrease in patient revenues
is due primarily to the Medicare reimbursement changes brought about by the
implementation of PPS and various other BBA initiatives. In addition, effective
April 1, 1999, the Company ceased operating a facility it had previously leased;
this facility provided $4.7 million in comparable revenues that were not
repeated in 1999. Overall occupancy for leased/owned facilities declined from
81.6% in 1998 to 77.0% in 1999, which was primarily due to occupancy declines in
the nursing home segment. There was a 3.3% decline in patient and resident days.
A decline of approximately 102,000 patient days was partially offset by an
approximately 23,000 increase in resident days. The terminated lease accounted
for approximately 37,000 of the decline in patient days. As to payor types,
there were declines of approximately 51,000, 28,000 and 23,000 days for
Medicaid, Medicare and private pay patients, respectively, representing
percentage declines of 4.3%, 25.1% and 9.2%, respectively. As a percent of
patient and resident revenues, revenues generated from the Medicare program
decreased to16.9% in 1999 from 22.1% in 1998 while Medicaid and similar programs
increased to 70.0% in 1999 from 58.8% in 1998.

Patient revenues also declined in 1999 compared to 1998 due to the recording of
negative revenue adjustments resulting from reimbursement issues with several
states. Two of the Company's Alabama facilities were decertified for a portion
of 1997. As a result of the decertifications, the state retroactively recouped
incentives that had previously been paid to these facilities with respect to
1996 and 1997. Although the Company believes that its efforts seeking
restitution through the judicial system may ultimately prove successful, since
such success is not assured, the incentive revenue was reversed in 1999.
Additionally, certain patient claims by the Company's West Virginia facilities
were denied in prior years by the third party intermediary. The Company has
exhausted efforts to obtain approval for the claims and reversed these revenues
during 1999. Finally, the Arkansas Medicaid system refused to pay to all nursing
home operators a rate increase that had been both communicated to the Company
and provided for in the state budget that would have covered a portion of both
1998 and 1999. Although the Company is not party to the action, litigation is
being pursued seeking to force the payment of the budgeted increase. Because the
prospects for collection are doubtful, the Company reversed this revenue that
had been recognized over the last half of 1998 and the first half of 1999. Taken
together, these reimbursement issues, along with miscellaneous other matters,
accounted for approximately $2.0 million of the decline in patient revenues.

Ancillary service revenues, prior to contractual allowances, decreased to $23.0
million in 1999 from $58.0 million in 1998, a decrease of $35.0 million, or
60.3%. The decrease is primarily attributable to reductions in revenue
availability under Medicare and is consistent with the Company's expectations.
Although the $1,500 per patient annual ceiling has now been lifted for a two
year period on physical, speech and occupational therapy services, the impact of
this relief is not expected to be sufficient to offset the substantial losses
that have been incurred by the Company and the long-term care industry from the
provision of therapy services. The Company anticipates that ancillary service
revenues will remain flat or trend up only marginally during the next 12 months.
The ultimate effect on the Company's operations cannot be predicted at this time
because the extent and composition of the ancillary cost limitations are subject
to change.

41
<PAGE> 42

Management fee revenues declined to $2.9 million in 1999 from $3.6 million in
1998, a decline of $695,000, or 19.2%. The decrease is substantially due to
reductions in management fees earned on four United States facilities due to the
failure to achieve required operational thresholds.

OPERATING EXPENSES. Operating expenses decreased to $152.6 million in 1999 from
$164.8 million in 1998, a decrease of $12.2 million, or 7.4%. The decrease is
primarily attributable to cost reductions implemented in response to the
Medicare reimbursement changes (that is, reduced provision of therapy services
and in the costs to provide them). Several significant expense increases,
however, combined to offset the general decrease. The provision for doubtful
accounts was $7.0 million in 1999 as compared with $2.4 million in 1998, an
increase of $4.6 million. The increase in the provision for doubtful accounts
in 1999 was the result of additional deterioration of past due amounts,
increased write-offs for denied claims and additional reserves for potential
uncollectible accounts receivable. The Company is self-insured for workers'
compensation claims prior to May 1997. In connection therewith, the Company
recognized a charge of $650,000 in 1999 to provide for the expected costs on
claims related to this period that remain open. The expected costs have grown
as the open cases continued to adversely develop in 1999. The Company also
recognized a charge of $493,000 in 1999 to provide additional reserves for the
self-insured portion of patient liability claims incurred prior to 1998, which
claims have developed adversely in 1999 compared to previous evaluations.
Finally, it is generally recognized that the regulatory environment in which
nursing homes operate has become more restrictive. In 1999, the Company
incurred approximately $400,000 in fines and penalties compared to $50,000 in
the 1998 period. The largest component of operating expense is wages, which
increased to $80.4 million in 1999 from $76.5 million in 1998, an increase of
$3.9 million, or 5.0%. Savings from staff reductions in response to census
declines have been offset by increases related to the provision of
rehabilitation therapy as well as increased wage levels due to tight labor
markets in most of the areas in which the Company operates in the United
States. The Company's wage increases are generally in line with inflation.
Approximately $4.1 million in operating expenses were not repeated in 1999 with
respect to the facility whose lease terminated in 1999. As a percent of patient
and resident revenues, operating expenses increased to 85.3% in 1999 from 81.8%
in 1998.

LEASE EXPENSE. Lease expense increased to $20.4 million in 1999 from $19.1
million in 1998, an increase of $1.3 million, or 6.6%. Of this increase,
$494,000, or 2.6% is attributable to the three New Facilities. The increase was
offset by $345,000 not repeated in 1999 due to the facility whose lease term
expired April 1, 1999. Adjustments in the majority of the Company's lease
agreements are generally tied to inflation.

GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased
to $11.8 million in 1999 from $11.0 million in 1998, an increase of $784,000, or
7.1%. As a percent of total net revenues, general and administrative expense
increased to 6.5% in 1999 compared with 5.3% in 1998. The 1999 period includes a
provision for $275,000 of severance benefits for the former Chief Financial
Officer of the Company.

INTEREST EXPENSE. Interest expense remained constant at $5.4 million during
1999 and 1998.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased
to $5.1 million in 1999 from $3.8 million in 1998, an increase of $1.3 million,
or 34.2%. The increase is primarily attributable to additional depreciable
property placed in service during 1999 and 1998.

42
<PAGE> 43

CHANGE IN ACCOUNTING PRINCIPLE. Effective January 1, 1999, the Company adopted
Statement of Position ("SOP") 98-5, Reporting on the Costs of Start-Up
Activities. SOP 98-5, issued by the Accounting Standards Executive Committee,
requires that the cost of start-up activities be expensed as these costs are
incurred. Start-up activities include one-time activities and organization
costs. Upon adoption, the Company incurred a pre-tax charge to income of
$433,000 ($277,000 net of tax), representing the write off of all previously
deferred balances. This write off has been reported as the cumulative effect of
a change in accounting principle in accordance with the provisions of SOP 98-5.

INCOME (LOSS) BEFORE INCOME TAXES; NET INCOME (LOSS); EARNINGS (LOSS) PER SHARE.
As a result of the above, the loss before income taxes and the cumulative effect
of the change in accounting principle was $13.8 million in 1999 as compared with
a loss of $4.8 million in 1998, a decrease of $9.0 million. The net loss after
taxes and the cumulative effect of the change in accounting principle was $21.7
million in 1999 as compared with a net loss of $3.1 million in 1998, a decrease
of $18.6 million. Excluding the effects of the increases and decreases discussed
previously, the increased net loss in 1999 is also the result of a $7.6 million
tax provision in 1999 compared to a $1.7 million tax benefit in 1998. The 1999
tax provision is the result of a $12.8 million increase in the Company's
valuation allowance against the Company's deferred tax assets due to the
uncertainty surrounding the realization of the future benefits of those deferred
tax assets. Basic and diluted earnings per share were each a loss of $3.98 in
1999 as compared with each being a loss of $.57 for each in 1998.

YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997

REVENUES. Net revenues increased to $205.2 million in 1998 from $182.2 million
in 1997, an increase of $23.0 million, or 12.6%. Patient revenues increased to
$166.5 million in 1998 from $163.1 million in 1997, an increase of $3.4 million,
or 2.1%. Resident revenues increased $19.7 million, or 130.4%, of which $19.9
million is attributable to the New Facilities. Revenue increases among
facilities operated at least one year were primarily due to inflationary
increases rather than from expanded services. These increases were offset by a
2.3% decline in patient days (approximately 45,000 days) among facilities in
operation for at least one year. Approximately 11,000 of this decline in patient
days is attributable to the facilities that experienced regulatory issues. As a
group, however, they recovered to post a modest gain in patient days in the
fourth quarter. The Company anticipates it is likely that states and the federal
government will continue to seek ways to retard the rate of growth in Medicaid
program rates. As a percent of patient and resident revenues, Medicare decreased
to 22.1% in 1998 from 25.2% in 1997 while Medicaid and similar programs
increased to 58.8% in 1998 from 55.8% in 1997.

Ancillary service revenues, prior to contractual allowances, increased to $58.0
million in 1998 from $57.0 million in 1997, an increase of $1.0 million or 1.7%.
The Company has emphasized expansion of ancillary services since its inception
in 1994. The modest increase in 1998 is consistent with the slower rate of
growth realized since 1996. Management believes that the opportunities available
for the expansion of ancillary services in its existing operations were
essentially fully realized by the beginning of 1997. Because cost limits have
been placed on ancillary services as part of the transition to the Medicare
prospective payment system as well as other cost limitation provisions that have
been announced or could occur, the Company anticipates that ancillary service
revenues with respect to its existing operations will remain flat or begin
trending down in 1999. The ultimate effect on the Company's operations cannot be
predicted at this time because the extent and composition of the cost
limitations are not yet certain.

43
<PAGE> 44

Management fee revenues decreased by $258,000, or 6.7%, to $3.6 million. The
decrease is directly due to the deterioration in the exchange value of the
Canadian dollar versus the U.S. dollar. Most of the Company's management
revenues are earned in Canada. Prior to the exchange adjustment, Canadian
management fees increased 1.2%.

OPERATING EXPENSE. Operating expense increased to $164.8 million in 1998 from
$146.6 million in 1997, an increase of $18.2 million, or 12.4%. Of this
increase, $12.3 million is attributable to the New Facilities. As a percent of
patient and resident revenues, operating expense decreased to 81.8% in 1998 from
82.2% in 1997. As a percent of patient and resident revenues, operating expense
of the New Facilities was 71.6%. Most of the New Facilities are assisted living
locations, which typically have lower operating costs than do nursing homes.
With respect to facilities operated at least one year, the operating expense
percentage was 84.0%. The Company's operating costs relative to revenues with
respect to nursing homes has increased as occupancy has declined and certain
costs have increased in response to regulatory issues. The largest component of
operating expense is wages, which increased to $76.5 million in 1998 from $67.2
million in 1997, an increase of $9.3 million, or 13.8%. Of this increase, $7.5
million is attributable to the New Facilities. Wages with respect to facilities
in operation for at least one year increased $1.8 million, or 2.6%. The
Company's wage increases are generally in line with inflation. With respect to
nursing home operations, general insurance expense increased to $6.3 million in
1998 from $3.9 million in 1997, an increase of $2.4 million, or 60.0%. In 1998,
general insurance expense included a fourth quarter charge of $928,000, based on
development of claims, to increase the reserve for expected payments under the
Company's large deductible program. Bad debt expense increased to $2.4 million
in 1998 from $2.0 million in 1997, an increase of $361,000, or 17.9%. The 1998
expense included a charge of $875,000 to increase the allowance for bad debts
based on analysis completed in the fourth quarter.

LEASE EXPENSE. Lease expense increased to $19.1 million in 1998 from $15.8
million in 1997, an increase of $3.3 million, or 20.6%. Of this increase, $3.0
million is attributable to the New Facilities, and the remainder is primarily
attributable to inflationary adjustments required under the terms of a majority
of the Company's operating leases.

GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense increased
to $11.0 million in 1998 from $9.6 million in 1997, an increase of $1.4 million,
or 13.8%. The increase in excess of inflation is primarily attributable to the
expense of managing the New Facilities and structural costs associated with the
Alabama decertifications and other regulatory issues. As a percent of total net
revenues, general and administrative expense remained flat at 5.3% in 1998.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization expenses increased
to $3.8 million in 1998 from $2.8 million in 1997, an increase of $1.0 million,
or 35.9%. This increase is primarily attributable to the New Facilities.

INTEREST EXPENSE. Interest expense increased to $5.4 million in 1998 from $2.7
million in 1997, an increase of $2.7 million, or 103.0%. This increase is
primarily attributable to the New Facilities plus interest on additional
borrowings under the Company's credit lines.

INCOME (LOSS) BEFORE INCOME TAXES; NET INCOME (LOSS); EARNINGS (LOSS) PER SHARE.
As a result of the above, as well as the non-recurring charges of $5.9 million,
the Company lost $(4.8) million before income taxes as compared with a profit of
$4.7 million in 1997, a decrease of $9.5 million, or (202.3)%. The effective
combined

44
<PAGE> 45

federal, state and provincial income tax rate was 36.0% in both 1998 and 1997.
The net loss was $(3.1) million in 1998 as compared with net income of $3.0
million in 1997, a decrease of $6.1 million, and basic earnings (loss) per share
was $(.57) as compared with $.56.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1999, the Company had negative working capital of $56.7 million
and the current ratio was 0.2, compared with negative working capital of $16.2
million and a current ratio of 0.7 at December 31, 1998. The increase in
negative working capital as of December 31, 1999 results primarily from the
increase in the Company's current maturities of long-term debt. The Company
cannot assure that internally generated cash flows from earnings and existing
cash balances will be sufficient to fund existing debt obligations or future
capital and working capital requirements during 2000. The increase in current
maturities is due to the Company's non-compliance with debt covenants in
various debt agreements, including net worth, cash flow and debt-to-equity
ratio requirements. Cross-default or material adverse change provisions
contained in the agreements allow the holders of substantially all of the
Company's debt to demand immediate repayment. The Company has not obtained
waivers of the non-compliance. Based on regularly scheduled debt service
requirements, the Company has a total of $27,195,000 of debt that must be
repaid or refinanced within the next 12 months. However, as a result of the
covenant noncompliance and other cross-default provisions, the Company has
classified a total of $53,098,000 of debt as current liabilities as of December
31, 1999. The Company would not be able to repay this portion of its
indebtedness if the applicable lenders demanded repayment.

At December 31, 1999, the Company had total debt outstanding of $60,925,000, of
which $34,950,000 was principally mortgage debt, bearing interest generally at
floating rates ranging from 6.3% to 8.6%. The Company also had outstanding a
promissory note payable to a bank in the amount of $9,412,000 and a reducing
demand loan to a Canadian bank in the amount of $1,038,000. The Company's
remaining debt of $15,524,000 was drawn under the Company's lines of credit,
consisting of a working capital line of credit and an acquisition line of
credit. Most of the Company's debt is at floating interest rates, generally at a
spread above the London Interbank Offered Rate ("LIBOR"). As of December 31,
1999, the Company's weighted average interest rate was 9.1%.

The $9,412,000 Promissory Note originally had a maturity date of July 1, 1999.
During 1999, the Company and its lenders agreed to modify the terms of the
promissory note by extending the stated maturity date to February 28, 2000,
increasing the interest rate to 12.0% fixed and providing certain security
interests to the lenders.

As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of
letters of credit outstanding, and had $1,939,000 remaining borrowing capability
under its working capital line of credit. The working capital line of credit
matured December 1, 1999, but was not called, and it carries a current extended
maturity date of February 28, 2000.

45
<PAGE> 46

The promissory note, the working capital line of credit and the Overline are
each held by the same lender. Each of these loans matured February 28, 2000. The
Company is currently negotiating modifications to the status of these loans with
the lender.

As of December 31, 1999, the Company had $11,100,000 outstanding under an
acquisition line of credit, which amount was secured by four nursing homes. No
further draws are available under the acquisition line of credit. Amounts
outstanding under the acquisition line of credit had a scheduled maturity date
of December 1, 1999. However, the lender has extended the maturity date to April
30, 2000.

Of the Company's 63 leased facilities, 30 are covered by a Master Lease
and other leases with Omega Healthcare Investors, Inc. ("Omega"). Under the
terms of the Master Lease, the Company must comply with certain covenants based
on total shareholders' equity of the Company as defined. The Company was not in
compliance with these covenants as of December 31, 1999. As a result of the
non-compliance, Omega has the right to terminate all of its leases with the
Company and seek recovery of any related financial losses, as well as other
miscellaneous remedies. The Company has not obtained waivers of the
non-compliance. The Company and Omega are currently in negotiations with respect
to modification of the existing lease agreements.

No assurance can be given that the Company will achieve profitable
operations in the near term. There can be no assurance that the Company can
increase growth in net revenues. The Company cannot assure that internally
generated cash flows from earnings and existing cash balances will be
sufficient to fund existing debt obligations on future capital and working
capital requirements through fiscal year 2000.

The Company is currently discussing potential restructuring, modification and
refinancing alternatives with its lenders, primary lessor and potential
investors. If the Company's lenders force immediate repayment, the Company would
not be able to repay the related debt outstanding. The Company is unable to
predict if it will be successful in reducing operating losses, in negotiating
waivers, amendments, or refinancings of outstanding debt or lease commitments,
or that the Company will be able to meet any amended financial covenants in the
future. Any demands for repayment by lenders or the inability to obtain waivers
or refinance the related debt would have a material adverse impact on the
financial position, results of operations and cash flows of the Company. If the
Company is unable to generate sufficient cash flow from its operations or
successfully negotiate debt or lease amendments, it will explore a variety of
other options, including but not limited to equity financing from outside
investors, asset dispositions or relief under the United States Bankruptcy code.

Net cash provided by operating activities totaled $9.2 million, $4.1 million and
$5.3 million in 1999, 1998 and 1997, respectively. These amounts primarily
represent the cash flows from net income plus changes in non-cash components of
operations offset by working capital changes, particularly, increases in
receivables.

Net cash used in investing activities totaled $5.1 million, $8.1 million and
$39.9 million in 1999, 1998 and 1997, respectively. The Company has used between
$2.7 million and $5.2 million for capital expenditures in each of the last three
calendar years ending December 31, 1998. Substantially all such expenditures
were for facility improvements and equipment, which were financed principally
through working capital. The 1998 additions were higher principally due to the
Company's conversion of its management information systems. For the year ended
December 31, 2000, the Company anticipates that capital expenditures for
improvements and equipment for its existing facility operations will be
approximately $3.2 million, including approximately $800,000 million for
non-routine projects. There were no purchase acquisitions completed in 1999 or
1998. In 1997, the Company purchased 17 facilities for net cash consideration of
$36.2 million. In 1999 and 1998, the Company invested in or advanced funds to
joint ventures in the amount of $576,000 and $2.1 million, respectively. In
general, the Company has been appointed as manager of the joint venture
properties.

Net cash provided by (used in) financing activities totaled $(4.6) million, $3.7
million and $35.4 million in 1999, 1998 and 1997, respectively. The net cash
provided from financing activities primarily represents net proceeds from the
issuance and repayment of debt.

46
<PAGE> 47

RECEIVABLES

The Company's operations could be adversely affected if it experiences
significant delays in reimbursement of its labor and other costs from Medicare,
Medicaid and other third-party revenue sources. The Company's future liquidity
will continue to be dependent upon the relative amounts of current assets
(principally cash, accounts receivable and inventories) and current liabilities
(principally accounts payable and accrued expenses). In that regard, accounts
receivable can have a significant impact on the Company's liquidity. Continued
efforts by governmental and third-party payors to contain or reduce the
acceleration of costs by monitoring reimbursement rates, by increasing medical
review of bills for services or by negotiating reduced contract rates, as well
as any delay by the Company in the processing of its invoices, could adversely
affect the Company's liquidity and results of operations.

Net accounts receivable attributable to the provision of patient and resident
services at December 31, 1999 and 1998, totaled $15.8 million and $28.3 million,
respectively, representing approximately 31 and 53 days in accounts receivable,
respectively. Accounts receivable from the provision of management services was
$412,000 and $387,000, respectively, at December 31, 1999 and 1998, representing
approximately 42 and 39 days in accounts receivable, respectively. The allowance
for bad debts was $5.0 million and $2.6 million at December 31, 1999 and 1998,
respectively.

The Company continually evaluates the adequacy of its bad debt reserves based on
patient mix trends, agings of older balances, payment terms and delays with
regard to third-party payors, collateral and deposit resources, as well as other
factors. The Company continues to evaluate and implement additional procedures
to strengthen its collection efforts and reduce the incidence of uncollectible
accounts.

HEALTH CARE INDUSTRY

The health care industry is subject to numerous laws and regulations of federal,
state and local governments. These laws and regulations include, but are not
necessarily limited to, matters such as licensure, accreditation, government
health care program participation requirements, reimbursement for patient
services, and Medicare and Medicaid fraud and abuse. Changes in these laws and
regulations, such as reimbursement policies of Medicare and Medicaid programs as
a result of budget cuts by federal and state governments or other legislative
and regulatory actions, could have a material adverse effect on the Company's
consolidated financial position, results of operations, and cash flows. Future
federal budget legislation and federal and state regulatory changes may
negatively impact the Company.

All of the Company's facilities are required to obtain annual licensure renewal
and are subject to annual surveys and inspections in order to be certified for
participation in the Medicare and Medicaid programs. In order to maintain their
operator's license and their certification for participation in Medicare and
Medicaid programs, the nursing facilities must meet certain statutory and
administrative requirements. These requirements relate to the condition of the
facilities, the adequacy and condition of the equipment used therein, the
quality and adequacy of personnel, and the quality of medical care. Such
requirements are subject to change. There can be no assurance that, in the
future, the Company will be able to maintain such licenses for its facilities or
that the Company will not be required to expend significant sums in order to do
so.

47
<PAGE> 48

Recently, government activity has increased with respect to investigations and
allegations concerning possible violations by health care providers of fraud and
abuse statutes and regulations. Violations of these laws and regulations could
result in expulsion from government health care programs together with the
imposition of significant fines and penalties, as well as significant repayments
for patient services previously billed. Management believes that the Company is
in compliance with fraud and abuse laws and regulations as well as other
applicable government laws and regulations. Compliance with such laws and
regulations can be subject to future government review and interpretation as
well as regulatory actions unknown or unasserted at this time.

During 1997 and 1998, the Company experienced certain adverse regulatory issues
with respect to certain facilities, including decertifications from the Medicare
and Medicaid programs. Although the Company did not experience any facility
decertifications during 1999, the Company did experience the increased
regulatory scrutiny that has been exerted on the industry in the form of
increased fines and penalties.

FOREIGN CURRENCY TRANSLATION

The Company has obtained its financing primarily in U.S. dollars; however, it
incurs revenues and expenses in Canadian dollars with respect to Canadian
management activities and operations of the Company's eight Canadian retirement
centers (three of which are owned) and two owned Canadian nursing homes.
Although not material to the Company as a whole, if the currency exchange rate
fluctuates, the Company may experience currency translation gains and losses
with respect to the operations of these activities and the capital resources
dedicated to their support. While such currency exchange rate fluctuations have
not been material to the Company in the past, there can be no assurance that the
Company will not be adversely affected by shifts in the currency exchange rates
in the future.

EXECUTIVE MANAGEMENT CHANGES

Effective June 30, 1999, Mary Margaret Hamlett resigned as Executive Vice
President, Chief Financial Officer and Secretary of the Company. Mr. Richard B.
Vacek, Jr. replaced Ms. Hamlett in those capacities effective August 16, 1999.
Ms. Hamlett also resigned as a Director of the Company coincident with her
resignation as an employee of the Company. Effective January 28, 2000, Mr. Vacek
resigned his position with the Company. Mr. James F. Mills, Jr., Vice President
and Controller, replaced Mr. Vacek as Secretary and Acting Chief Financial
Officer.

In addition, Mr. Charles H. Rinne joined the Company effective June 28, 1999.
Mr. Rinne is President and Chief Operating Officer of the Company.

STOCK EXCHANGE

On November 10, 1999, the Company's stock began being quoted on the NASD's OTC
Bulletin Board under the symbol AVCA. Previously, the Company's common stock was
traded on the New York Stock Exchange under the symbol AVC. The Company's common
stock is also traded on the Toronto Stock Exchange under the symbol AVCU.

48
<PAGE> 49

INFLATION

Management does not believe that the Company's operations have been materially
affected by inflation. The Company expects salary and wage increases for its
skilled staff to continue to be higher than average salary and wage increases,
as is common in the health care industry. To date, these increases as well as
normal inflationary increases in other operating expenses have been adequately
covered by revenue increases.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. SFAS
No. 133, as amended by SFAS No. 137, "Deferral of the Effective Date of SFAS
133", is effective for fiscal quarters beginning after June 15, 2000. The impact
of the adoption of SFAS No. 133 is not expected to have a material impact on the
Company's results of operations or financial position.

IMPACT OF THE YEAR 2000

The Company experienced the changeover to the year 2000 ("Y2K") without
difficulty. In preparation for the potential of Y2K related problems, the
Company established a Y2K compliance committee, which was responsible for
identifying such problems and developing remedial or contingency plans to
address them. Working closely with the Company's insurance carrier, the
committee developed a formal, documented plan that was put into place. The costs
of the Company's Y2K compliance program were not material.

Although the Company experienced no catastrophic interruptions in its business
in the changeover to the year 2000, it remains on alert for potential Y2K
problems. To date, no problems have been noted with any of the Company's
vendors. The greatest potential risk that remains is a delay in the liquidation
of receivables from ntermediaries or other payors for services provided to
patients and residents. Such delays are not expected, but they could yet occur.

The foregoing Y2K disclosure is intended to be a "Year 2000 statement" as the
term is defined in the Year 2000 Information and Readiness Disclosure Act of
1998 (the "Year 2000 Act"), and, to the extent such disclosure relates to Y2K
processing of the Company or to products or services offered by the Company, it
is also intended to be the "Year 2000 readiness disclosure," as that term is
defined in the Year 2000 Act.

FORWARD-LOOKING STATEMENTS

The foregoing discussion and analysis provides information deemed by management
to be relevant to an assessment and understanding of the Company's consolidated
results of operations and its financial condition. It should be read in
conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1998. Certain statements made by or on behalf of the Company,
including those contained in this "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere, are
forward-looking statements as defined in the Private Securities Litigation
Reform Act of 1995. These statements involve risks and uncertainties including,
but not limited to, changes in governmental reimbursement or regulation, health
care reforms, the increased cost of borrowing under the Company's credit
agreements,

49
<PAGE> 50

covenant waivers from the Company's lenders, possible amendments to the
Company's credit agreements, the impact of future licensing surveys, the ability
to execute on the Company's acquisition program, both in obtaining suitable
acquisitions and financing therefor, changing economic conditions as well as
others. Investors also should refer to the risks identified in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" as well as risks identified in the Company's Form 10-K for the year
ended December 31, 1998 for a discussion of various risk factors of the Company
and that are inherent in the healthcare industry. Given these risks and
uncertainties, the Company can give no assurances that these forward-looking
statements will, in fact, transpire and, therefore, cautions investors not to
place undue reliance on them. Actual results may differ materially from those
described in such forward looking statements. Such cautionary statements
identify important factors that could cause the Company's actual results to
materially differ from those projected in forward-looking statements. In
addition, the Company disclaims any intent or obligation to update these
forward-looking statements.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Audited financial statements are contained on pages F-1 through F-33 of this
Annual Report on Form 10-K and are incorporated herein by reference. Audited
supplemental schedule data is contained on pages S-1 and S-2 of this Annual
Report on Form 10-K and is incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

50
<PAGE> 51

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning Directors and Executive Officers of the Company is
incorporated herein by reference to the Company's definitive proxy materials for
the Company's 2000 Annual Meeting of Shareholders.

ITEM 11. EXECUTIVE COMPENSATION

Information concerning Executive Compensation is incorporated herein by
reference to the Company's definitive proxy materials for the Company's 2000
Annual Meeting of Shareholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information concerning Security Ownership of Certain Beneficial Owners and
Management is incorporated herein by reference to the Company's definitive proxy
materials for the Company's 2000 Annual Meeting of Shareholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information concerning Certain Relationships and Related Transactions is
incorporated herein by reference to the Company's definitive proxy materials for
the Company's 2000 Annual Meeting of Shareholders.

51
<PAGE> 52

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

Financial statements and schedules of the Company and its subsidiaries required
to be included in Part II, Item 8 are listed below.

<TABLE>
<CAPTION>
Form 10-K
Pages
---------
<S> <C>
FINANCIAL STATEMENTS

Report of Independent Public Accountants F-1

Consolidated Balance Sheets, December 31, 1999 and 1998 F-2

Consolidated Statements of Operations for the Years Ended December 31, 1999,
1998 and 1997 F-3

Consolidated Statements of Shareholders' Equity for the Years Ended
December 31, 1999, 1998 and 1997 F-4

Consolidated Statements of Comprehensive Income for the Years Ended
December 31, 1999, 1998 and 1997 F-5

Consolidated Statements of Cash Flows for the Years Ended December 31, 1999,
1998 and 1997 F-6 to F-7

Notes to Consolidated Financial Statements, December 31, 1999,
1998 and 1997 F-8 to F-33

FINANCIAL STATEMENT SCHEDULE

Report of Independent Public Accountants S-1

Schedule II - Valuation and Qualifying Accounts S-2

</TABLE>

EXHIBITS

The exhibits filed as part of this Report on Form 10-K are listed in the Exhibit
Index immediately following the financial statement pages.

REPORTS ON FORM 8-K

None.

52
<PAGE> 53

SIGNATURES

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 be signed on its
behalf by the undersigned, thereunto duly authorized.

ADVOCAT INC.

/s/ Charles W. Birkett, M.D.
- --------------------------------
Charles W. Birkett, M.D., Chairman of the Board
March 30, 2000

/s/ James F. Mills, Jr.
- --------------------------------
James F. Mills, Jr.
Vice President and Controller, Acting Chief Financial Officer
(Principal Financial and Accounting Officer)
March 30, 2000

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.

/s/ Charles W. Birkett, M.D. /s/ William C. O'Neil
- -------------------------------- --------------------------------
Charles W. Birkett, M.D. William C. O'Neil
Chairman of the Board Director
(Principal Executive Officer) March 30, 2000
March 30, 2000

/s/ Paul Richardson /s/ J. Bransford Wallace
- -------------------------------- --------------------------------
Paul Richardson J. Bransford Wallace
Director Director
March 30, 2000 March 30, 2000

/s/ Edward G. Nelson
- --------------------------------
Edward G. Nelson
Director
March 30, 2000

<PAGE> 54
ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 1999 AND 1998

TOGETHER WITH REPORT OF

INDEPENDENT PUBLIC ACCOUNTANTS

<PAGE> 55

INDEX TO FINANCIAL STATEMENTS

Report of Independent Public Accountants F-1

Consolidated Balance Sheets F-2

Consolidated Statements of Operations F-3

Consolidated Statements of Shareholders' Equity F-4

Consolidated Statements of Comprehensive Income F-5

Consolidated Statements of Cash Flows F-6

Notes to Consolidated Financial Statements F-8

<PAGE> 56

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Advocat Inc.:

We have audited the accompanying consolidated balance sheets of ADVOCAT INC. (a
Delaware Corporation) and subsidiaries as of December 31, 1999 and 1998 and the
related consolidated statements of operations, comprehensive income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
Advocat Inc.'s management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the
audits to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our 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 Advocat Inc. and
subsidiaries as of December 31, 1999 and 1998 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.

The accompanying consolidated financial statements have been prepared assuming
that Advocat Inc. will continue as a going concern. Advocat Inc. has incurred
net losses in the years ended December 31, 1999 and 1998 and expects to incur
losses in 2000. As discussed in Notes 2 and 9, Advocat Inc. is also not in
compliance with certain debt covenants that allow the holders of substantially
all of Advocat Inc.'s debt to demand immediate principal repayment. In addition,
Advocat, Inc. has limited resources available to meet its operating, capital
expenditure and debt service requirements during 2000. As discussed in Notes 2
and 13, Advocat Inc. is also not in compliance with the financial covenants
applicable to the lease agreements covering a majority of its United States
nursing facilities. These factors raise substantial doubt about Advocat Inc.'s
ability to continue as a going concern. Management's plans in regard to these
matters are described in Note 2. The accompanying consolidated financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset carrying amounts or the amounts and
classification of liabilities that might result should the Company be unable to
continue as a going concern.

ARTHUR ANDERSEN LLP

Nashville, Tennessee
March 28, 2000

F-1
<PAGE> 57
ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

DECEMBER 31, 1999 AND 1998
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
ASSETS

CURRENT ASSETS:
Cash and cash equivalents $ 1,913,000 $ 2,347,000
Receivables, less allowance for doubtful
accounts of 11,719,000 26,289,000
$4,958,000 and $2,650,000, respectively
Income taxes receivable -- 800,000
Inventories 754,000 1,102,000
Prepaid expenses and other assets 813,000 1,528,000
Deferred income taxes -- 1,719,000
------------- -------------
Total current assets 15,199,000 33,785,000
------------- -------------

PROPERTY AND EQUIPMENT, AT COST 87,667,000 84,129,000
Less accumulated depreciation and
amortization (19,015,000) (15,548,000)
------------- -------------
Net property and equipment 68,652,000 68,581,000
------------- -------------

OTHER ASSETS:
Deferred tax benefit -- 6,338,000
Deferred financing and other costs, net 939,000 1,150,000
Assets held for sale or redevelopment 1,476,000 1,476,000
Investments in and receivables from joint 8,126,000 7,194,000
ventures
Other assets 1,793,000 2,770,000
Total other assets 12,334,000 18,928,000
------------- -------------
$ 96,185,000 $ 121,294,000
============= =============

</TABLE>

<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
Current portion of long-term debt $ 53,098,000 $ 30,126,000
Trade accounts payable 7,984,000 9,327,000
Accrued expenses:
Payroll and employee benefits 4,001,000 4,920,000
Interest 221,000 857,000
Current portion of self-insurance
reserves 3,508,000 2,375,000
Other 3,086,000 2,413,000
------------- -------------
Total current liabilities 71,898,000 50,018,000
------------- -------------

NONCURRENT LIABILITIES:
Long-term debt, less current portion 7,827,000 33,514,000
Self-insurance reserves, less current 2,268,000 1,665,000
portion
Deferred gains with respect to 3,047,000 3,293,000
leases, net
Other 4,878,000 5,243,000
------------ ------------
Total noncurrent liabilities 18,020,000 43,715,000
------------ ------------
COMMITMENTS AND CONTINGENCIES

SHAREHOLDERS' EQUITY:
Preferred stock, authorized
1,000,000 shares, $.10 par value,
none issued and outstanding -- --
Common stock, authorized 20,000,000
shares, $.01 par value, 5,492,000 and
5,399,000 shares issued and
outstanding, respectively 55,000 54,000
Paid-in capital 15,907,000 15,765,000
Retained earnings (accumulated deficit) (9,695,000) 11,742,000
------------- -------------
Total shareholders' equity 6,267,000 27,561,000
------------- -------------
$ 96,185,000 $ 121,294,000
============= =============

</TABLE>

The accompanying notes are an integral part of
these consolidated balance sheets.

F-2
<PAGE> 58

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES:
Patient revenues, net $ 141,022,000 $ 166,529,000 $ 163,094,000
Resident revenues 37,905,000 34,804,000 15,105,000
Management fees 2,932,000 3,627,000 3,886,000
Interest 159,000 192,000 158,000
------------- ------------- -------------
182,018,000 205,152,000 182,243,000
------------- ------------- -------------
EXPENSES:
Operating 152,557,000 164,769,000 146,555,000
Lease 20,375,000 19,109,000 15,850,000
General and administrative 11,753,000 10,969,000 9,636,000
Depreciation and amortization 5,167,000 3,838,000 2,823,000
Non-recurring charges 500,000 5,859,000 --
Interest 5,460,000 5,425,000 2,672,000
------------- ------------- -------------
195,812,000 209,969,000 177,536,000
------------- ------------- -------------

INCOME (LOSS) BEFORE INCOME TAXES
(13,794,000) (4,817,000) 4,707,000

PROVISION (BENEFIT) FOR INCOME TAXES 7,605,000 (1,734,000) 1,694,000
------------- ------------- -------------

INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE (21,399,000) (3,083,000) 3,013,000
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE, NET OF TAX BENEFIT (277,000) -- --
------------- ------------- -------------
NET INCOME (LOSS) $ (21,676,000) $ (3,083,000) $ 3,013,000
============= ============= =============

EARNINGS (LOSS) PER SHARE:
Basic $ (3.98) $ (.57) $ .56
============= ============= =============
Diluted $ (3.98) $ (.57) $ .56
============= ============= =============

WEIGHTED AVERAGE SHARES:
Basic 5,445,000 5,388,000 5,339,000
============= ============= =============
Diluted 5,445,000 5,388,000 5,373,000
============= ============= =============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

F-3
<PAGE> 59

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

<TABLE>
<CAPTION>
Retained
Common Stock Earnings
--------------------------- Paid-in Accumulated
Shares Amount Capital (Deficit) Total
--------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 5,316,000 $ 53,000 $ 15,083,000 $ 12,212,000 $ 27,348,000

Issuance of common stock 61,000 1,000 555,000 -- 556,000
Net income -- -- -- 3,013,000 3,013,000
Translation loss, net of tax -- -- -- (184,000) (184,000)
--------- ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1997 5,377,000 54,000 15,638,000 15,041,000 30,733,000

Issuance of common stock 22,000 -- 127,000 -- 127,000
Net income -- -- -- (3,083,000) (3,083,000)
Translation loss, net of tax -- -- -- (216,000) (216,000)
--------- ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1998 5,399,000 54,000 15,765,000 11,742,000 27,561,000

Issuance of common stock 93,000 1,000 142,000 -- 143,000
Net loss -- -- -- (21,676,000) (21,676,000)
Translation gain, net of tax -- -- -- 239,000 239,000
--------- ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1999 5,492,000 $ 55,000 $ 15,907,000 $ (9,695,000) $ 6,267,000
========= ============ ============ ============ ============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

F-4
<PAGE> 60

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------------
1999 1998 1997
-------------- -------------- --------------
<S> <C> <C> <C>
NET INCOME (LOSS) $ (21,676,000) $ (3,083,000) $ 3,013,000

OTHER COMPREHENSIVE INCOME (LOSS):
Foreign currency translation adjustments 374,000 (338,000) (286,000)
Income tax benefit (provision) (135,000) 122,000 102,000
-------------- -------------- --------------
239,000 (216,000) (184,000)
-------------- -------------- --------------

COMPREHENSIVE INCOME (LOSS) $ (21,437,000) $ (3,299,000) $ 2,829,000
============== ============== ==============

</TABLE>

The accompanying notes are an integral part of
these consolidated financial statements.

F-5
<PAGE> 61

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $(21,676,000) $ (3,083,000) $ 3,013,000
Items not involving cash:
Depreciation and amortization 5,167,000 3,838,000 2,861,000
Provision for doubtful accounts 7,037,000 2,306,000 2,029,000
Deferred income taxes 7,923,000 (1,645,000) 2,131,000
Equity in (earnings) loss in joint ventures 177,000 (69,000) (53,000)
Amortization of deferred balances 894,000 (513,000) (1,022,000)
Non-recurring charge write-off -- 1,630,000 --
Asset impairment provision 500,000 2,858,000 --
Write-off pursuant to change in
accounting principle 433,000 -- --

Changes in other non-cash items, net of acquisitions:
Receivables, net 7,942,000 (4,306,000) (3,878,000)
Inventories 348,000 (5,000) (430,000)
Prepaid expenses and other assets 729,000 (273,000) (206,000)
Trade accounts payable and
accrued expenses (242,000) 3,367,000 847,000
Other (27,000) (36,000) 12,000
------------ ------------ ------------
Net cash provided by operating activities 9,205,000 4,069,000 5,304,000
------------ ------------ ------------

INVESTING ACTIVITIES:
Acquisitions, net of cash acquired -- -- (36,151,000)
Purchases of property and equipment, net (4,382,000) (5,186,000) (2,710,000)
Investment in TDLP (160,000) (632,000) (655,000)
Mortgages receivable, net 179,000 118,000 (307,000)
Investments in and advances to joint ventures, net (576,000) (2,086,000) 36,000
Deposits, pre-opening costs and other (461,000) (577,000) (349,000)
TDLP partnership distributions 345,000 307,000 201,000
------------ ------------ ------------
Net cash used in investing activities (5,055,000) (8,056,000) (39,935,000)
------------ ------------ ------------

</TABLE>

(continued)

F-6
<PAGE> 62

ADVOCAT INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(continued)

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
FINANCING ACTIVITIES:
Proceeds from issuance of debt $ 26,364,000 $ -- $ 36,129,000
Repayment of debt obligations (25,730,000) (890,000) (730,000)
Financing costs (532,000) (207,000) (535,000)
Net proceeds from repayment of bank line
of credit (3,689,000) 5,674,000 3,000
Repayment of bank line of credit -- --
Lessor advances, net -- 442,000
Proceeds from sale of common stock 143,000 127,000 556,000
Advances to TDLP, net (1,305,000) (1,043,000) (503,000)
Increases in lease obligations 165,000 -- --
------------ ------------ ------------
Net cash provided by financing activities (4,584,000) 3,661,000 35,362,000
------------ ------------ ------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (434,000) (326,000) 731,000

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 2,347,000 2,673,000 1,942,000
------------ ------------ ------------

CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,913,000 $ 2,347,000 $ 2,673,000
============ ============ ============

SUPPLEMENTAL INFORMATION:
Cash payments of interest $ 6,095,000 $ 5,016,000 $ 2,526,000
============ ============ ============
Cash payments (refunds) of income taxes, net $ (981,000) $ 330,000 $ 392,000
============ ============ ============

</TABLE>

NON-CASH TRANSACTIONS:

During 1999, the Company's executive benefit plan was terminated. In connection
therewith, the Company distributed net benefit plan deposits and relieved net
benefit plan liabilities of $1,124,000. The Company received net benefit plan
deposits and earnings and recorded net benefit plan liabilities of $443,000 and
$265,000 for 1998 and 1997, respectively.

The accompanying notes are an integral part of
these consolidated financial statements.

F-7
<PAGE> 63

ADVOCAT INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 1999, 1998 AND 1997

1. BACKGROUND

Advocat Inc. (together with its subsidiaries, "Advocat" or the "Company")
provides long-term care services to nursing home patients and residents of
assisted living facilities in 12 states, primarily in the Southeast, and
three Canadian provinces. The Company's facilities provide a range of
health care services to their patients and residents. In addition to the
nursing, personal care and social services usually provided in long-term
care facilities, the Company offers a variety of comprehensive
rehabilitation services as well as medical supply and nutritional support
services. As of December 31, 1999, the Company operates 119 facilities,
consisting of 65 nursing homes with 7,307 licensed beds and 54 assisted
living facilities with 5,215 units. Within the current portfolio, 35
facilities are managed on behalf of other owners, 29 on behalf of
unrelated owners and 6 in which the Company holds a minority equity
interest. The remaining facilities, consisting of 61 leased and 23 owned
facilities, are operated for the Company's own account.

In recent periods, the long-term health care environment has undergone
substantial change with regards to reimbursement and other payor sources,
compliance regulations, competition among other health care providers and
relevant patient liability issues. The Company continually monitors these
industry developments as well as other factors that affect its business.
See Note 13 for further discussion of recent changes in the long-term
health care industry and the related impact on the Operations of the
Company.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

The financial statements include the operations and accounts of Advocat
and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation. Investments in
entities in which the Company lacks control but has the ability to
exercise significant influence over operating and financial policies are
accounted for under the equity method. Investments in entities in which
the Company lacks the ability to exercise significant influence are
included in the consolidated financial statements at the cost of the
Company's investment.

BASIS OF ACCOUNTING

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company
has incurred net losses in the years ended December 31, 1999 and 1998. The
Company has a working capital deficit of $56.7 million as of December 31,
1999. The Company expects to continue to incur losses in 2000. Also, the
Company has limited resources available to meet its operating, capital
expenditure and debt service requirements during 2000. In addition, the
Company is currently not in compliance with certain debt covenants that

F-8
<PAGE> 64
allow the holders of substantially all of the Company's debt to demand
immediate principal repayment. Although the Company does not anticipate
that such demand will be made, the continued forbearance on the part of
the Company's lenders cannot be assured at this time. Accordingly, the
Company has classified the related debt principal amounts as current
liabilities in the accompanying consolidated financial statements as of
December 31, 1999. Given that events of default exist under the Company's
working capital line of credit, there can be no assurance that the lender
will continue to provide working capital advances. The Company is also not
in compliance with the financial covenants applicable to the lease
agreements covering a majority of its United States nursing facilities.
Under the agreements, the lessor has the right to terminate the lease
agreements and seek recovery of any related financial losses as well as
other remedies. At a minimum, the Company's cash requirements over the
next 12 months include funding operations, capital expenditures, scheduled
debt service, and working capital requirements. No assurance can be given
that the Company will have sufficient cash to meet its requirements for
the next 12 months.

The Company is currently discussing potential restructuring and
refinancing alternatives with its lenders, primary lessor and potential
investors. If the Company's lenders force immediate repayment, the Company
would not be able to repay the related debt outstanding. The Company is
unable to predict if it will be successful in reducing operating losses,
in negotiating waivers, amendments, or refinancings of outstanding debt or
lease commitments, or if the Company will be able to meet any amended
financial covenants in the future. Any demands for repayment by lenders or
the inability to obtain waivers or refinance the related debt would have a
material adverse impact on the financial position, results of operations
and cash flows of the Company. If the Company is unable to generate
sufficient cash flow from its operations or successfully negotiate debt or
lease amendments, it will explore a variety of other options, including
but not limited to other sources of equity or debt financings, asset
dispositions, or relief under the United States Bankruptcy code. These
factors raise substantial doubt about the Company's ability to continue as
a going concern. The accompanying consolidated financial statements do not
include any adjustments relating to the recoverability and classification
of recorded asset carrying amounts or the amounts and classification of
liabilities that might result should the Company be unable to continue as
a going concern.

REVENUES

PATIENT AND RESIDENT REVENUES - The fees charged by the Company to
patients in its nursing homes and residents in its assisted living
facilities include fees with respect to individuals receiving benefits
under federal and state-funded cost reimbursement programs. These revenues
are based on approved rates for each facility that are either based on
current costs with retroactive settlements or prospective rates with no
cost settlement. Amounts earned under federal and state programs with
respect to nursing home patients are subject to review by the third-party
payors. Final cost settlements, if any, are recorded when objectively
determinable, generally within three years of the close of a reimbursement
year depending upon the timing of appeals and third-party settlement
reviews or audits. Contractual adjustments for revenues earned from
federal and state programs amounted to $20,727,000, $54,618,000 and
$38,245,000 for 1999, 1998 and 1997, respectively.

MANAGEMENT FEES - Under its management agreements, the Company has
responsibility for the day-to-day operation and management of each of its
managed facilities. The Company typically receives a base management fee
ranging generally from 3.5% to 6.0% of net revenues of each managed
facility. Other than certain corporate and regional overhead costs, the
services provided at the facility are at the facility owner's expense. The
facility

F-9
<PAGE> 65

owner also is obligated to pay for all required capital expenditures. The
Company generally is not required to advance funds to the owner. Other
than with respect to facilities managed during insolvency or receivership
situations, the Company's management fees are generally subordinated to
the debt payments of the facilities it manages. In addition, the Company
is generally eligible to receive incentives over and above its base
management fees based on the profits at these facilities. Approximately
91.0% of 1999 management fee revenues were derived from agreements that
expire beginning in 2001 through 2015. The remaining management agreements
have remaining lives that expire or are cancelable at various times during
2000.

LEASE EXPENSE

The Company operates 61 long-term care facilities under operating leases,
including 30 owned by Omega Healthcare Investors, Inc. ("Omega"), 11 owned
by Counsel Corporation (together with its affiliates, "Counsel"), 13 owned
by members or affiliates of Pierce Management Group ("Pierce") and seven
owned by other parties. The Company's operating leases generally require
the Company to pay stated rent, subject to increases based on changes in
the Consumer Price Index or increases in the net revenues of the leased
properties. The Company's leases are "triple-net," requiring the Company
to maintain the premises, pay taxes, and pay for all utilities. The
Company generally grants its lessor a security interest in the Company's
personal property located at the leased facility. The leases generally
require the Company to maintain a minimum tangible net worth and prohibit
the Company from operating any additional facilities within a certain
radius of each leased facility. The Company is generally required to
maintain comprehensive insurance covering the facilities it leases as well
as personal and real property damage insurance and professional
malpractice insurance. The failure to pay rentals within a specified
period or to comply with the required operating and financial covenants
generally constitutes a default, which default, if uncured, permits the
lessor to terminate the lease. The Company's interest in the premises is
subordinated to that of the lessor's lenders. See Note 13 for discussion
of the Company's non-compliance with the financial covenants applicable
to lease agreements covering a majority of its United States nursing
facilities.

CLASSIFICATION OF EXPENSES

The Company classifies all expenses (except interest, depreciation and
amortization, and lease expenses) that are associated with its corporate
and regional management support functions as general and administrative
expenses. All other expenses (except interest, depreciation and
amortization, and lease expenses) that are incurred by the Company at the
facility level are classified as operating expenses.

PROVISION FOR DOUBTFUL ACCOUNTS

The Company includes provisions for doubtful accounts in operating
expenses in its consolidated statements of operations. The provisions for
doubtful accounts were $7,037,000, $2,306,000 and $2,030,000 for 1999,
1998 and 1997, respectively.

F-10
<PAGE> 66

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost with depreciation being
provided over the shorter of the remaining lease term (where applicable)
or the assets' estimated useful lives on the straight-line basis as
follows:

Buildings and leasehold improvements - 10 to 40 years
Furniture and equipment - 2 to 15 years
Vehicles - 5 years

Interest incurred during construction periods is capitalized as part of
the building cost. Maintenance and repairs are charged against income as
incurred, and major betterments and improvements are capitalized. Property
and equipment obtained through purchase acquisitions are stated at their
estimated fair value determined on the respective dates of acquisition.

The Company utilizes Statement of Financial Accounting Standards ("SFAS")
No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed of." In accordance with SFAS No. 121, the
Company evaluates the carrying value of its properties in light of each
property's projected cash flows from operations.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents include cash on deposit with banks and all
highly liquid investments with original maturities of three months or
less.

INVENTORIES

Inventory is recorded at the lower of cost or net realizable value, with
cost being determined principally on the first-in, first-out basis.

DEFERRED FINANCING AND OTHER COSTS

Financing costs are amortized over the term of the related debt.

Effective January 1, 1999, the Company adopted Statement of Position
("SOP") 98-5, "Reporting on the Costs of Start-Up Activities." SOP 98-5
requires that the cost of start-up activities be expensed as they are
incurred. Start-up activities include one-time activities and organization
costs. As a result of adoption, the Company recorded a charge to income of
$433,000 ($277,000 net of tax), which is reported as the cumulative effect
of a change in accounting principle in the accompanying 1999 consolidated
statement of operations.

INCOME TAXES

The Company utilizes SFAS No. 109, "Accounting for Income Taxes," for the
financial reporting of income taxes, which generally requires the Company
to record deferred income taxes for the differences between book and tax
bases in its assets and liabilities. Income taxes have been provided for
all items included in the statements of operations, regardless of the
period when such items will be deductible for tax purposes. The principal
temporary differences between financial and tax reporting arise from
depreciation and from reserves that are not currently deductible, as well
as the timing of the recognition of gains on sales of assets. See Note 12
for discussion of the 1999 write-off of deferred tax assets totaling
$12,802,000, resulting in a 1999 tax provision of $7,605,000.

F-11
<PAGE> 67

DISCLOSURE OF FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses approximate fair value because of
the short-term nature of these accounts. The carrying amount of the
Company's debt approximates fair value because the interest rates
approximate the current rates available to the Company and its individual
facilities.

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses, as well as in the disclosure of
contingent assets and liabilities. Actual results could differ from those
estimates.

FOREIGN OPERATIONS AND TRANSLATION POLICIES

The results of the Canadian operations have been translated at the
respective average rates (for purposes of the consolidated statements of
operations) and respective year-end rates (for purposes of the
consolidated balance sheets).

OTHER COMPREHENSIVE INCOME

The Company has adopted SFAS No. 130, "Reporting on Comprehensive Income,"
which requires the reporting of comprehensive income in addition to net
income from operations. Comprehensive income is a more inclusive financial
reporting methodology that includes disclosure of certain financial
information that historically has not been recognized in the calculation
of net income.

Information with respect to the accumulated other comprehensive income
balance included in retained earnings is as follows:

Foreign Currency Translation Unrealized Losses:

<TABLE>
<CAPTION>
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Beginning balance $(412,000) $(196,000) $ (12,000)
Current period change, net of tax 239,000 (216,000) (184,000)
--------- --------- ---------
Ending balance $(173,000) $(412,000) $(196,000)
========= ========= =========
</TABLE>

EARNINGS PER SHARE

The Company utilizes SFAS No. 128, "Earnings Per Share," for the financial
reporting of earnings per share. Basic earnings per share excludes
dilution and is computed by dividing income available to common
shareholders by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or otherwise resulted in the
issuance of common stock that then shared in the earnings of the Company.
The effect of the Company's potential dilutive securities (primarily stock
options) was anti-dilutive in 1999 and 1998.

F-12
<PAGE> 68

RECLASSIFICATIONS

Certain amounts in the 1998 and 1997 financial statements have been
reclassified to conform with the 1999 presentation.

NEW ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 133 establishes accounting and reporting standards
requiring that every derivative instrument be recorded in the balance
sheet as either an asset or liability measured at its fair value. SFAS No.
133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met.
SFAS No. 133, as amended by SFAS No. 137, "Deferral of the Effective Date
of SFAS No. 133," is effective for fiscal quarters beginning after June
15, 2000. The impact of the adoptions of SFAS No. 133 is not expected to
have a material impact on the Company's results of operations or financial
position.

3. RECEIVABLES

Accounts receivable, before allowances, consists of the following
components:

<TABLE>
<CAPTION>
December 31,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Medicare $ 5,800,000 $10,809,000
Medicaid and other non-federal programs 5,716,000 10,614,000
Other patient and resident receivables 4,264,000 6,868,000
Management fees - affiliates 309,000 354,000
Management fees 103,000 32,000
Other receivables and advances 485,000 262,000
----------- -----------
$16,677,000 $28,939,000
=========== ===========

</TABLE>

The Company generally provides patient and resident services and manages
health care facilities primarily located in the southeastern United States
and three provinces in Canada.

The Company provides credit for a substantial portion of its revenues and
continually monitors the credit-worthiness and collectibility from its
clients, including proper documentation of third-party coverage.

The Company is subject to accounting losses from uncollectible receivables
in excess of its reserves.

F-13
<PAGE> 69

4. ACQUISITIONS

Effective October 1, 1997, the Company completed the acquisition or lease
of 29 assisted living facilities from Pierce. The Company purchased 15
facilities with 1,093 units and entered into leases on the remaining 14
facilities with 1,209 units. The aggregate purchase price was
approximately $34,148,000, which includes related costs of the
acquisition. To fund the Pierce acquisition, the Company issued
$34,100,000 in new debt. Rather than redevelop certain of the purchased
properties as originally planned, the Company has since elected to sell
two facilities with 139 units and is evaluating ongoing offers for the
properties.

In addition, the Company acquired two Canadian assisted living facilities
on October 1, 1997. Immediately prior to the acquisitions, the Company had
managed these facilities, which total 125 units, during receivership
proceedings. The combined purchase price was approximately $2,317,000
($3,200,000 Canadian), which was funded by internal sources and the
issuance by the Company's principal Canadian lender of 10-year term loans
totaling $2,029,000 ($2,800,000 Canadian).

5. SALE/LEASEBACK OF FACILITIES

Effective August 14, 1992, the Company entered into an agreement with
Omega whereby 21 of the Company's facilities were sold to Omega and leased
back to the Company under a master lease agreement (the "Master Lease").
In addition, the Company entered into a participating mortgage (the
"Participating Mortgage") with Omega on three other facilities. The net
gain on the sale/leaseback was deferred in accordance with sale/leaseback
accounting. The Company is amortizing the deferred gain over 20 years,
which is the initial lease term and the renewal period. The net deferred
gain totaled $3,047,000 as of December 31, 1999. Amortization of the
deferred gain totaled $246,000 for each of 1999, 1998 and 1997 and is
included as a decrease to lease expense in the accompanying consolidated
statements of operations.

6. SALE OF TEXAS HOMES

In 1991, the Company sold six of its Texas nursing homes to Texas
Diversicare Limited Partnership ("TDLP") for a sales price of
approximately $13,137,000. Total consideration for the sale in 1991
included a $7,500,000 wrap mortgage receivable from TDLP and $4,370,000
cash. Underlying the wrap mortgage receivable is a note payable to a bank
by the Company of $1,895,000 as of December 31, 1999. The TDLP properties
are collateral for this debt.

Under a repurchase agreement, the Company has agreed to purchase up to
10.0% of the partnership units per year, beginning in January 1997 (up to
a maximum of 50.0% of the total partnership units) through January 2001.
The purchase of the partnership units is upon demand from the limited
partners and the 10.0% maximum per year is not cumulative. The repurchase
price is the original cash sales price per unit less certain amounts based
on the depreciation from 1991 to the December 31 prior to the date of
repurchase. No units were put to the Company for repurchase in January
2000. However, pursuant to its repurchase obligation, the Company has
purchased a cumulative total of 22.6% through December 31, 1999. Total
consideration for these purchases was

F-14
<PAGE> 70

$1,444,000. Units acquired pursuant to the repurchase agreement do not
have voting rights with respect to any matters coming before the limited
partners of TDLP.

As part of the TDLP transaction, the Company has guaranteed certain cash
flow requirements of TDLP for a ten-year period through August 2001. As of
December 31, 1999, the Company has provided working capital funding and
requirements under the cash flow guarantee to TDLP totaling $5,590,000.

Because of the guaranteed financial requirements to the TDLP partners, the
Company is accounting for this transaction under the leasing method of
accounting under SFAS No. 66. Under this method, the Company has not
recorded a sale of the assets. The cash received from TDLP was recorded as
an advance liability, and the wrap mortgage receivable has not been
reflected in the financial statements. The advance liability is adjusted
throughout the year based on mortgage note payments and advances to or
repayments from TDLP. In addition, the Company's consolidated statements
of operations will continue to reflect the operations of the facilities
until the expiration of the Company's commitments with respect to TDLP.

The Company continually evaluates the funding contingencies discussed
above in relation to its guarantees to TDLP, the balance in the advance
liability account, the future wrap mortgage receivable collections, and
the estimated fair value of the related nursing homes. The accounting
treatment under SFAS No. 66 is applicable as long as the Company's
recorded net assets with respect to TDLP are less than the total of the
estimated fair value of the Company's investment in TDLP and the Company's
interest in the wrap mortgage due from TDLP. Based upon management's
evaluation, the Company has recorded a reserve of $3,000,000 for the
estimated impairment of the Company's investment in TDLP. Of the total
reserve, $500,000 was recognized in 1999 and $2,500,000 in 1998. The
reserve has reduced the Company's net assets in TDLP to the estimated
amount of cash to ultimately be realized by the Company from its
investment in TDLP.

The consolidated statements of operations include the recognition of
income and expenses from the TDLP homes since the sale. During 1999, 1998
and 1997, the consolidated statements of operations include TDLP operating
income (loss) before taxes of $(1,739,000), $(287,000) and $123,000,
respectively, which have also been reflected as an adjustment of the
advance liability account.

7. PROPERTY AND EQUIPMENT

Property and equipment, at cost, consists of the following:

<TABLE>
<CAPTION>
December 31,
----------------------------
1999 1998
----------- -----------
<S> <C> <C>
Land $ 5,172,000 $ 5,098,000
Buildings and leasehold improvements 61,863,000 59,629,000
Furniture, fixtures and equipment 20,632,000 19,402,000
----------- -----------
$87,667,000 $84,129,000
=========== ===========

</TABLE>

Substantially all of the Company's gross property and equipment is
security for debt obligations.

F-15
<PAGE> 71

8. INVESTMENTS IN AND RECEIVABLES FROM JOINT VENTURES

Investments in and receivables from joint ventures consist of the
following:

December 31,
--------------------------
1999 1998
---------- ----------
Investments $3,567,000 $3,528,000
Receivables 4,148,000 3,666,000
Note receivable 411,000 --
---------- ----------
$8,126,000 $7,194,000
========== ==========

The investments consist primarily of investments in joint ventures
operating long-term care facilities in Canada and Texas. The investments
are accounted for on the equity or cost method, as applicable. Receivables
represent management fees receivable from TDLP. The note receivable
represents a loan to a joint venture project located in Canada and is
secured by a second mortgage on the facility. The note receivable accrues
interest at 6% with the entire balance due in 2002.

9. LONG-TERM DEBT

Long-term debt consists of the following:

<TABLE>
<CAPTION>
December 31,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Mortgages payable to a commercial finance company; secured
by 13 assisted living properties; interest payable
monthly at 2.35% above LIBOR (8.17% at December 31, 1999);
balloon maturity in July 2002 $ 25,080,000 $ --

Acquisition line of credit payable to a commercial finance company;
secured by four nursing homes; interest payable monthly at
2.75% above LIBOR (8.57% at December 31, 1999); balloon
maturity in April 2000 11,100,000 11,100,000

Working capital line of credit payable to a bank; secured by certain
accounts receivable and substantially all other Company assets;
interest payable monthly at either 14.00% or 2.50% above LIBOR or the
bank's Index rate (at December 31, 1999: $3,500,000 at 14.00% and
$924,000 at 8.97%, respectively); matured on February 28, 2000;
negotiations underway with lender 4,424,000 8,112,000

</TABLE>

F-16
<PAGE> 72

<TABLE>
<CAPTION>
December 31,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>

Promissory note payable to a bank secured by secondary
interests in certain Company assets; interest payable
monthly at 12.00%; matured on February 28, 2000;
negotiations underway with lender; reduction refinanced in
1999 through issuance of mortgages payable $ 9,412,000 $ 34,100,000

Mortgage payable to a bank; secured by the six TDLP nursing homes;
interest and principal payable monthly, interest at 8.00%;
balloon maturity in August 2001 1,895,000 2,572,000

Mortgages payable to a Canadian bank; secured by two nursing homes and
three assisted living facilities; interest and principal payable
monthly; interest ranging from 6.34% to 7.89%; balloon maturities
December 2004 through October 2007 5,421,000 5,201,000

Reducing demand loan payable to a Canadian bank; secured by pledgable
security interest in Canadian operations; principal of approximately
$17,000 and interest payable monthly; interest at bank prime rate plus
0.25% (6.50% at December 31, 1999); matures in December 2004 1,038,000 --

Mortgage payable to a bank; secured by one nursing home; interest and
principal payable monthly; interest at the lending bank's base rate
plus 0.75% (8.50% at December 31, 1999); balloon maturity in August
2001 2,396,000 2,393,000

Mortgages payable to two banks; secured by second interests
in the nursing home referred to immediately above;
interest and principal payable monthly; interest at the lead bank's
base rate plus 0.75% (8.50% at December 31, 1999); balloon maturity
in August 2001 159,000 162,000
------------ ------------

60,925,000 63,640,000
Less current portion (53,098,000) (30,126,000)
------------ ------------
$ 7,827,000 $ 33,514,000
============ ============

</TABLE>

F-17
<PAGE> 73

Scheduled principal payments for the Company of long-term debt (assuming
no accelerations by the lenders) for the next five years and thereafter
beginning January 1, 2000, are as follows:

2000 $27,195,000
2001 4,152,000
2002 24,497,000
2003 129,000
2004 1,181,000
Thereafter 3,771,000
-----------
$60,925,000
===========

As of December 31, 1999, the Company's weighted average interest rate was
9.1%.

Certain of the Company's loan agreements contain various financial
covenants, the most restrictive of which relate to net worth, cash flow,
debt-to-equity ratio requirements, and limits on the payment of dividends
to shareholders. As of December 31, 1999, the Company was not in
compliance with the covenants. Cross-default or material adverse change
provisions contained in the agreements allow the holders of substantially
all of the Company's debt to demand repayment. The Company has not
obtained waivers of the non-compliance. Based on regularly scheduled debt
service requirements, the Company has a total of $27,195,000 of debt that
must be repaid or refinanced within the next 12 months. However, as a
result of the covenant noncompliance and other cross-default provisions,
the Company has classified a total of $53,098,000 of debt as current
liabilities as of December 31, 1999. The Company would not be able to
repay this portion of its indebtedness if the applicable lenders demanded
repayment. Additionally, the Company does not currently have refinancing
or other sources of funds available to service the current maturities in
2000.

The promissory note payable to a bank had an original indebtedness of
$34,100,000. It was used to fund the purchase of the Company's North
Carolina assisted living operations, which purchase closed on September
30, 1997. With the application of the net proceeds from new mortgages
payable in 1999, the balance of the promissory note was reduced to
$9,412,000. Prior to the principal reduction, the promissory note had a
maturity date of July 1, 1999, carried interest at LIBOR plus 3.0% and had
a restriction against pledging the North Carolina assets as collateral
with any other lender. With the reduction in the principal balance, the
Company and its lenders agreed to modify the terms of the promissory note
by extending the stated maturity date, increasing the interest rate to
12.0% fixed and providing certain security interests to the lenders. The
security interests include two non-operating properties in North Carolina
and the Company's limited partnership interests in TDLP, and the Company
has agreed to apply against the promissory note indebtedness any net
proceeds realized from the sale of the collateral comprising the
additional security interests. The promissory note matured February 28,
2000, but has not been called due by the lender. The Company and the
lender are currently negotiating alterations to the status of the
promissory note.

As of December 31, 1999, the Company had drawn $924,000, had $5,537,000 of
letters of credit outstanding, and had $1,929,000 remaining borrowing
capability under its working capital line of credit. The interest rate
applicable at December 31, 1999, was 8.97%. The working capital line of
credit matured December 1, 1999, but was not called, and it carries a
current extended maturity date of February 28, 2000. A further extension
of the existing agreement or a replacement working capital line of credit
is currently being negotiated with the existing bank lender.

F-18
<PAGE> 74

Since early 1998, the Company's bank lender has provided additional line
of credit availability (the "Overline"). Availability under the Overline
began at $1,250,000 and was increased over time to its maximum level of
$4,000,000. Subsequently, the availability was reduced to its existing
outstanding balance of $3,500,000. Since April 14, 1999, the Overline has
carried interest at 14.0% but was otherwise subject to the same terms and
conditions as the Company's working capital line of credit. Maturity of
the Overline had been scheduled for July 1, 1999. However, coincident with
the changes with respect to the promissory note, the lender agreed to
revised terms with respect to the Overline. These revisions extended the
maturity date, provided for increased reporting responsibility to the
lender, and cooperation, if requested by the lender, in the completion of
an audit of the Company's accounts receivable. In addition, the Company
has provided, with respect to certain available assets, first and second
secured positions in certain assets in favor of the lender. The Overline
matured on February 28, 2000, and it is included in the ongoing
negotiations between the Company and the lender. Given that events of
default under the Company's working capital line of credit, there can be
no assurance that the respective lender will continue to provide working
capital advances.

In 1999, the Company secured a credit agreement with a bank to support its
Canadian operations. The Company obtained a $1,038,000 ($1,500,000
Canadian) loan. This loan is a reducing demand loan with scheduled monthly
payments aggregating $208,000 ($300,000 Canadian) annually. The loan
agreement includes a second facility for working capital loans up to
$692,000 ($1,000,000 Canadian). The Company had no working capital draws
outstanding under this facility at December 31, 1999.

With respect to the promissory note, the working capital line of credit,
and the Overline, the Company is currently negotiating with the existing
lender to further restructure the terms, including further extension of
their maturity dates. The Company expects to repay a portion of this debt
through various means such as the sale of certain assets, refinancing
mortgage debt, securing additional equity investments, and through cash
generated from operations. The Company expects to repay the $1,038,000
reducing demand loan and certain other miscellaneous current maturities of
$1,220,000 with cash generated from operations. Management is hopeful that
it will be successful in restructuring the Company's debt as described.
However, there can be no assurance that the Company's restructuring
efforts will be successful.

F-19
<PAGE> 75

10. SHAREHOLDERS' EQUITY AND STOCK PLANS

SHAREHOLDERS' RIGHTS PLAN

In 1995, the Company adopted a shareholders' rights plan (the "Plan"). The
Plan is designed to protect the Company's shareholders from unfair or
coercive takeover tactics. The rights under the Plan were effective for
all shareholders of record at the close of business March 20, 1995, and
thereafter and exist for a term of ten years. The Plan, as amended
December 7, 1998, provides for one right with respect to each share of
common stock. Each right entitles the holder to acquire, at a 50.0%
discount from the then-current market, $100 worth of common stock of the
Company or that of a non-approved acquiring company. The rights may be
exercised only upon the occurrence of certain triggering events, including
the acquisition of, or a tender offer for, 15.0% or more of the Company's
common stock without the Company's prior approval.

STOCK-BASED COMPENSATION PLANS

In 1994, the Company adopted the 1994 Incentive and Nonqualified Stock
Option Plan for Key Personnel (the "Key Personnel Plan"). Under the Key
Personnel Plan, as amended in May 1998, 1,060,000 shares of common stock
have been reserved for issuance upon exercise of options granted
thereunder.

In 1994, the Company adopted the 1994 Nonqualified Stock Option Plan for
the Directors (the "Director Plan"). Under the Director Plan, as amended
in May 1996, 190,000 shares of common stock have been reserved for
issuance upon exercise of options granted thereunder.

Under both plans, the option exercise price equals the stock's closing
market price on the day prior to the grant date. The maximum term of any
option granted pursuant to either the Key Personnel Plan or to the
Director Plan is ten years. Options issued under either plan are one-third
vested at the grant date with an additional one-third vesting on each of
the next two anniversaries of the grant date. Shares subject to options
granted under either plan that expire, terminate, or are canceled without
having been exercised in full become available again for future grants.

In 1994, the Company adopted the 1994 Employee Stock Purchase Plan and
reserved 250,000 shares for issuance under the plan. Employees may
purchase stock, subject to certain limitations, at 85% of the lower of the
closing market price at the beginning or at the end of each plan year. The
plan year begins July 1 and ends the following June 30. In July 1999, 1998
and 1997, there were 93,000, 22,000 and 17,000 shares, respectively,
issued pursuant to this plan. The fair value of shares sold under the plan
was $1.94, $6.87, and $9.50 in 1999, 1998 and 1997, respectively.

The Company accounts for these plans under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," under which no
compensation cost has been recognized. Had compensation cost for these

F-20
<PAGE> 76

plans been determined consistent with SFAS No. 123, "Accounting for
Stock-Based Compensation," the Company's net income (loss) and earnings
(loss) per share would have been reduced to the following pro forma
amounts:

<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Net Income (Loss):
As reported $ (21,676,000) $ (3,083,000) $ 3,013,000
------------- ------------- -------------
Pro forma $ 22,705,000 $ (3,541,000) $ 2,813,000
------------- ------------- -------------

Basic Earnings (Loss) Per Share:
As reported $ (3.98) $ (.57) $ .56
------------- ------------- -------------
Pro forma $ (4.17) $ (.66) $ .53
------------- ------------- -------------

Diluted Earnings (Loss) Per Share:
As reported $ (3.98) $ (.57) $ .56
------------- ------------- -------------
Pro forma $ (4.17) $ (.66) $ .52
------------- ------------- -------------

</TABLE>

Because the provisions of SFAS No. 123 have not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years.

Summarized activity of the stock option plans is presented below:

<TABLE>
<CAPTION>
Shares
-----------------------
Key Weighted
Personnel Director Average
Plan Plan Exercise Price
--------- -------- --------------
<S> <C> <C> <C>
Outstanding,
December 31, 1996 511,000 116,000 $ 9.71
Issued 39,000 21,000 9.88
Exercised (44,000) -- 9.67
Expired or canceled (22,000) (26,000) 10.19
------- ------- --------

Outstanding,
December 31, 1997 484,000 111,000 9.69
Issued 196,000 6,000 9.76
Expired or canceled (33,000) -- 9.81
------- ------- --------

Outstanding,
December 31, 1998 647,000 117,000 9.71
Issued 210,000 5,000 1.78
Expired or canceled (16,000) -- 9.56
------- ------- --------

Outstanding,
December 31, 1999 841,000 122,000 $ 7.94
======= ======= ========

Vested, December 31, 1999 640,000 117,000 $ 8.94
======= ======= ========

Available for future grants,
December 31, 1999 163,000 58,000
======= =======

</TABLE>

F-21
<PAGE> 77

The outstanding options have exercise prices ranging from $0.15 to $13.13
and have a weighted average remaining life of 5.1 years. The weighted
average fair value of options granted was $1.78, $4.62 and $4.20 in
1999, 1998 and 1997, respectively.

The fair value of each option is estimated on the grant date using the
Black-Scholes option pricing model with the following weighted-average
assumptions used for the 1999, 1998, and 1997 grants: risk free interest
rates ranging from 5.9% to 6.5% for 1999, 5.0% to 5.7% for 1998 and from
5.7% to 6.2% for 1997; no expected dividend yield for each of the years;
expected lives of five years for each of the years; and, expected
volatility of 118.2% for 1999, 44.4% for 1998 and 7.2% for 1997.

PREFERRED STOCK

The Company is authorized to issue up to 1,000,000 shares of preferred
stock. The Company's Board of Directors is authorized to establish the
terms and rights of each series, including the voting powers,
designations, preferences, and other special rights, qualifications,
limitations, or restrictions thereof.

11. EARNINGS (LOSS) PER SHARE

Information with respect to the calculation of basic and diluted (loss)
earnings per share data is presented below:

<TABLE>
<CAPTION>
Net Earnings
Income (Loss)
(Loss) Shares Per Share
------------- ------------ ------------
<S> <C> <C> <C>
Year ended December 31, 1999:
Basic earnings (loss) per share $(21,676,000) 5,445,000 $ (3.98)
============
Employee stock purchase plan -- --
Options -- --
------------ ------------
Diluted earnings (loss) per share $(21,676,000) 5,445,000 $ (3.98)
============ ============ ============

Year ended December 31, 1998:
Basic earnings (loss) per share $ (3,083,000) 5,388,000 $ (.57)
============
Employee stock purchase plan -- --
Options -- --
------------ ------------
Diluted earnings (loss) per share $ (3,083,000) 5,388,000 $ (.57)
============ ============ ============

Year ended December 31, 1997:
Basic earnings (loss) per share $ 3,013,000 5,339,000 $ .56
============
Employee stock purchase plan -- 9,000
Options -- 25,000
------------ ------------
Diluted earnings (loss) per share $ 3,013,000 5,373,000 $ .56
============ ============ ============

</TABLE>

F-22
<PAGE> 78

For each period presented, the Company had options outstanding at prices
in excess of the average market price of the Company's common stock. Such
options were excluded from the computation because to include them would
have been antidilutive. In addition, in years in which the Company
reported a net loss, options that would have otherwise qualified for
inclusion, were excluded from the computation of earnings per share
because of anti-dilution.

12. INCOME TAXES

The provision (benefit) for income tax is composed of the following
components:

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Current payable (benefit):
Federal $ (528,000) $ (557,000) $ (823,000)
State and province 76,000 488,000 386,000
------------ ------------ ------------
(452,000) (89,000) (437,000)
------------ ------------ ------------

Deferred taxes:
Federal 5,952,000 (1,405,000) 1,941,000
State and province 2,105,000 (240,000) 190,000
------------ ------------ ------------
8,057,000 (1,645,000) 2,131,000
------------ ------------ ------------
Provision (benefit) for income taxes $ 7,605,000 $ (1,734,000) $ 1,694,000
============ ============ ============

</TABLE>

A reconciliation of taxes computed at statutory income tax rates is as
follows:

<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------------------
1999 1998 1997
------------ ------------ ------------
<S> <C> <C> <C>
Provision (benefit) for federal
income taxes at statutory
rates $ (4,837,000) $ (1,638,000) $ 1,600,000
Provision (benefit) for state
and province income taxes at
statutory rates (569,000) (193,000) 118,000
Increase in valuation
allowance 12,802,000 -- --
Other 209,000 97,000 (24,000)
------------ ------------ ------------
Provision (benefit) for income taxes $ 7,605,000 $ (1,734,000) $ 1,694,000
============ ============ ============

</TABLE>

F-23
<PAGE> 79

The net deferred tax assets and liabilities, at the respective income tax
rates are as follows:

<TABLE>
<CAPTION>
December 31,
-------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Current deferred asset:
Accrued liabilities $ 2,641,000 $ 1,719,000
Less valuation allowance (2,641,000) --
------------ ------------
Current deferred asset $ -- $ 1,719,000
============ ============
Non-current deferred asset:
Net operating loss $ 6,460,000 $ 1,222,000
Tax gain on sale transactions in excess of
recognized financial reporting gain 1,114,000 1,043,000
Tax goodwill and intangibles 7,918,000 9,170,000
Impairment of TDLP net assets 1,140,000 950,000
Other -- 323,000
------------ ------------
16,632,000 12,708,000
Less valuation allowance (15,661,000) (5,500,000)
------------ ------------
971,000 7,208,000
------------ ------------

Non-current deferred liability:
Deferred costs -- (136,000)
------------ ------------
Depreciation (971,000) (734,000)
------------ ------------
(971,000) (870,000)
------------ ------------
Net non-current deferred asset $ -- $ 6,338,000
============ ============

</TABLE>

Due to the uncertainty surrounding the realization of the future benefits
of the deferred tax assets, the Company increased the valuation allowance
by $12,802,000 during 1999. As a result, all deferred tax assets are fully
reserved as of December 31, 1999.

13. COMMITMENTS AND CONTINGENCIES

LEASE COMMITMENTS

The Company is committed under long-term operating leases with various
expiration dates and varying renewal options. Minimum annual rentals
(exclusive of taxes, insurance, and maintenance costs) under these leases
for the next five years beginning January 1, 2000, are as follows:

2000 $ 21,516,000
2001 22,063,000
2002 22,575,000
2003 22,942,000
2004 22,431,000
Thereafter 217,355,000
------------
$328,882,000
============

Under lease agreements with Omega, Counsel, Pierce and others, the
Company's lease payments are subject to periodic annual escalations as
described in Note 2. Total lease expense was $20,375,000, $19,109,000 and
$15,850,000, for 1999, 1998 and 1997, respectively.

F-24
<PAGE> 80

OMEGA LEASES

The Company's Master Lease with Omega covering 21 facilities provides for
an initial term of ten years through August 2002 and allows the Company
one ten-year renewal option. The Company issued a letter of credit in the
amount of $3,800,000 in favor of Omega as security for its obligations
under the Master Lease. First mortgage revenue bonds of $4,370,000 were
assumed by Omega as of August 14, 1992. The Company remains secondarily
liable for the debt service through maturity of these bonds. Omega has
indemnified the Company for any losses suffered by the Company as a result
of a default by Omega on the bonds. Omega has represented to the Company
that the debt service on the bonds was current as of December 31, 1999.
The Company is leasing from Omega the two facilities mortgaged by these
bonds.

Effective December 1, 1994, the Company entered into a series of
agreements with Omega and a third party. Under the agreements, the Company
leases a total of nine nursing facilities with a total of 805 beds.
Through December 31, 1998, the Company had executed formal lease
agreements with respect to five of the nine facilities. Formal lease
agreements with respect to the remaining four facilities were executed in
March 1999. Prior to the completion of the formal lease agreements, each
of the nine facilities were managed by the Company. Under the management
agreements, the Company was responsible for the operating assets and
liabilities of the facilities and received a management fee equal to the
net profits of the facilities. The Company accounted for these nine
properties as operating leases in anticipation of the completion of formal
lease agreements. The initial lease period for the nine facilities will be
ten years with two five-year renewal options at the Company's option. The
Company deposited $300,000 with Omega and issued a letter of credit in the
amount of $1,150,000 in favor of Omega as security interests for its
obligations under these leases.

Under the terms of the Master Lease, the Company must comply with certain
covenants based on total shareholders' equity of the Company as defined.
The Company was not in compliance with these covenants as of December 31,
1999. As a result of the non-compliance, Omega has the right to terminate
all of its leases with the Company and seek recovery of any related
financial losses, among other things. The Company has not obtained waivers
of the non-compliance. The Company and Omega are currently in negotiations
with respect to modification of the existing lease agreements.

COUNSEL LEASES

The Company leases five facilities from Counsel with a remaining term
expiring in April 2004. With respect to these facilities, the Company has
a right of first refusal and a purchase option at the end of the lease
term.

The Company leases three additional facilities from Counsel with an
initial term of ten years through April 2004 and one ten-year renewal
option. With respect to these facilities, the Company has the right of
first refusal and a purchase option at the end of the lease term.

The Company leases three additional facilities from Counsel with a lease
term through August 2002. At the end of the lease term, the Company has
the right to purchase these facilities. In addition, the Company can
require Counsel to transfer these facilities to Omega, at which time the
Company has the right to lease these facilities from Omega in accordance
with the terms of the Master Lease.

F-25
<PAGE> 81

PIERCE LEASES

The Company acquired leases with respect to 14 facilities as part of the
Pierce transaction. Of these leases, 12 are with the former principal
owners of Pierce and have an initial term of 15 years through September
2012 and two five-year renewal options. Beginning at the fifth
anniversary, the Company has a right to purchase all twelve facilities as
a group for their fair market value. An additional sublease, which expires
in 2003, is with an affiliate of Pierce who is a current employee of the
Company. The remaining lease is a sublease that expires in 2017.

INSURANCE MATTERS

The entire United States long-term care industry has seen a dramatic
increase in personal injury/wrongful death claims based on alleged
negligence by nursing homes and their employees in providing care to
patients and residents. As a result, the Company has numerous liability
claims and disputes outstanding for professional liability and other
related issues. Professional liability insurance up to certain limits is
carried by the Company and its subsidiaries for coverage of such claims.
However, due to the increasing number of claims against the Company and
throughout the long-term care industry, the Company's professional
liability insurance premiums and deductible amounts have increased
substantially during 1998 and 1999. Additional increases in premiums and
deductibles will also occur for the policy year 2000.

As of March 9, 2000, all of the Company's professional liability policies
are currently on a claims made basis and are renewable annually. Prior to
March 9, 2000, all of these policies were on an occurrence basis. The
Company currently maintains general and professional liability insurance
with coverage limits of $1,000,000 per medical incident, aggregate
coverage limits of $3,000,000 per location and total aggregate policy
coverage limits of $12,000,000 for its long-term care services. Through
December 31, 1997, with respect to a majority of its United States nursing
homes, the Company was self-insured for the first $25,000 per occurrence
and $500,000 in the aggregate. Effective January 1, 1998, the Company
substantially increased the self-insurance portion of its liability with
respect to its United States nursing home operations up to $250,000 per
occurrence and $2,500,000 in the aggregate per year. Effective February 1,
1999, all United States nursing homes became part of the
$250,000/$2,500,000 deductible program, including the six TDLP facilities.
For 1999 and 1998, the Company expects to ultimately fully incur the
aggregate deductible amount. A reserve has been established in
anticipation of the settlement of the 1999 and 1998 claims, which may take
up to four years from the date of the injury event to reach final
settlement.

Effective March 9, 2000, the self-insured per claim amount for all United
States nursing homes increased to $500,000 per claim with no aggregate
limit. The Company also maintains umbrella liability coverage of
$15,000,000 per occurrence for all United States facilities.

The assisted living operations acquired in the Pierce transaction are
self-insured, with respect to each location, for the first $5,000 per
occurrence and $25,000 in the aggregate. The Company also maintains a
$10,000,000 aggregate umbrella liability policy for claims in excess of
the foregoing limits for these assisted living operations.

F-26
<PAGE> 82

The Canadian facilities owned or leased by the Company maintain general
and professional liability insurance with per claim coverage limits of up
to $3,462,000 ($5,000,000 Canadian). The Company also maintains an
aggregate umbrella policy for claims in excess of the above limit for
these facilities.

The ultimate results of the Company's professional liability claims and
disputes are unknown at the present time. However, management is currently
of the opinion that there would be no material amounts in excess of
liability coverage and established reserves.

With respect to workers' compensation insurance, substantially all of the
Company's employees became covered under either an indemnity insurance
plan or state-sponsored programs in May 1997. Prior to that time, the
Company was self-insured for the first $250,000, on a per claim basis, for
workers' compensation claims in a majority of its United States nursing
facilities. The Company has been and remains a non-subscriber to the Texas
workers' compensation system and is, therefore, completely self-insured
for employee injuries with respect to its Texas operations. The Company
has provided reserves for the settlement of outstanding self-insured
claims at amounts believed to be adequate as of December 31, 1999. The
differences between actual settlements and reserves are included in
expense in the year finalized.

The Company is self-insured for health insurance benefits for certain
employees and dependents for amounts up to $125,000 per individual
annually. In the current policy year, expected claims under this program
are approximately $2,800,000, and the Company has secured stop-loss
insurance coverage for claims in excess of approximately $3,700,000. The
Company provides reserves for the settlement of outstanding self-insured
health claims at amounts believed to be adequate. The differences between
actual settlements and reserves are included in expense in the year
finalized.

EMPLOYMENT AGREEMENTS

The Company has employment agreements with certain members of management
that provide for the payment to these members of amounts up to 2.5 times
their annual base salary in the event of a termination without cause, a
constructive discharge (as defined), or upon a change in control of the
Company (as defined). The maximum contingent liability under these
agreements is approximately $2,000,000. In addition, upon the occurrence
of any triggering event, certain executives may elect to require the
Company to purchase options granted to them for a purchase price equal to
the difference in the event that the fair market value of the Company's
Common Stock at the date of termination exceeds the stated option exercise
price. The terms of such agreements are from one to three years and
automatically renew for one year if not terminated by the employee or the
Company.

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN

The Company established a Supplemental Executive Retirement Plan (the
"SERP") in 1994 to provide retirement benefits for certain officers and
employees of the Company. Under the SERP, participants could defer up to
6.0% of his or her base pay, and the Company made matching contributions
of 100.0% of the amount deferred by each participant. During 1999, the
Company terminated the SERP plan, declared all contributions 100.0% vested
and distributed the funds to the participants.

F-27
<PAGE> 83
HEALTH CARE INDUSTRY

The health care industry is subject to numerous laws and regulations of
federal, state and local governments. These laws and regulations include,
but are not necessarily limited to, matters such as licensure,
accreditation, government health care program participation requirements,
reimbursement for patient services, and Medicare and Medicaid fraud and
abuse. Changes in these laws and regulations, such as reimbursement
policies of Medicare and Medicaid programs as a result of budget cuts by
federal and state governments or other legislative and regulatory actions,
could have a material adverse effect on the Company's consolidated
financial position, results of operations, and cash flows. Future federal
budget legislation and federal and state regulatory changes may negatively
impact the Company.

All of the Company's facilities are required to obtain annual licensure
renewal and are subject to annual surveys and inspections in order to be
certified for participation in the Medicare and Medicaid programs. In
order to maintain their operator's license and their certification for
participation in Medicare and Medicaid programs, the nursing facilities
must meet certain statutory and administrative requirements. These
requirements relate to the condition of the facilities, the adequacy and
condition of the equipment used therein, the quality and adequacy of
personnel, and the quality of medical care. Such requirements are subject
to change. There can be no assurance that, in the future, the Company will
be able to maintain such licenses for its facilities or that the Company
will not be required to expend significant sums in order to do so.

Recently, government activity has increased with respect to investigations
and allegations concerning possible violations by health care providers of
fraud and abuse statutes and regulations. Violations of these laws and
regulations could result in expulsion from government health care programs
together with the imposition of significant fines and penalties, as well
as significant repayments for patient services previously billed.
Management believes that the Company is in compliance with fraud and abuse
laws and regulations as well as other applicable government laws and
regulations. Compliance with such laws and regulations can be subject to
future government review and interpretation as well as regulatory actions
unknown or unasserted at this time.

During 1997 and 1998, the Company experienced certain adverse regulatory
issues with respect to certain facilities, including decertifications from
the Medicare and Medicaid programs. Although the Company did not
experience any facility decertifications in 1999, the Company did
experience the increased regulatory scrutiny that has been exerted on the
industry in the form of increased fines and penalties.

F-28
<PAGE> 84

Medicare therapy allowable cost and fee reductions, the Company estimates
that net operations was negatively impacted in both 1998 and 1999 and will
continue to be negatively impacted beyond 1999 as a result of the changes
brought about under the BBA.

These changes have affected the entire long-term industry. They have
resulted pursuant to the administrative implementation of the guidelines
contained in the BBA. Under the BBA, Medicare expenditures by the Federal
government have been cut approximately 20.0%. This has been a sudden,
drastic blow to the industry. Other providers who relied more heavily on
the provision of services to higher acuity patients have been impacted
more severely than the Company. There have already been several major
bankruptcy filings. Without remediation, the long-term effect on the
industry is expected to be catastrophic. As the impact of these changes
upon both providers and beneficiaries has become known, there has been
growing political awareness of a need to re-examine the drastic cuts that
have been implemented. On November 29, 1999, President Clinton signed into
law a budget agreement that restores over three years $2.7 billion in
Medicare funding. The bill contains several components that become
effective at various times over the three year period. As a result of the
legislation, individual nursing facilities now have the option, for cost
reporting years beginning after December 29, 1999, of continuing under the
current PPS transition formula or adopting the full federal PPS per diem.
In addition, the measure provides a two-year moratorium on the Part B
therapy caps beginning January 1, 2000, and it also provides increases in
the per diems for the care of certain groups of patients. The Company is
continuing to evaluate the impact of the legislation on its operations.
However, the ultimate impact on the Company's operations cannot be
reasonably estimated at this time.

There is also movement that may result in further legislative relief or
the institution of administrative changes that would restore additional
revenues to the U.S. nursing home industry. While such activity is
positive, there is no expectation by management that the current round of
legislative and administrative relief under consideration is sufficient to
restore the economic viability that the industry needs. Current levels of
or further reductions in government spending for long-term health care
would continue to have an adverse effect on the operating results and cash
flows of the Company. The Company will attempt to maximize the revenues
available to it from governmental sources within the changes that have
occurred and will continue to occur under the BBA. In addition, the
Company will attempt to increase revenues from non-governmental sources,
including expansion of its assisted living and Canadian operations to the
extent capital is available to do so, if at all.

While federal regulations do not provide states with grounds to curtail
funding of their Medicaid cost reimbursement programs due to state budget
deficiencies, states have nevertheless curtailed funding in such
circumstances in the past. No assurance can be given that states will not
do so in the future or that the future funding of Medicaid programs will
remain at levels comparable to the present levels. The United States
Supreme Court ruled in 1990 that healthcare providers could use the Boren
Amendment to require states to comply with their legal obligation to
adequately fund Medicaid programs. The BBA repeals the Boren Amendment and
authorizes states to develop their own standards for setting payment
rates. It requires each state to use a public process for establishing
proposed rates whereby the methodologies and justifications used for
setting such rates are available for public review and comment. This
requires facilities to become more involved in the rate setting process
since failure to do so may interfere with a facility's ability to
challenge rates later.

F-29
<PAGE> 85

14. OPERATING SEGMENT INFORMATION

In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related
Information," which was adopted by the Company on January 1, 1998. The
Company has three reportable segments: U.S. nursing homes, U.S. assisted
living facilities, and Canadian operations, which consist of both nursing
home and assisted living services. Management evaluated each of these
segments independently due to the geographic, reimbursement, marketing,
and regulatory differences between the segments. The accounting policies
of these segments are the same as those described in the summary of
significant accounting policies described in Note 2. Management evaluates
performance based on profit or loss from operations before income taxes
not including non-recurring gains and losses and foreign translation gains
and losses. The following information is derived from the Company's
segments' internal financial statements and include information related to
the Company's unallocated corporate revenues and expenses:

F-30
<PAGE> 86

<TABLE>
<CAPTION>
1999 1998 1997
-------------- ------------- -------------
<S> <C> <C> <C>
Net revenues:
U.S. nursing homes $ 138,421,000 $ 164,646,000 $ 161,683,000
U.S. assisted living facilities 28,689,000 25,552,000 6,296,000
Canadian operations 15,029,000 14,950,000 14,248,000
Corporate (121,000) 4,000 16,000
------------- ------------- -------------
Total $ 182,000,000 $ 205,152,000 $ 182,243,000
============= ============= =============

Depreciation and amortization:
U.S. nursing homes $ 2,645,000 $ 2,156,000 $ 2,113,000
U.S. assisted living facilities 1,808,000 1,263,000 306,000
Canadian operations 356,000 348,000 298,000
Corporate 78,000 71,000 106,000
------------- ------------- -------------
Total $ 4,887,000 $ 3,838,000 $ 2,823,000
============= ============= =============

Operating income (loss):
U.S. nursing homes $ (12,314,000) $ (2,321,000) $ 5,185,000
U.S. assisted living facilities (684,000) 708,000 223,000
Canadian operations 1,726,000 1,912,000 1,889,000
Corporate (2,522,000) (5,116,000) (2,590,000)
------------- ------------- -------------
Total $ (13,794,000) $ (4,817,000) $ 4,707,000
============= ============= =============

Long-lived assets:
U.S. nursing homes $ 32,777,000 $ 41,072,000 $ 39,154,000
U.S. assisted living facilities 34,332,000 33,987,000 34,552,000
Canadian operations 12,933,000 10,536,000 9,337,000
Corporate 9,321,000 10,862,000 9,992,000
Eliminations (8,377,000) (8,948,000) (10,704,000)
------------- ------------- -------------
Total $ 80,986,000 $ 87,509,000 $ 82,331,000
============= ============= =============

Total assets:
U.S. nursing homes $ 55,796,000 $ 75,327,000 $ 68,918,000
U.S. assisted living facilities 36,568,000 36,926,000 36,067,000
Canadian operations 16,737,000 13,718,000 14,327,000
Corporate 18,712,000 11,869,000 11,688,000
Eliminations (31,628,000) (16,546,000) (16,039,000)
------------- ------------- -------------
Total $ 96,185,000 $ 121,294,000 $ 114,961,000
============= ============= =============

Capital expenditures:
U.S. nursing homes $ 1,341,000 $ 4,043,000 $ 2,216,000
U.S. assisted living facilities 937,000 688,000 59,000
Canadian operations 1,856,000 422,000 408,000
Corporate 248,000 33,000 27,000
------------- ------------- -------------
Total $ 4,382,000 $ 5,186,000 $ 2,710,000
============= ============= =============

</TABLE>

F-31
<PAGE> 87

15. RELATED PARTIES

The Company commenced operations effective with an initial public offering
of common stock in May 1994. The Company's predecessor operations were in
companies owned or controlled by Counsel. From the Company's inception
through November 1996, the Company had two Directors who are directors and
key executives of Counsel. The Company provides management services for
nine facilities owned by two Canadian limited partnerships. The president
of the general partners of these partnerships is a director and key
executive of Counsel, and Counsel leases seven of these facilities from
one of the partnerships. Management fees from these facilities totaled
$1,805,000, $1,742,000 and $1,814,000 for 1999, 1998 and 1997,
respectively.

The Company has loaned one of the limited partnerships $929,000 and
$1,050,000 as of December 31, 1999 and 1998, respectively. The Company has
received second, third and fourth mortgage security interests in the
partnership's assets. The notes receivable bear interest at 8.0% and are
being repaid over the life of the management contract through December
2005.

Lease expense related to the facilities leased from Counsel totaled
$2,132,000, $2,064,000 and $2,091,000 for the years ended December 31,
1999, 1998 and 1997, respectively.

16. NON-RECURRING CHARGES

During the second and fourth quarters of 1998, the Company recorded
various non-recurring charges totaling $5,859,000. In addition, in the
third quarter of 1999, the Company recorded non-recurring charges of
$500,000. Information with respect to each non-recurring charge is
presented below:

1999 1998
---------- ----------
<S> <C> <C>
Impaired Assets $ 500,000 $2,858,000
MIS Conversion -- 1,166,000
Legal and Contractual Settlements -- 1,276,000
Termination of Proposed Financing
and Acquisition Transactions -- 559,000
---------- ----------
$ 500,000 $5,859,000
========== ==========

</TABLE>

As discussed in Note 6, the Company has recorded total charges of
$3,000,000 ($500,000 in the third quarter of 1999 and $2,500,000 in the
fourth quarter of 1998) for the estimated impairment of the Company's
investment in TDLP due to the continuing funding of certain contractual
cash flow requirements. In addition, in the fourth quarter of 1998,
management identified two locations for which leases would not be renewed
and wrote off the impairment of certain long-lived assets with respect to
these locations, $358,000.

F-32
<PAGE> 88

centralized accounting organization. The related $1,166,000 charge in 1998
represents the write-off of capitalized software costs, costs associated
with the closing of certain regional offices and severance packages of
affected personnel.

During 1998, the Company recorded costs related to certain legal matters
and contractual disputes that were settled, resulting in total charges of
$1,276,000.

During 1998, the Company also wrote off costs associated with terminated
prospective financing and acquisition transactions.

17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Selected quarterly financial information for each of the quarters in the
year ended December 31, 1999 and 1998 is as follows:

<TABLE>
<CAPTION>
Quarter
----------------------------------------------------------------------------
1999 First Second Third Fourth
---- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues $ 46,712,000 $ 44,590,000 $ 44,500,000 $ 46,216,000
============ ============ ============ ============

Net loss $ (983,000)(1) $ (2,606,000) $ (4,217,000)(2) $(13,870,000)(3)
============ ============ ============ ============

Basic and diluted loss per share $ (.18)(1) $ (.48) $ (.77)(2) $ (2.55)(3)
============ ============ ============ ============

</TABLE>

<TABLE>
<CAPTION>
Quarter
----------------------------------------------------------------------------
1998 First Second Third Fourth
---- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues $ 51,493,000 $ 52,698,000 $ 51,305,000 $ 49,656,000
============ ============ ============ ============

Net income (loss) $ 355,000(4) $ (337,000)(4)(5) $ 800,000 $ (3,901,000)(2)(5)
============ ============ ============ ============

Basic and diluted earnings
(loss) per share $ .07(4) $ (.06)(4)(5) $ .15 $ (.72)(2)(5)
============ ============ ============ ============

</TABLE>

- ----------

(1) Includes the write off of certain deferred charges of $277,000, net of
tax, due to mandated change in accounting principle. (See Note 2.)
(2) Includes non-recurring charges primarily related to SFAS No. 121 asset
impairment. (See Note 16.)
(3) Includes the write-off of deferred tax assets totaling $12,802,000. (See
Note 12).
(4) Includes the negative impact resulting from the decertification of two
nursing homes from participation in the Medicare and Medicaid programs.
(5) Includes non-recurring charges primarily related to conversion of
management information systems as well as legal and contractual
settlements. (See Note 16.)

F-33

<PAGE> 89
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Advocat Inc.:

We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Advocat Inc. and subsidiaries, included in
this Annual Report on Form 10-K and have issued our report thereon dated March
21, 2000. Our audit was made for the purpose of forming an opinion on those
statements taken as a whole. The financial statement schedule listed in the
index under Item 16(b) is the responsibility of the Company's management and is
presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements, and, in our opinion, fairly states in all
material respect the financial data required to be set forth therein in relation
to the basic financial statements taken as a whole.

ARTHUR ANDERSEN LLP

Nashville, Tennessee
March 28, 2000

S-1

<PAGE> 90

ADVOCAT INC.

SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)

<TABLE>
<CAPTION>
Column a Column B Column C Column D Column E
- ----------- ------------ ------------------------------------------------ ------------- ------------
Additions
------------------------------------------------
Balance
At Charged Balance
Beginning to Charged At
of Costs and to Other End of
Description Period Expenses Accounts Other Deductions(1) Period
- ----------- ------------ ------------ ------------ ------------ ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Year ended
December 31,
1999:
Allowance
for doubtful
accounts $ 2,650 $ 7,037 $ -- $ 100 $ (4,829) $ 4,958
============ ============ ============ ============ ============ ============

Year ended
December 31,
1998:
Allowance
for doubtful
accounts $ 2,702 $ 2,306 $ -- $ -- $ (2,358) $ 2,650
============ ============ ============ ============ ============ ============

Year ended
December 31,
1997:
Allowance
for doubtful
accounts $ 2,524 $ 2,030 $ -- $ -- $ (1,852) $ 2,702
============ ============ ============ ============ ============ ============

</TABLE>
- ----------

(1) Amounts written off as uncollectible accounts, net of recoveries.

S-2

<PAGE> 91
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
2.1 Asset Purchase Agreement among the Company, Pierce Management
Group First Partnership and others dated July 23, 1997
(incorporated by reference to Exhibit 2 to the Company's
quarterly report on Form 10-Q for the quarter ended June 30,
1997).

3.1 Certificate of Incorporation of the Registrant (incorporated
by reference to Exhibit 3.1 to the Company's Registration
Statement No. 33-76150 on Form S-1).

3.2 Bylaws of the Company (incorporated by reference to Exhibit
3.2 to the Company's Registration Statement No. 33-76150 on
Form S-1).

3.3 Amendment to Certificate of Incorporation dated March 23, 1995
(incorporated by reference to Exhibit A of Exhibit 1 to the
Company's Form 8-A filed March 30, 1995).

4.1 Form of Common Stock Certificate (incorporated by reference to
Exhibit 4 to the Company's Registration Statement No. 33-76150
on Form S-1).

4.2 Rights Agreement dated March 13, 1995, between the Company and
Third National Bank in Nashville (incorporated by reference to
Exhibit 1 to the Company's Current Report on Form 8-K dated
March 13, 1995).

4.3 Summary of Shareholder Rights Plan adopted March 13, 1995
(incorporated by reference to Exhibit B of Exhibit 1 to Form
8-A filed March 30, 1995).

4.4 Rights Agreement of Advocat Inc. dated March 23, 1995
(incorporated by reference to Exhibit 1 to Form 8-A filed
March 30, 1995).

4.5 Amended and Restated Rights Agreement dated as of December 7,
1998 (incorporated by reference to Exhibit 1 to Form 8-A/A
filed December 7, 1998).

10.1 Asset Contribution Agreement among Counsel Corporation and
Certain of its Direct and Indirect Subsidiaries dated May 10,
1994 (incorporated by reference to Exhibit 10.1 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).

10.2 Asset Contribution Agreement among Diversicare Inc. and
Certain of its Direct and Indirect Subsidiaries dated May 10,
1994 (incorporated by reference to Exhibit 10.2 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).
</TABLE>

<PAGE> 92

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.3 1994 Incentive and Non-Qualified Stock Plan for Key Personnel
(incorporated by reference to Exhibit 10.3 to the Company's
Registration Statement No. 33-76150 on Form S-1).

10.4 1994 Non-Qualified Stock Option Plan for Directors
(incorporated by reference to Exhibit 10.4 to the Company's
Registration Statement No. 33-76150 on Form S-1).

10.5 Master Agreement and Supplemental Executive Retirement Plan
(incorporated by reference to Exhibit 10.6 to the Company's
Registration Statement No. 33-76150 on Form S-1).

10.6 1994 Employee Stock Purchase Plan (incorporated by reference
to Exhibit 10.7 to the Company's Registration Statement No.
33-76150 on Form S-1).

10.7 Form of Employment Agreements dated May 10, 1994, between the
Registrant and Dr. Birkett, Mr. Richardson and Ms. Hamlett
(incorporated by reference to Exhibit 10.8 to the Company's
Registration Statement No. 33-76150 on Form S-1).

10.8 Form of Director Indemnification Agreement (incorporated by
reference to Exhibit 10.8 to the Company's Registration
Statement No. 33-76150 on Form S-1).

10.9 Separation Agreement dated as of June 30, 1999, by and between
Mary Margaret Hamlett and the Company (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999).

10.10 Employment Agreement dated June 28, 1999 by and between the
Company and Charles H. Rinne (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999).

10.11 Employment Agreement dated June 28, 1999 by and between the
Company and Richard Vacek (incorporated by reference to
Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1999.

10.12 Master Lease Agreement dated August 14, 1992, between
Diversicare Corporation of America and Omega Healthcare
Investors, Inc. (incorporated
</TABLE>

2
<PAGE> 93

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>

by reference to Exhibit 10.12 to the Company's Registration
Statement No. 33-76150 on Form S-1).

10.13 Consent, Assignment and Amendment Agreement between
Diversicare Corporation of America, Counsel Nursing
Properties, Inc., Advocat Inc., Diversicare Leasing
Corporation and Omega Healthcare Investors, Inc. dated May 10,
1994 (incorporated by reference to Exhibit 10.10 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994).

10.14 Advocat Inc. Guaranty in favor of Omega Healthcare Investors,
Inc. dated May 10, 1994 (incorporated by reference to Exhibit
10.11 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).

10.15 Consolidation, Modification and Renewal Note dated August 30,
1991, by Diversicare Nursing Centers, Inc. to the order of
Sovran Bank/Tennessee (incorporated by reference to Exhibit
10.19 to the Company's Registration Statement No. 33-76150 on
Form S-1).

10.16 Wraparound Promissory Note dated August 30, 1991, by Texas
Diversicare Limited Partnership and Diversicare Nursing
Centers, Inc. (incorporated by reference to Exhibit 10.20 to
the Company's Registration Statement No. 33-76150 on Form
S-1).

10.17 Management Agreement dated August 30, 1991, between Texas
Diversicare Limited Partnership and Diversicare Corporation of
America, as assigned effective October 1, 1991, to Diversicare
Management, with consent of Texas Diversicare Limited
Partnership, as amended (incorporated by reference to Exhibit
10.21 to the Company's Registration Statement No. 33-76150 on
Form S-1).

10.18 Amended and Restated Limited Partnership Agreement dated
August 30, 1991, among Diversicare General Partner, Inc., J.
Scott Jackson and each Limited Partner (incorporated by
reference to Exhibit 10.22 to the Company's Registration
Statement No. 33-76150 on Form S-1).

10.19 Participation Agreement dated August 30, 1991, between Texas
Diversicare Limited Partnership and Diversicare Corporation of
America (incorporated by reference to Exhibit 10.23 to the
Company's Registration Statement No. 33-76150 on Form S-1).
</TABLE>

3
<PAGE> 94

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.20 Agreement of Purchase and Sale entered into August 30, 1991,
among Diversicare Corporation of America, Texas Diversicare
Limited Partnership' and Diversicare Corporation of America
(incorporated by reference to Exhibit 10.25 to the Company's
Registration Statement No. 33-76150 on Form S-1).

10.21 Partnership Services Agreement entered into August 30, 1991,
among Texas Diversicare Limited Partnership, Diversicare
Incorporated and Counsel Property Corporation (incorporated by
reference to Exhibit 10.26 to the Company's Registration
Statement No. 33-76150 on Form S-1).

10.22 Guaranteed Return Loan Security Agreement entered into August
30, 1991, between Texas Diversicare Limited Partnership and
Diversicare Incorporated (incorporated by reference to Exhibit
10.27 to the Company's Registration Statement No. 33-76150 on
Form S-1).

10.23 Credit and Security Agreement dated October 12, 1994, between
NationsBank of Tennessee, N.A., the Company and the Company's
subsidiaries (incorporated by reference to Exhibit 10.20 to
the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1994).

10.24 Promissory Note by Advocat Inc. to the order of Diversicare
Inc. dated May 10, 1994 (incorporated by reference to Exhibit
10.21 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1994).

10.25 Promissory Note by Advocat Inc. to the order of Counsel
Nursing Properties, Inc. dated May 10, 1994 (incorporated by
reference to Exhibit 10.22 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994).

10.26 Demand Master Promissory Note by Advocat Inc. to the order of
Diversicare Corporation of America dated May 10, 1994
(incorporated by reference to Exhibit 10.23 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1994).

10.27 Lease Agreement between Counsel Healthcare Assets Inc. and
Counsel Nursing Properties, Inc. dated May 10, 1994
(incorporated by reference to Exhibit 10.24 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1994).

10.28 Lease Agreement between Counsel Healthcare Assets Inc. and
Counsel Nursing Properties, Inc. dated May 10, 1994
(incorporated by reference to
</TABLE>

4
<PAGE> 95

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
Exhibit 10.25 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1994).

10.29 Management and Guaranteed Return Loan Agreement dated as of
November 30, 1985, between Diversicare VI Limited Partnership
and Diversicare Incorporated, an Ontario corporation, as
amended, as assigned effective October 1, 1991, to Diversicare
Management Services Co., with consent of Diversicare VI
Limited Partnership (incorporated by reference to Exhibit
10.34 to the Company's Registration Statement No. 33-76150 on
Form S-1).

10.30 Management Agreement dated August 24, 1981, between Americare
Corporation and Diversicare Corporation of America, as
assigned to Diversicare Management Services Co., with consent
of Americare Corporation (incorporated by reference to Exhibit
10.36 to the Company's Registration Statement No. 33-76150 on
Form S-1).

10.31 Management Agreement between Counsel Healthcare Assets, Inc.,
an Ontario corporation and Counsel Nursing Properties, Inc.
dated April 30, 1994, as assigned effective May 10, 1994, to
Diversicare Canada Management Services Co., Inc (incorporated
by reference to Exhibit 10.28 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1994).

10.32 Lease Agreement between Spring Hill Medical, Inc. and First
American HealthCare, Inc. dated February 1, 1994 (incorporated
by reference to Exhibit 10.38 to the Company's Registration
Statement No. 33-76150 on Form S-1).

10.33 Lease Agreement, as amended, between Bryson Hill Associates of
Alabama, Inc. and Estates Nursing Homes, Inc. dated June 15,
1984, as assigned effective May 10, 1994, to Diversicare
Leasing Corp. (incorporated by reference to Exhibit 10.39 to
the Company's Registration Statement No. 33-76150 on Form
S-1).

10.34 Lease Agreement between HealthCare Ventures and Wessex Care
Corporation dated October 23, 1989, as assigned effective May
10, 1994, to Diversicare Leasing Corp. (incorporated by
reference to Exhibit 10.40 to the Company's Registration
Statement No. 33-76150 on Form S-1).
</TABLE>

<PAGE> 96

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.35 Lease Agreement between Osborne & Wilson Development Corp.,
Inc. and Diversicare Corporation of America dated July 7,
1989, as assigned effective May 10, 1994, to Diversicare
Leasing Corp. (incorporated by reference to Exhibit 10.41 to
the Company's Registration Statement No. 33-76150 on Form
S-1).

10.36 Florida Lease Agreement between Counsel Nursing Properties,
Inc. and Diversicare Leasing Corp. dated May 10, 1994
(incorporated by reference to Exhibit 10.33 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1994).

10.37 Lease Agreement between Counsel Nursing Properties, Inc. and
Diversicare Leasing Corp. dated May 10, 1994 (incorporated by
reference to Exhibit 10.34 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994).

10.38 Letter Agreement dated November 23, 1994, among Advocat Inc.,
Omega Healthcare Investors, Inc., Sterling Health Care
Centers, Inc. and E.B. Lowman, II (incorporated by reference
to Exhibit 10.36 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994).

10.39 Assignment and Assumption Agreement of Master Lease dated
September 1, 1995, between Sterling Health Care Management,
Inc., Diversicare Leasing Corp. and Sterling Acquisition Corp
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1995).

10.40 Master Lease dated December 1, 1994, between Sterling Health
Care Management, Inc. and Sterling Acquisition Corp
(incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1995).

10.41 Assignment and Assumption Agreement of Master Sublease dated
September 1, 1995, between Sterling Health Care Management,
Inc., Diversicare Leasing Corp. and O S Leasing Company
(incorporated by reference to Exhibit 10.3 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1995).

10.42 Master Sublease dated December 1, 1994, between Sterling
Health Care Management, Inc. and O S Leasing Company
(incorporated by reference to
</TABLE>

<PAGE> 97

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1995).

10.43 Letter of Credit Agreement dated September 1, 1995, between
Omega Health Care Investors, Inc., Sterling Acquisition Corp.,
Sterling Acquisition Corp II, O S Leasing Company and
Diversicare Leasing Corp (incorporated by reference to Exhibit
10.5 to the Company's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 1995).

10.44 Advocat Inc. Guaranty dated September 1, 1995, in favor of
Omega Health Care Investors, Inc., Sterling Acquisition Corp.,
Sterling Acquisition Corp. II and O S Leasing Company
(incorporated by reference to Exhibit 10.6 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1995).

10.45 Management Agreement between Diversicare Management Services
Co. and Emerald-Cedar Hill, Inc. dated February 20, 1996
(incorporated by reference to Exhibit 10.43 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995).

10.46 Management Agreement between Diversicare Management Services
Co. and Emerald-Golfcrest, Inc. dated February 20, 1996
(incorporated by reference to Exhibit 10.44 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995).

10.47 Management Agreement between Diversicare Management Services
Co. and Emerald-Golfview, Inc. dated February 20, 1996
(incorporated by reference to Exhibit 10.45 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995).

10.48 Management Agreement between Diversicare Management Services
Co. and Emerald-Southern Pines, Inc. dated February 20, 1996
(incorporated by reference to Exhibit 10.46 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995).

10.49 Loan Agreement between Omega Healthcare Investors, Inc. and
Diversicare Leasing Corp., d/b/a Good Samaritan Nursing Home,
dated February 20, 1996 (incorporated by reference to Exhibit
10.47 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1995).
</TABLE>

<PAGE> 98

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.50 Short Term Note by Diversicare Leasing Corp. to Omega
Healthcare Investors, Inc. dated February 20, 1996
(incorporated by reference to Exhibit 10.48 to the Company's
Annual Report on Form 10-K for the fiscal year ended December
31, 1995).

10.51 Advocat Inc. Guaranty in favor of Omega Healthcare Investors,
Inc. dated February 20, 1996 (incorporated by reference to
Exhibit 10.49 to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1995).

10.52 First Amendment to Credit and Security Agreement dated
November 28, 1995, between NationsBank of Tennessee, N.A.,
Advocat Inc. and the Subsidiaries (as defined) (incorporated
by reference to Exhibit 10.50 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995).

10.53 Second Amendment to Credit and Security Agreement dated
December 1, 1995, between NationsBank of Tennessee, N.A.,
Advocat Inc. and the Subsidiaries (as defined) (incorporated
by reference to Exhibit 10.51 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995).

10.54 Third Amendment to Credit and Security Agreement dated
December 1, 1995, between NationsBank of Tennessee, N.A.,
Advocat Inc. and the Subsidiaries (as defined) (incorporated
by reference to Exhibit 10.52 to the Company's Annual Report
on Form 10-K for the fiscal year ended December 31, 1995).

10.55 Fourth Amendment to Credit and Security Agreement dated April
1, 1996, between NationsBank of Tennessee, N.A., Advocat Inc.
and the Subsidiaries (as defined) (incorporated by reference
to Exhibit 10.53 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1996).

10.56 Fifth Amendment to Credit and Security Agreement dated May 1,
1996, between NationsBank of Tennessee, N.A., Advocat Inc. and
the Subsidiaries (as defined) (incorporated by reference to
Exhibit 10.54 to the Company's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1996).
</TABLE>

<PAGE> 99

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.57 Sixth Amendment to Credit and Security Agreement dated June
28, 1996, between NationsBank of Tennessee, N.A., Advocat
IInc. and the Subsidiaries (as defined) (incorporated by
reference to Exhibit 10.55 to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 1996).

10.58 Seventh Amendment to Credit and Security Agreement dated
September 1, 1996, between NationsBank of Tennessee, N.A.,
Advocat Inc. and the Subsidiaries (as defined) (incorporated
by reference to Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended September 30,
1996).

10.59 Eighth Amendment to Credit and Security Agreement dated
November 1, 1996, between NationsBank of Tennessee, N.A.,
Advocat Inc. and the Subsidiaries (as defined) (incorporated
by reference to Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q for the quarterly period ended September 30,
1996).

10.60 Master Credit and Security Agreement dated December 27, 1996,
between First American National Bank, GMAC-CM Commercial
Mortgage Corporation, Advocat Inc., Management Services Co.
and the Subsidiaries (as defined) (incorporated by reference
to Exhibit 10.58 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1996).

10.61 Project Loan Agreement (Good Samaritan) dated December 27,
1996, between GMAC-CM Commercial Mortgage Corporation Advocat
Inc., Diversicare Management Services Co. and the Subsidiaries
(as defined) (incorporated by reference to Exhibit 10.59 to
the Company's Annual Report on Form for the fiscal year ended
December 31, 1996).

10.62 Project Loan Agreement (Afton Oaks) dated December 27,
1996between GMAC-CM Commercial Mortgage Corporation, Advocat
Inc., Diversicare Management Services Co. and the Subsidiaries
(as defined) (incorporated by reference Exhibit 10.60 to the
Company's Annual Report on Form for the fiscal year ended
December 31, 1996).

10.63 Project Loan Agreement (Pinedale) dated December 27, 1996,
between GMAC-CM Commercial Mortgage Corporation, Advocat Inc.,
Diversicare Management Services Co. and the Subsidiaries (as
defined) (incorporated by reference Exhibit 10.61 to the
Company's Annual Report on Form for the fiscal year ended
December 31, 1996).
</TABLE>

<PAGE> 100

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.64 Project Loan Agreement (Windsor House) dated December 27 1996,
between GMAC-CM Commercial Mortgage Corporation, Advocat Inc.,
Diversicare Management Services Co. and Subsidiaries (as
defined) (incorporated by reference to Exhibit 10.62 to the
Company's Annual Report on Form for the fiscal year ended
December 31, 1996).

10.65 Asset Purchase Agreement dated November 30, 1995, Williams
Nursing Homes Inc., d/b/a Afton Oaks Center, Lynn Mayers,
Thomas E. Mayers, and Diversicare Leasing Corp. (incorporated
by reference to Exhibit 2.1 the Company's Current Report on
Form 8-K dated November 30, 1995).

10.66 Purchase Agreement between Diversicare Leasing Corporation and
Americare Corporation dated February 20, 1996 (incorporated by
reference to Exhibit 2.2 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1995).

10.67 Amendment to 1994 Incentive and Non-Qualified Stock Plan for
Key Personnel (incorporated by reference to Exhibit A to the
Company's Schedule 14A filed March 31, 1997).

10.68 Amendment to 1994 Non-Qualified Stock Option Plan for
Directors (incorporated by reference to Exhibit A to the
Company's Schedule 14A filed April 19, 1996).

10.69 Amendment No. 3 Advocat Inc. 1994 Incentive and Nonqualified
Stock Option Plan For Key Personnel (incorporated by reference
to Exhibit A to the Company's Schedule 14A filed April 3,
1998).

10.70 Renewal and Modification Promissory Note dated March 31, 1998,
between the Company and AmSouth Bank.(incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 1998).

10.71 Renewal and Modification Promissory Note dated March 31, 1998,
between the Company and First American National Bank
(incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1996).

10.72 Second Amendment to Loan and Negative Pledge Agreement dated
March 31, 1998, between Diversicare Assisted Living Services
NC, LLC and First American National Bank, both individually
and as Agent for AmSouth Bank
</TABLE>

<PAGE> 101

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
(incorporated by reference to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1996).

10.73 Loan Agreement dated the 4th day of June, 1999, by and between
Diversicare Assisted Living Services Nc II, LLC, a Delaware
limited liability company and GMAC Commercial Mortgage
Corporation, a California corporation (incorporated by
reference to Exhibit 10.4 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999).

10.74 Loan Agreement dated the 4th day of June, 1999, by and between
Diversicare Assisted Living Services NC I, LLC, a Delaware
limited liability company and GMAC Commercial Mortgage
Corporation, a California corporation (incorporated by
reference to Exhibit 10.5 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1999).

10.75 Fourth Amendment to Master Credit and Security Agreement dated
as of April 14, 1999 (incorporated by reference to Exhibit
10.6 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999).

10.76 Form of Fifth Amendment to Master Credit and Security
Agreement between Diversicare Management Services Co. and
First American National Bank (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1999).

10.77 Fourth Amendment to Loan and Negative Pledge Agreement dated
October 1, 1999 between Diversicare Assisted Living Services
NC, LLC. and First American National Bank along with AmSouth
Bank (incorporated by reference to Exhibit 10.2 to the
Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999).

10.78 Line of Credit Note (Overline Facility) dated October 1, 1999
between Diversicare Management Services Co. and First American
National Bank (incorporated by reference to Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1999).

10.79 Fifth Amendment to Loan and Negative Pledge Agreement dated
December 1, 1999 between Diversicare Assisted Living Services
PC, LLC and First American National Bank along with AmSouth
Bank (incorporated by reference to Exhibit 10.4 to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1999).
</TABLE>

<PAGE> 102

<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
------ -----------------------
<S> <C>
10.80 Sixth Amendment to Master Credit and Security Agreement dated
December 1, 1999 between Diversicare Management Services Co.
and First American National Bank along with GMAC Commercial
Mortgage Company (incorporated by reference to Exhibit 10.5 to
the Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1999).

10.81 Amendments to Promissory Notes dated November 30, 1999 between
Diversicare Management Services Co. and GMAC Commercial
Mortgage Corporation. (Four amendments extending the term to
April 30, 2000 on four notes totaling $11.1
million.)(incorporated by reference to Exhibit 10.6 to the
Company's Quarterly Report on Form 10-Q/A for the quarter
ended September 30, 1999).

21 Subsidiaries of the Registrant.

23 Consent of Arthur Andersen LLP.

27 Financial Data Schedule (for SEC use only).
</TABLE>

<PAGE> 1

EXHIBIT 21
SUBSIDIARIES

NAME OF CORPORATION STATE OF INCORPORATION
- ------------------- ----------------------

Advocat Ancillary Services, Inc. Tennessee

Advocat Distribution Services, Inc. Tennessee

Advocat Finance, Inc. Delaware

Diversicare Assisted Living Services, Inc. Tennessee

Diversicare Assisted Living Services NC, LLC Tennessee

Diversicare Assisted Living Services NC I, LLC Delaware

Diversicare Assisted Living Services NC II, LLC Delaware

Diversicare Canada Management Services Co., Inc. Ontario, Canada

Diversicare General Partner, Inc. Texas

Diversicare Leasing Corp. Tennessee

Diversicare Leasing Corp. of Alabama Alabama

Diversicare Management Services Co. Tennessee

First American Health Care, Inc. Alabama

Sterling Health Care Management, Inc. Kentucky

<PAGE> 1
EXHIBIT 23

CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public accountants, we hereby consent to the incorporation of
our reports included in this Form 10-K of Advocat Inc. and subsidiaries into
the Company's previously filed Registration Statement File Numbers 33-93940,
33-93946 and 33-93950.

ARTHUR ANDERSEN LLP

Nashville, Tennessee
March 28, 2000

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF ADVOCAT INC. AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH ANNUAL REPORT ON FORM 10-K FOR THE ANNUAL PERIOD
ENDED DECEMBER 31, 1999.
</LEGEND>
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 1,913
<SECURITIES> 0
<RECEIVABLES> 16,777
<ALLOWANCES> 4,958
<INVENTORY> 754
<CURRENT-ASSETS> 15,199
<PP&E> 87,667
<DEPRECIATION> 19,015
<TOTAL-ASSETS> 96,185
<CURRENT-LIABILITIES> 71,898
<BONDS> 0
0
0
<COMMON> 55
<OTHER-SE> 6,212
<TOTAL-LIABILITY-AND-EQUITY> 96,185
<SALES> 0
<TOTAL-REVENUES> 182,018
<CGS> 0
<TOTAL-COSTS> 195,812
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 7,037
<INTEREST-EXPENSE> 5,459
<INCOME-PRETAX> (13,794)
<INCOME-TAX> 7,605
<INCOME-CONTINUING> (21,399)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (277)
<NET-INCOME> (21,676)
<EPS-BASIC> (3.98)
<EPS-DILUTED> (3.98)

</TABLE>