Advocat Inc.

277 Mallory Stations Road, Suite 130
Franklin, Tennessee 37067
U.S.A.
Telephone: (615) 771-7575
Fax: (615) 771-7409
Web site: http://irino.com/avc

Public Company
Incorporated: 1980 as Diversicare Inc.
Employees: 5,620
Sales: $196 million (2000)
Stock Exchanges: OTC
Ticker Symbol: AVCA
NAIC: 623110 Nursing Care Facilities

Based in Franklin, Tennessee, Advocat Inc. operates assisted-living facilities for the elderly as well as nursing homes. The company concentrates on serving smaller communities in 12 mostly southern states and four provinces in Canada. Changes in reimbursement levels from Medicare have led to serious financial difficulties for the company, resulting in its stock being delisted by both the New York Stock Exchange and Toronto Stock Exchange.

Company Origins: 1980

The driving force behind Advocat is its chairman and CEO, Dr. Charles W. Birkett, who became involved in the nursing home industry in 1980. Born in Canada, he completed his medical training at the University of Toronto in 1960. He gained management experience at Sterling Drug Ltd of Aurora, Ontario, ultimately becoming a vice-president and the medical director of the firm. He supplemented his practical business experience by returning to school, earning an MBA from York University in 1972. Birkett then went to work as a senior consultant for Hickling-Johnston Ltd, a Toronto company that offered consulting services to the Canadian health-care industry. He was named a partner in the firm in 1975 and eventually became a vice-president and director. In 1980, Birkett left Hickling-Johnston to help found a corporation called Diversicare Inc., devoted to the “assisted living” field. It would lead to the eventual creation of Advocat.

The first step for Diversicare was to acquire a financially troubled Toronto complex that included 246 nursing home beds, Although the building also featured 287 apartments for seniors, only a handful of those residents actually employed services from the nursing home staff. Birkett described this early venture in a 1996 article he wrote for Nursing Homes, explaining that the Diversicare team did not recognize a connection between independent seniors and those requiring greater care: “What we had, in, fact, were two separate concepts—independent living and nursing home care—sharing a building…. Within three years we came to recognize how very little we knew about the elderly, especially those who didn’t need nursing home care. Once we achieved that realization, we were able to develop a new mind-set, one that made it possible to begin to learn what this continuum of care concept—elderly residents moving from independence, to frailty, to infirmity—is all about.” Moreover, Birkett came to realize that “much of the definitions, organization, and development of health care has been for the convenience of the provider. That is most definitely the wrong mind-set.” Although Diversicare applied many of these early lessons in the 1980s, the company continued to view assisted living facilities and nursing homes as separate endeavors, each requiring a different approach. According to Birkett, “We saw the nursing home business as one of expense control and the assisted living/retirement housing business as one of revenue maximization.” As a result Diversicare was organized into two divisions.

In 1983, Diversicare was acquired for its real estate portfolio by Counsel Corp., a Toronto-based company that had been formed in 1979 and had been primarily involved in financial services and real estate development. Counsel’s entry into the assisted living industry was not that unusual, however, because a number of real estate developers viewed the business simply as an extension of the housing market rather than a part of the healthcare industry. Birkett stayed on as president of Diversicare, in addition to becoming a director on Counsel’s board.

Diversicare expanded to the U.S. market, establishing a subsidiary based in Clearwater, Florida, then in 1988 made a major acquisition, purchasing Wessex Corp, a Franklin, Tennessee, health-care services company. The nursing home business of Wessex was the primary reason for the deal, but a home health-care business called American HomePatient was also included. Two years earlier, Atlanta-based American Home Patients Centers Inc. acquired Wessex in a $21 million stock swap, then assumed its name, merged management teams, and relocated to Franklin. Counsel elected to operate American HomePatient as a subsidiary of Diversicare, which now moved its headquarters to Franklin, a more central location for the company’s U.S. facilities than was Clearwater.

The health-care business, at the time, was not a significant contributor to Counsel, which by 1989 boasted $2 billion in assets and generated $350 million in annual revenues. The fortunes of the conglomerate soon suffered, however, as a recession ensued and the bottom fell out of real estate prices. Because the corporation’s U.S. health-care business continued to show healthy growth, Counsel decided in 1991 to spin-off Diversicare, taking it public in 1991.

The $15 million raised in the initial public offering of Diversicare was earmarked for an expansion program, which the company actively pursued in 1992. Diversicare began the year with 24 facilities in four states and ended with 53 facilities in ten states. All of the company’s purchases were located in southern states, with the exception of the acquisition of Duracare Medical Equipment in Tempe, Arizona. For the most part, however, the plan was to expand by moving into secondary markets, with populations between 50,000 and 250,000, and where Diversicare operations were already in place in an adjacent state. The demographics of the United States, with an aging population, looked promising for the future, especially in the home health care side of the business. Moreover, the nursing home industry was highly fragmented, with a majority of the businesses being single facilities and family owned, a situation that offered opportunities for public companies to greatly enhance market share.

Advocat Formed in 1994

Counsel now decided to split up the businesses of Diversicare. In 1994, the nursing home management operation was spun off as a new company called Advocat, with Birkett as CEO, and Diversicare subsequently changed its name to its remaining subsidiary, American HomePatient. Advocat was then taken public in May 1994, raising $5.2 million. In addition, the new company arranged a $17.5 million line of credit, of which $10 million was budgeted for acquisitions of long-term care facilities. By the end of the year, Advocat acquired a 134-bed nursing home, as well as securing leases on six other nursing homes with a total of 625 beds and three other nursing homes under construction and scheduled to open in mid-1995.

Advocat entered its first full year with a certain number of acquisitions it wished to achieve. Prices were considered too high, however, and it was not until December 1995 that the company found a property, a 169-bed Texas facility, that management felt was reasonably priced. The company had better success with a new 40-bed Alzheimer’s unit that it opened in Corpus Christi, Texas, in February 1995, the result of market research on local needs. It was also an extension of the lessons Birkett learned during his early years with Diversicare, a matter of focusing on the entire range of patient care, from independence to infirmity. Within six months the Alzheimer facility was fully occupied and making a significant contribution to the balance sheet. As a result of the company’s inability to make acquisitions, it fell short of its overall financial goals for the year. Nevertheless, Advocat topped $133 million in net revenues for 1995 and posted a net profit of more than $4.4 million.

Acquisition prices were more in line with Advocat’s expectations in 1996, and as a result the company was extremely active, adding four facilities in both the United States and Canada. The company purchased a 60-bed nursing home in St. Petersburg, Florida; an 86-bed nursing home in Hartford, Alabama; a 130-bed nursing home in Little Rock, Arkansas; and a 74-unit continuum-of-care center located in Brantford, Ontario. In addition, Advocat opened a new 60-bed nursing home and expanded existing facilities. In all, the company added 350 beds and $10 million in annual revenues. For the year, revenues showed a significant increase over the previous year, reaching almost $159 million, with net income reaching $4.7 million. Advocat also took steps in 1996 to offer new patient services, such as rehabilitation and fitness programs, medical alert services, adult day care, and specialized recreational programs. The company formed a strategic relationship with Prism Health Group of Boston to research some of these potential services.

Advocat made its largest acquisition in 1997, when it paid $32 million for the assets of the Pierce Management Group, the largest operator of assisted-living facilities in North Carolina. Under terms of the transaction, Advocat purchased 15 rest homes and gained leases to 14 others, with the option to purchase 12 of them after five years. Management viewed the Pierce acquisition as a base from which to build a U.S. presence in the assisted-living services market, one that Advocat’s Canadian operations had been involved in for many years. The new facilities, mostly located in rural areas, added approximately 2,000 patients and was expected to increase Advocat’s annual revenues by $26 million.

Company Perspectives:

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 pursuit of acquisitions and establishing new businesses, however, would be superceded by adverse developments in 1997. Advocat settled a wrongful death suit involving one of its Alabama facilities, but state regulators then cut off Medicare and Medicaid payments to two of the company’s Alabama nursing homes after finding that the facilities lacked adequate staffing, used inappropriate physical restraints, and served food at improper temperatures. As a result, one facility was decertified for 69 days and the other for 91 days before inspectors deemed the company was in compliance. Not only did the loss of Medicare and Medicaid payments have a negative impact on year-end results for Advocat, the bad publicity also caused the price of its stock to drop. Management maintained that Alabama officials overreacted and that intermediate penalties should have been imposed rather than immediately turning to decertification. Nevertheless, Advocat conducted a review of its seven Alabama facilities and took steps to improve relationships with that state.

Balanced Budget Act of 1997 Hurts Nursing Home Industry

A far more important development in 1997, one that would affect the entire industry, was the Federal government’s passage of the Balanced Budget Act of 1997, which included a number of cost-saving measures for Medicare and Medicaid. Nursing homes were now required over the next three years to transition to a prospective payment system (PPS). In effect, PPS set standard reimbursement rates for Medicare and Medicaid services, thus forcing management to cut operational expenses to offset reduced revenues from the government programs. The actual effects of these changes would not be immediately apparent. In the meantime, Advocat posted another record year in revenues, exceeding $177 million in 1997, although net profits fell to $3 million, due in large part to the Alabama losses.

As Advocat moved to convert its facilities to PPS, it became clear that the reduced Medicare and Medicaid reimbursement levels combined with more stringent regulations were going to severely hurt its business. The company spent $2.5 million on a new information system to help it better manage its costs in response to PPS, but even greater efficiencies could not compensate for the lower reimbursement rates. Fortunately for Advocat, its Canadian operations were not affected, and its new assisted-living facilities in North Carolina were performing well. As a result, revenues grew to $205.2 million in 1998, although the company posted a $3 million loss on the year. Advocat faced an uncertain future, and Birkett, according to press accounts, was now very much interested in selling the company. Attempts to find a new partner with deep pockets, however, proved fruitless.

The financial situation would only worsen for the nursing home industry in 1999. Reduced Medicare and Medicaid payments and the costs incurred from increased regulation were debilitating enough, but an increased level of litigation drove up the cost of liability insurance. As a result, a large number of nursing home operators were forced into bankruptcy. Even with the benefit of its Canadian business and assisted-living operation, Advocat suffered through a disastrous 1999. Net revenues fell to $182 million and the company lost more than $21.6 million. Just to survive the year Advocat required forbearance from its major landlord and banker. Unable to meet equity and capitalization requirements of the New York Stock Exchange, Advocat, whose stock lost 75 percent of its value in the previous year, was delisted and its shares forced to trade over the counter. In order to free himself to focus on these financial difficulties, Birkett hired Charles H. Rinne, an executive with considerable experience in the nursing home industry, to serve as president and chief operating officer and take over the day-to-day operational responsibilities.

Conditions improved only slightly in 2000. Advocat managed to avoid defaulting on loans, and by the end of the year was able to consolidate its debt and renegotiate its leases. Net revenues for the year improved to $196 million, and the company was able to cut its net loss to $3.85 million. Some of the Medicare and Medicaid cutbacks were restored, but the changes would not be felt until 2001. Advocat, and the nursing industry as a whole, looked for relief from a new president in 2001, hoping that the regulatory burden might be eased. The cost of liability insurance, on the other hand, appeared as if it would only grow worse, especially in Texas and Florida. Clearly, the company faced an uncertain future, yet the demographics had not changed: America was aging and Americans were living longer. As a result, the long-term prospects for Advocat remained somewhat optimistic.

Principal Subsidiaries

Advocat Ancillary Services, Inc.; Diversicare Assisted Living Services, Inc; Diversicare Canada Management Services Co., Inc.; First American Health Care, Inc.

Principal Competitors

Beverly Enterprises Inc.; Life Care Centers; Manor Care Inc.

Key Dates:

1980:

Dr. Charles Birkett founds Diversicare in Canada.

1983:

Counsel Corp. acquires Diversicare.

1988:

Diversicare acquires Wessex Corp of Franklin, Tennessee.

1994:

Diversicare spins off Advocat, which is taken public.

1999:

The company is delisted by New York Stock Exchange.

Further Reading

Birkett, Charles, “Moving into Assisted Living,” Nursing Homes, February 1996, p. 22.

“Diversicare Inc,” Wall Street Transcript, May 17, 1993.

“Diversicare Sells Subsidiary to Continue Home-Care Push,” Modern Healthcare, March 14, 1994, p. 20.

“Dr. Charles W. Birkett,” Wall Street Transcript, March 31, 1997.

Mallett, Gina and David North, “We Make House Calls,” Canadian Business, January 1996, p. 73.

Russell, Keith, “Advocat Makes Exec Changes,” Nashville Business Journal, June 25, 1999.

—Ed Dinger