| CAPITAL SENIOR LIVING CORP ITEM 1A RISK FACTORS The Company’s business involves various risks |
| When evaluating the Company’s business the following information should be carefully considered in conjunction with the other information contained in our periodic filings with the Securities and Exchange Commission |
| Additional risks and uncertainties not known to the Company currently or that currently the Company deems to be immaterial also may impair the Company’s business operations |
| If the Company is unable to prevent events that have a negative effect from occurring, then the Company’s business may suffer |
| Negative events are likely to decrease the Company’s revenue, increase its costs, make its financial results poorer and/or decrease its financial strength, and may cause its stock price to decline |
| The Company has significant debt |
| The Company’s failure to generate cash flow sufficient to cover required interest and principal payments could result in defaults of the related debt |
| As of December 31, 2005, the Company had mortgage and other indebtedness totaling approximately dlra268dtta1 million |
| The Company cannot assure you that it will generate cash flow from operations or receive proceeds from refinancings, other financings or the sales of assets sufficient to cover required interest, principal and, if applicable, operating lease payments |
| Any payment or other default could cause the applicable lender to foreclose upon the communities securing the indebtedness or, if applicable, in the case of an operating lease, could terminate the lease, with a consequent loss of income and asset value to the Company |
| Further, because some of the Company’s mortgages contain cross-default and cross-collateralization provisions, a payment or other default by the Company with respect to one community could affect a significant number of the Company’s other communities |
| The Company’s failure to comply with financial covenants contained in debt instruments could result in the acceleration of the related debt |
| There are various financial covenants and other restrictions in certain of the Company’s debt instruments, including provisions which: • require the Company to meet specified financial tests at the parent company level, which include, but are not limited to, liquidity requirements, earnings before interest, taxes and depreciation and amortization (“EBITDA”) requirements, and tangible net worth requirements; • require the Company to meet specified financial tests at the community level, which include, but are not limited to, occupancy requirements, debt service coverage tests, cash flow tests and net operating income requirements; and • require consent for changes in control of the Company |
| If the Company fails to comply with any of these requirements, then the related indebtedness could become due and payable prior to its stated maturity date |
| The Company cannot assure that it could pay this debt if it became due |
| 20 _________________________________________________________________ [75]Table of Contents The Company will require additional financing and/or refinancings in the future |
| The Company’s ability to meet its long-term capital requirements, including the repayment of certain long-term debt obligations, will depend, in part, on its ability to obtain additional financing or refinancings on acceptable terms from available financing sources, including through the use of mortgage financing, joint venture arrangements, by accessing the debt and/or equity markets and possibly through operating leases or other types of financing, such as lines of credit |
| There can be no assurance that the financing or refinancings will be available or that, if available, it will be on terms acceptable to the Company |
| Moreover, raising additional funds through the issuance of equity securities could cause existing stockholders to experience dilution and could adversely affect the market price of the Company’s common stock |
| The Company’s inability to obtain additional financing or refinancings on terms acceptable to the Company could delay or eliminate some or all of the Company’s growth plans, necessitate the sales of assets at unfavorable prices or both, and would have a material adverse effect on the Company’s business, financial condition and results of operations |
| The Company’s current floating rate debt, and any future floating rate debt, exposes it to rising interest rates |
| The Company currently has indebtedness with floating interest rates |
| Future indebtedness and, if applicable, lease obligations may be based on floating interest rates prevailing from time to time |
| Therefore, increases in prevailing interest rates would increase the Company’s interest or lease payment obligations and could have a material adverse effect on the Company’s business, financial condition and results of operations |
| The Company has significant operating lease obligations |
| The Company’s failure to generate cash flows sufficient to cover these lease obligations could result in defaults under the lease agreements |
| As of December 31, 2005, the Company leases seven communities with lease obligations totaling approximately dlra82dtta7 million over a 10 year period, with minimum lease obligations of dlra8dtta9 million in fiscal 2006 |
| The Company cannot assure you that it will generate cash flow from operations or receive proceeds from refinancings, other financings or the sales of assets sufficient to cover these required operating lease obligations |
| Any payment or other default under the Company’s leases could result in the termination of the lease, with a consequent loss of income and asset value to the Company |
| Further, because all of the Company’s leases contain cross-default provisions, a payment or other default by the Company with respect to one leased community could affect a significant number of the Company’s other leased communities |
| Certain of the Company’s leases contain various financial and other restrictive covenants, which could limit the Company’s flexibility in operating its business |
| Failure to maintain compliance with the lease obligations as set forth in the Company’s lease agreements could have a material adverse impact on the Company |
| The Company cannot assure that it will be able to effectively manage its growth |
| The Company intends to expand its operations, directly or indirectly, through the acquisition of new senior living communities, the expansion of some of its existing senior living communities and through the increase in the number of communities which it manages under management agreements |
| The success of the Company’s growth strategy will depend, in large part, on its ability to implement these plans and to effectively operate these communities |
| If the Company is unable to manage its growth effectively, its business, results of operations and financial condition may be adversely affected |
| The Company cannot assure that it will be able to acquire additional senior living communities or expand existing senior living communities |
| The acquisition of existing communities or other businesses involves a number of risks |
| Existing communities available for acquisition frequently serve or target different markets than those presently served by the Company |
| The Company may also determine that renovations of acquired communities and changes in staff and operating management personnel are necessary to successfully integrate those communities or businesses into its existing operations |
| The costs incurred to reposition or renovate newly acquired communi- 21 _________________________________________________________________ [76]Table of Contents ties may not be recovered by the Company |
| In undertaking acquisitions, the Company also may be adversely impacted by unforeseen liabilities attributable to the prior operators of those communities or businesses, against whom it may have little or no recourse |
| The success of the Company’s acquisition strategy will be determined by numerous factors, including its ability to identify suitable acquisition candidates; the competition for those acquisitions; the purchase price; the requirement to make operational or structural changes and improvements; the financial performance of the communities or businesses after acquisition; its ability to finance the acquisitions; and its ability to integrate effectively any acquired communities or businesses into its management, information, and operating systems |
| The Company cannot assure that its acquisition of senior living communities or other businesses will be completed at the rate currently expected, if at all, or if completed, that any acquired communities or businesses will be successfully integrated into its operations |
| The Company’s ability to successfully expand existing senior living communities will depend on a number of factors, including, but not limited to, its ability to acquire suitable sites for expansion at reasonable prices; its success in obtaining necessary zoning, licensing, and other required governmental permits and authorizations; and its ability to control construction costs and accurately project completion schedules |
| Additionally, the Company anticipates that the expansion of existing senior living communities may involve a substantial commitment of capital for a period of time of two years or more until the expansions are operating and producing revenue, the consequence of which could be an adverse impact on its liquidity |
| The Company cannot assure that its expansion of existing senior living communities will be completed at the rate currently expected, if at all, or if completed, that such expansions will be profitable |
| Termination of resident agreements and resident attrition could affect adversely the Company’s revenues and earnings |
| State regulations governing assisted living facilities require written resident agreements with each resident |
| Most of these regulations also require that each resident have the right to terminate the resident agreement for any reason on reasonable notice |
| Consistent with these regulations, the resident agreements signed by the Company allow residents to terminate their agreement on 30 days’ notice |
| Thus, the Company cannot contract with residents to stay for longer periods of time, unlike typical apartment leasing arrangements that involve lease agreements with specified leasing periods of up to a year or longer |
| If a large number of residents elected to terminate their resident agreements at or around the same time, then the Company’s revenues and earnings could be adversely affected |
| In addition, the advanced age of the Company’s average resident means that the resident turnover rate in the Company’s senior living facilities may be difficult to predict |
| The Company largely relies on private pay residents |
| Circumstances that adversely effect the ability of the elderly to pay for the Company’s services could have a material adverse effect on the Company |
| Approximately 95prca of the Company’s total revenues from communities that it owned and managed for each of the years ended December 31, 2005 and 2004 were attributable to private pay sources |
| For each of the same periods, approximately 5prca of the Company’s revenues from these communities were attributable to reimbursements from Medicare and Medicaid |
| The Company expects to continue to rely primarily on the ability of residents to pay for the Company’s services from their own or familial financial resources |
| Inflation or other circumstances that adversely affect the ability of the elderly to pay for the Company’s services could have a material adverse effect on the Company’s business, financial condition and results of operations |
| The Company is subject to some particular risks related to third-party management agreements |
| The Company currently manages 15 senior living communities for third parties and eight senior living communities for joint ventures in which it has a minority interest pursuant to multi-year management agreements |
| The management agreements generally have initial terms of between five and fifteen years, subject to certain renewal rights |
| Under these agreements the Company provides management services to third party and joint venture owners to operate senior living communities and has provided, and may in the future provide, management and consulting services to third parties on market and site selection, pre-opening 22 _________________________________________________________________ [77]Table of Contents sales and marketing, start-up training and management services for facilities under development and construction |
| In most cases, either party to the agreements may terminate them upon the occurrence of an event of default caused by the other party |
| In addition, subject to the Company’s rights to cure deficiencies, community owners may terminate the Company as manager if any licenses or certificates necessary for operation are revoked, or if the Company has a change of control |
| Also, in some instances, a community owner may terminate the management agreement relating to a particular community if the Company is in default under other management agreements relating to other communities owned by the same community owner or its affiliates |
| In addition, in certain cases the community owner may terminate the agreement upon 30 days’ notice to the Company in the event of a sale of the community |
| In those agreements, which are terminable in the event of a sale of the community, the Company has certain rights to offer to purchase the community |
| The termination of a significant portion of the Company’s management agreements could have a material adverse effect on its business, financial condition and results of operations |
| Performance of the Company’s obligations under its joint venture arrangements could have a material adverse effect on the Company |
| The Company holds minority interests ranging from approximately 5prca to 11prca in several joint ventures with affiliates of Prudential and GE Healthcare |
| The Company also manages the communities owned by these joint ventures |
| Under the terms of the joint venture agreements with Prudential covering four properties, the Company is obligated to meet certain cash flow targets and failure to meet these cash flow targets could result in termination of the management agreements |
| Under the terms of the joint venture agreements with GE Healthcare covering four properties, the Company is obligated to meet certain net operating income targets and failure to meet these net operating income targets could result in termination of the management agreements |
| All of the management agreements with the joint ventures contain termination and renewal provisions |
| The Company does not control joint venture decisions covering termination or renewal |
| Performance of the above obligations or termination or non-renewal of the management agreements could have a material adverse effect on the Company’s business, financial condition and results of operations |
| The senior living services industry is very competitive and some competitors have substantially greater financial resources than the Company |
| The senior living services industry is highly competitive, and the Company expects that all segments of the industry will become increasingly competitive in the future |
| The Company competes with other companies providing independent living, assisted living, skilled nursing, home health care and other similar services and care alternatives |
| The Company also competes with other health care businesses with respect to attracting and retaining nurses, technicians, aides and other high quality professional and non-professional employees and managers |
| Although the Company believes there is a need for senior living communities in the markets where it operates residences, the Company expects that competition will increase from existing competitors and new market entrants, some of whom may have substantially greater financial resources than the Company |
| In addition, some of the Company’s competitors operate on a not-for-profit basis or as charitable organizations and have the ability to finance capital expenditures on a tax-exempt basis or through the receipt of charitable contributions, neither of which are available to the Company |
| Furthermore, if the development of new senior living communities outpaces the demand for those communities in the markets in which the Company has senior living communities, those markets may become saturated |
| Regulation in the independent and assisted living industry, which represents a substantial portion of the Company’s senior living services, is not substantial |
| Consequently, development of new senior living communities could outpace demand |
| An oversupply of those communities in the Company’s markets could cause the Company to experience decreased occupancy, reduced operating margins and lower profitability |
| The Company relies on the services of key executive officers and the loss of these officers or their services could have a material adverse effect on the Company |
| The Company depends on the services of its executive officers for its management |
| The loss of some of the Company’s executive officers and the inability to attract and retain qualified management personnel could 23 _________________________________________________________________ [78]Table of Contents affect its ability to manage its business and could adversely effect its business, financial condition and results of operations |
| A significant increase in the Company’s labor costs could have a material adverse effect on the Company |
| The Company competes with other providers of senior living services with respect to attracting and retaining qualified management personnel responsible for the day-to-day operations of each of its communities and skilled personnel responsible for providing resident care |
| A shortage of nurses or trained personnel may require the Company to enhance its wage and benefits package in order to compete in the hiring and retention of these personnel or to hire more expensive temporary personnel |
| The Company also will be dependent on the available labor pool of semi-skilled and unskilled employees in each of the markets in which it operates |
| No assurance can be given that the Company’s labor costs will not increase, or that, if they do increase, they can be matched by corresponding increases in rates charged to residents |
| Any significant failure by the Company to control its labor costs or to pass on any increased labor costs to residents through rate increases could have a material adverse effect on its business, financial condition and results of operations |
| There is an inherent risk of liability in the provision of personal and health care services, not all of which may be covered by insurance |
| The provision of personal and health care services in the long-term care industry entails 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 negligence or related legal theories, many of which involve large claims and result in the incurrence of significant defense costs |
| Moreover, senior living communities offer residents a greater degree of independence in their daily living |
| This increased level of independence may subject the resident and, therefore, the Company to risks that would be reduced in more institutionalized settings |
| The Company currently maintains insurance in amounts it believes are comparable to that maintained by other senior living companies based on the nature of the risks, the Company’s historical experience and industry standards, and the Company believes that this insurance coverage is adequate |
| However, the Company may become subject to claims in excess of its insurance or claims not covered by its insurance, such as claims for punitive damages, terrorism and natural disasters |
| A claim against the Company not covered by, or in excess of, its insurance could have a material adverse effect upon the Company |
| In addition, the Company’s insurance policies must be renewed annually |
| Based upon poor loss experience, insurers for the long-term care industry have become increasingly wary of liability exposure |
| A number of insurance carriers have stopped writing coverage to this market, and those remaining have increased premiums and deductibles substantially |
| Therefore, the Company cannot assure that it will be able to obtain liability insurance in the future or that, if that insurance is available, it will be available on acceptable economic terms |
| The Company is subject to government regulations and compliance, some of which are burdensome and some of which may change to the Company’s detriment in the future |
| Federal and state governments regulate various aspects of the Company’s business |
| The development and operation of senior living communities and the provision of health care services are subject to federal, state and local licensure, certification and inspection laws that regulate, among other matters, the number of licensed beds, the provision of services, the distribution of pharmaceuticals, billing practices and policies, equipment, staffing (including professional licensing), operating policies and procedures, fire prevention measures, environmental matters and compliance with building and safety codes |
| Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, temporary suspension of admission of new residents, suspension or decertification from the Medicare program, restrictions on the ability to acquire new communities or expand existing communities and, in extreme cases, the revocation of a community’s license or closure of a community |
| The Company believes that such regulation will increase in the future and the Company is unable to predict the content of new regulations or their effect on its business, any of which could materially adversely affect the Company |
| 24 _________________________________________________________________ [79]Table of Contents Various states, including several of the states in which the Company currently operates, control the supply of licensed skilled nursing beds, assisted living communities and home health care agencies through (CON) or other programs |
| In those states, approval is required for the construction of new health care communities, the addition of licensed beds and some capital expenditures at those communities, as well as the opening of a home health care agency |
| To the extent that a CON or other similar approval is required for the acquisition or construction of new communities, the expansion of the number of licensed beds, services, or existing communities, or the opening of a home health care agency, the Company could be adversely affected by its failure or inability to obtain that approval, changes in the standards applicable for that approval, and possible delays and expenses associated with obtaining that approval |
| In addition, in most states, the reduction of the number of licensed beds or the closure of a community requires the approval of the appropriate state regulatory agency and, if the Company were to seek to reduce the number of licensed beds at, or to close, a community, the Company could be adversely affected by a failure to obtain or a delay in obtaining that approval |
| Federal and state anti-remuneration laws, such as “anti-kickback” laws, govern some financial arrangements among health care providers and others who may be in a position to refer or recommend patients to those providers |
| These laws prohibit, among other things, some direct and indirect payments that are intended to induce the referral of patients to, the arranging for services by, or the recommending of, a particular provider of health care items or services |
| Federal anti-kickback laws have been broadly interpreted to apply to some contractual relationships between health care providers and sources of patient referral |
| Similar state laws vary, are sometimes vague, and seldom have been interpreted by courts or regulatory agencies |
| Violation of these laws can result in loss of licensure, civil and criminal penalties, and exclusion of health care providers or suppliers from participation in Medicare and Medicaid programs |
| There can be no assurance that those laws will be interpreted in a manner consistent with the Company’s practices |
| Under the Americans with Disabilities Act of 1990, all places of public accommodation are required to meet federal requirements related to access and use by disabled persons |
| A number of additional federal, state and local laws exist that also may require modifications to existing and planned communities to create access to the properties by disabled persons |
| Although the Company believes that its communities are substantially in compliance with present requirements or are exempt therefrom, if required changes involve a greater expenditure than anticipated or must be made on a more accelerated basis than anticipated, additional costs would be incurred by the Company |
| Further legislation may impose additional burdens or restrictions with respect to access by disabled persons, the costs of compliance with which could be substantial |
| The Health Insurance Portability and Accountability Act of 1996, in conjunction with the federal regulations promulgated thereunder by the Department of Health and Human Services, has established, among other requirements, standards governing the privacy of certain protected and individually identifiable health information that is created, received or maintained by a range of covered entities |
| HIPAA has also established standards governing uniform health care transactions, the codes and identifiers to be used by the covered entities and standards governing the security of certain electronic transactions conducted by covered entities |
| Penalties for violations can range from civil money penalties for errors and negligent acts to criminal fines and imprisonment for knowing and intentional misconduct |
| HIPAA is a complex set of regulations and many unanswered questions remain with respect to the manner in which HIPAA applies to businesses such as those operated by the Company |
| The Company may be subject to liability for environmental damages |
| Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at the property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean up costs incurred by those parties in connection with the contamination |
| These laws typically impose clean-up responsibility and liability without regard to whether the owner knew of or caused the presence of the contaminants, and liability under these laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility |
| The costs of investigation, remediation or removal of the substances may be 25 _________________________________________________________________ [80]Table of Contents substantial, and the presence of the substances, or the failure to properly remediate the property, may adversely affect the owner’s ability to sell or lease the property or to borrow using the property as collateral |
| In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination |
| Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the costs of removal or remediation of the substances at the disposal or treatment facility, whether or not the facility is owned or operated by the person |
| Finally, the owner of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site |
| If the Company becomes subject to any of these claims the costs involved could be significant and could have a material adverse effect on its business, financial condition and results of operations |