| EMERITUS CORP\WA\ ITEM 1A RISK FACTORS Our business, results of operations and financial condition are subject to many risks, including, but not limited to, those set forth below: The following important factors, among others, could cause actual operating results to differ materially from those expressed in forward-looking statements included in this report and presented elsewhere by our management from time to time |
| Do not place undue reliance on these forward-looking statements, which speak only as of the date of this report |
| A number of the matters and subject areas discussed in this report refer to potential future circumstances, operations and prospects, and therefore, are not historical or current facts |
| The discussion of such matters and subject areas is qualified by the inherent risks and uncertainties surrounding future expectations, which may materially differ from our actual future experience involving any one or more of such matters and subject areas as a result of various factors, including: various risks, uncertainties and other factors that could cause actual results to differ, including, without limitation: the effects of competition and economic conditions on the occupancy levels in our communities, including possible excess assisted living capacity; our ability under current market conditions to maintain and increase our resident charges without adversely affecting occupancy levels; our ability to control community operation expenses, including the management of costs largely beyond our control (such as insurance and utility costs) without adversely affecting the level of occupancy and resident charges; our ability to generate cash flow sufficient to service our debt and other fixed payment requirements, our vulnerability to defaults as a result of noncompliance with various debt and lease covenants; the effects of cross-default terms, competition, uncertainties relating to construction, licensing, environmental, and other matters that affect acquisition, disposition and development of assisted living communities, our ability to find sources of financing and capital on satisfactory terms to meet our cash requirements to the extent that they are not met by operation; and final resolution of the adverse Texas jury verdict and other uncertainties related to professional liability claims |
| We have attempted to identify, in context, certain of the factors that may cause actual future experience and results to differ from our current expectations regarding the relevant matter or subject area |
| We are not obligated to release publicly the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events |
| We have incurred losses since we began doing business, except for 2005, and may continue to incur losses for the foreseeable future |
| For 2005, 2004, and 2003, we recorded net income (losses) before preferred dividends of dlra12dtta3 million income, dlra40dtta5 million loss, and dlra8dtta1 million loss, respectively |
| Our net income in 2005 includes a gain on the sale of our investment in Alterra of dlra55dtta4 million |
| We believe that the historically aggressive growth of our portfolio through acquisitions and developments and related financing activities, as well as our inability (along with much of the assisted living industry) to increase occupancy rates at our communities, were among the causes of these losses |
| To date, at many of our communities, we have been generally able to stabilize occupancy and rate structures to levels that have 9 _________________________________________________________________ [77]Table of Contents resulted in positive cash flow but not earnings for the Company as a whole |
| Our ongoing operations may not become profitable in line with our current expectations or may not become profitable at all |
| If we cannot generate sufficient cash flow to cover required interest, principal and lease payments, we risk defaults on our debt agreements and leases |
| At December 31, 2005, we had total debt of dlra80dtta5 million, with minimum principal payments of about dlra2dtta8 million due in 2006 |
| At December 31, 2005, we were obligated under both long-term operating and capital leases requiring minimum annual cash lease payments of which dlra101dtta1 million is payable in 2006 |
| In addition, we will have approximately dlra3dtta3 million and dlra54dtta3 million in principal amount of debt repayment obligations that become due in 2007 and 2008, respectively |
| We also have dlra26dtta6 million of debentures that are due on July 1, 2008 |
| Of the original dlra32dtta0 million of debentures, dlra5dtta4 million were redeemed in January 2006 |
| If we are unable to generate sufficient cash flow to make such payments as required and are unable to renegotiate payments or obtain additional equity or debt financing, a lender could foreclose on our communities secured by the respective indebtedness or, in the case of an operating lease, could terminate our lease, resulting in loss of income and asset value |
| In some cases, our indebtedness is secured by a particular community and a pledge of our interests in a subsidiary entity that owns that community |
| In the event of a default, a lender could avoid judicial procedures required to foreclose on real property by foreclosing on our pledge instead, thus accelerating its acquisition of that community |
| Furthermore, because of cross-default and cross-collateralization provisions in certain of our mortgage and sale-leaseback agreements, if we default on one of our payment obligations, we could adversely affect a significant number of our communities |
| Because we are highly leveraged, we may not be able to respond to changing business and economic conditions or continue with selected acquisitions |
| A substantial portion of our future cash flow will be devoted to debt service and lease payments |
| In the past, we have frequently been dependent on third party financing and disposition of assets to fund these obligations in full and we may be required to do so in the future |
| In addition, we are periodically required to refinance these obligations as they mature |
| As a consequence of acquisitions of communities, we substantially increased our leverage in 2004 |
| In 2005, our long-term debt increased from dlra54dtta7 million at December 31, 2004, to dlra80dtta5 million at December 31, 2005, in part due to the acquisition of 3 communities with debt financing |
| Our obligations under long-term operating leases increased from dlra321dtta9 million at December 31, 2004 to dlra338dtta9 million at December 31, 2005 |
| However, our obligations under long-term capital leases, net of imputed interest, decreased from dlra629dtta5 million to dlra626dtta7 million |
| These circumstances reduce our flexibility and ability to respond to our business needs, including changing business and financial conditions such as increasing interest rates and opportunities to expand our business through selected acquisitions |
| We may be unable to increase or stabilize our occupancy rates that would result in positive earnings |
| In previous years, we have been unable to increase our occupancy to levels that would result in net income on a sustained basis |
| Our historical losses have resulted, in part, from occupancy levels that were lower than anticipated when we acquired or developed our communities |
| While our occupancy levels increased in 2005 and 2004, during the last three years prior to that, occupancy levels declined, excluding the effects of acquired communities |
| We cannot guarantee that our occupancy levels will increase |
| We will occasionally seek additional funding through public or private financing, including equity financing |
| We may not find adequate equity, debt, or sale-leaseback financing when we need it or on terms acceptable to us |
| This could affect our ability to finance our operations or refinance our properties to avoid the consequences of default and foreclosure under our existing financing as described elsewhere |
| In addition, if we raise additional funds by issuing equity securities, our shareholders may experience dilution of their investment |
| If we fail to comply with financial covenants contained in our debt instruments, our lenders may accelerate the related debt |
| From time to time, we have failed to comply with certain covenants in our financing and lease agreements |
| In the future, we may not be able to comply with these covenants, which generally relate to matters such as cash flow, debt and lease coverage ratios, and certain other performance standards |
| If we 10 _________________________________________________________________ [78]Table of Contents fail to comply with any of these requirements and are not able to obtain waivers, our lenders could accelerate the related indebtedness so that it becomes due and payable prior to its stated due date |
| We may be unable to pay or refinance this debt if it becomes due |
| We self-insure many of the liabilities we face |
| In recent years, participants in the long-term-care industry have faced an increasing number of lawsuits alleging negligence, malpractice, or other related legal theories |
| Many of these suits involve large claims and significant legal costs |
| We expect we will occasionally face such suits because of the nature of our business |
| In February 2005, a San Antonio, Texas, jury found one of our assisted living communities negligent in the care of a resident |
| The jury awarded a verdict against us in the amount of dlra1dtta5 million in compensatory damages and dlra18dtta0 million in punitive damages |
| The verdict was in connection with an action brought by the relatives of a resident at one of our assisted living facilities that alleged negligence in an incident occurring in 2003 |
| The verdict is currently under appeal as described under “Legal Proceedings |
| ” In 2004, we formed a wholly owned captive insurance company domiciled in the US, which provides general and professional liability insurance on a claims-made basis |
| Because we are responsible for a self-insured retention, funding losses up to the captive limits through premiums and losses in excess of the captive limits, we are ultimately responsible for the full loss of professional liability claims |
| Claims against us, regardless of their merit or eventual outcome, may also undermine our ability to attract residents or expand our business and would require management to devote time to matters unrelated to the operation of our business |
| We currently do not carry professional liability insurance other than through our captive insurance subsidiary and although we review our liability insurance annually, we may not be able to obtain third party liability insurance coverage in the future or, if available, on acceptable terms |
| During the past several years, retained losses relating to high self-insured retention and annual premiums have increased significantly, which have substantially compounded our costs associated with insurance and claims defense |
| We face risks associated with selective acquisitions |
| We intend to continue to seek selective acquisition opportunities |
| However, we may not succeed in identifying any future acquisition opportunities or completing any identified acquisitions |
| The acquisition of communities presents a number of risks |
| Existing communities available for acquisition may frequently serve or target different market segments than those we presently serve |
| It may be necessary in these cases to reposition and renovate acquired communities or turn over the existing resident population to achieve a resident care level and income profile that is consistent with our objectives |
| In the past, these obstacles have delayed the achievement of acceptable occupancy levels and increased operating and capital expenditures |
| As a consequence, we currently plan to target assisted living communities with established operations, which could reduce the number of acquisitions we can complete and increase the expected cost |
| Even in these acquisitions, however, we may need to make staff and operating management personnel changes to successfully integrate acquired communities into our existing operations |
| We may not succeed in repositioning acquired communities or in effecting any necessary operational or structural changes and improvements on a timely basis |
| We also may face unforeseen liabilities attributable to the prior operator of the acquired communities, against whom we may have little or no recourse |
| We expect competition in our industry to increase, which could cause our occupancy rates and resident fees to decline |
| The long-term care industry is highly competitive, and given the relatively low barriers to entry and continuing health care cost containment pressures, we expect that our industry will become increasingly competitive in the future |
| We believe that the industry is experiencing over-capacity in several of our markets, thereby intensifying competition and adversely affecting occupancy levels and pricing |
| We compete with other companies providing assisted living services as well as numerous other companies providing similar service and care alternatives, such as home healthcare agencies, independent living facilities, retirement communities, and skilled nursing facilities |
| We expect that competition will increase from new market entrants, as assisted living residences receive increased market awareness and more states decide to include assisted living services in their Medicaid programs |
| Many of these competitors may have substantially greater financial resources than we do |
| Increased competition may limit our ability to attract or 11 _________________________________________________________________ [79]Table of Contents retain residents or maintain our existing rate structures |
| This could lead to lower occupancy rates or lower rate structures in our communities |
| We also cannot predict the effect of the healthcare industry trend toward managed care on the assisted living marketplace |
| Managed care, an arrangement whereby service and care providers agree to sell specifically defined services to public or private payers in an effort to achieve more efficiency with respect to utilization and cost, is not currently a significant factor in the assisted living marketplace |
| However, managed care plans sponsored by insurance companies or HMOs may in the future affect pricing and the range of services provided in the assisted living marketplace |
| If development of new assisted living facilities outpaces demand, we may experience decreased occupancy, depressed margins, and diminished operating results |
| We believe that some assisted living markets have become or are on the verge of becoming overbuilt |
| The barriers to entry in the assisted living industry are not substantial |
| Consequently, the development of new assisted living facilities could outpace demand |
| Overbuilding in the markets in which we operate could thus cause us to experience decreased occupancy and depressed margins and could otherwise adversely affect our operating results |
| Market forces could undermine our efforts to attract seniors with sufficient resources |
| We rely on our residents’ abilities to pay our fees from their own or familial financial resources |
| Generally, only seniors with income or assets meeting or exceeding the comparable median in the region where our assisted living communities are located can afford our fees |
| Inflation or other circumstances may undermine the ability of seniors to pay for our services |
| If we encounter difficulty in attracting seniors with adequate resources to pay for our services, our occupancy rates may decline |
| Our labor costs may increase and may not be matched by corresponding increases in rates we charge to our residents |
| We compete with other providers of assisted living services and long-term care in attracting and retaining qualified and skilled personnel |
| We depend on our ability to attract and retain management personnel responsible for the day-to-day operations of each of our communities |
| If we are unable to attract or retain qualified community management personnel, our results of operations may suffer |
| In addition, possible shortages of nurses or trained personnel may require us to enhance our wage and benefits packages to compete in the hiring and retention of personnel |
| We also depend on the available labor pool of semi-skilled and unskilled employees in each of the markets in which we operate |
| As a result of these and other factors, our labor costs may increase and may not be matched by corresponding increases in rates we charge to our residents |
| We face possible environmental liabilities at each of our properties |
| Under various federal, state, and local environmental laws, ordinances, and regulations, a current or previous owner or operator of real property may be held liable for the costs of removal or remediation of certain hazardous or toxic substances, including asbestos-containing materials that could be located on, in, or under its property |
| These laws and regulations often impose liability whether or not the owner or operator knew of, or was responsible for, the presence of the hazardous or toxic substances |
| We could face substantial costs of any required remediation or removal of these substances, and our liability typically is not limited under applicable laws and regulations |
| Our liability could exceed our properties’ value or the value of our assets |
| We may be unable to sell or rent our properties, or borrow using our properties as collateral, if any of these substances are present or if we fail to remediate them properly |
| Under these laws and regulations, if we arrange for the disposal of hazardous or toxic substances such as asbestos-containing materials at a disposal site, we also may be liable for the costs of the removal or of the hazardous or toxic substances at the disposal site |
| In addition to liability for these costs, we could be liable for governmental fines and injuries to persons or properties |
| We are not aware of any hazardous or toxic substances at any of our properties |
| Some of our facilities generate infectious medical waste due to the illness or physical condition of the residents, including, for example, blood-soaked bandages, swabs, and other medical waste products, and incontinence products of those residents diagnosed with an infectious disease |
| The management of 12 _________________________________________________________________ [80]Table of Contents infectious medical waste, including handling, storage, transportation, treatment, and disposal, is subject to regulation under various laws, including federal and state environmental laws |
| These environmental laws set forth the management requirements, as well as permit, record-keeping, notice, and reporting obligations |
| Each of our facilities has an agreement with a waste management company for the proper disposal of all infectious medical waste |
| Any finding that we are not in compliance with these environmental laws could adversely affect our business and financial condition |
| While we are not aware of any non-compliance with environmental laws related to infectious medical waste at any of our properties, these environmental laws are amended from time to time and we cannot predict when and to what extent liability may arise |
| In addition, because these environmental laws vary from state to state, expansion of our operations to states where we do not currently operate may subject us to additional restrictions on the manner in which we operate our facilities |
| Our chief executive officer, Daniel R Baty, has personal interests that may conflict with ours due to his interest in Holiday Retirement Corporation and Columbia-Pacific Group, Inc |
| Baty is a principal shareholder, director, and Chairman of the Board of Holiday Retirement Corporation, and is the principal owner of Columbia-Pacific Group, Inc |
| Substantially all of the independent living facilities operated by Holiday are owned by partnerships that are controlled by Mr |
| Baty and Holiday |
| Baty’s varying financial interests and responsibilities include the acquisition, financing, and refinancing of independent living facilities and the development and construction of, and capital raising activities to finance new facilities |
| Columbia-Pacific and affiliated partnerships own assisted living communities and independent living facilities, many of which we manage under various management agreements |
| The financial interests and management and financing responsibilities of Mr |
| Baty with respect to Holiday and Columbia-Pacific and their affiliated partnerships could present conflicts of interest with us, including potential competition for residents in markets where both companies operate and competing demands for the time and efforts of Mr |
| Because Mr |
| Baty is both our Chief Executive Officer as well as Holiday’s Chairman of the Board and is the principal owner of Columbia-Pacific, circumstances could arise that would distract him from our operations |
| Our interests and those of Holiday and Columbia-Pacific interests may, on some occasions, be incompatible |
| We have entered into a non-compete agreement with Mr |
| Baty, but this non-compete agreement does not limit Mr |
| Baty’s current role with Holiday or its related partnerships, so long as assisted living is only an incidental component of Holiday’s operation or management of independent living facilities |
| We have entered into agreements with a number of entities that are owned or controlled by Mr |
| Baty, whose interests with respect to these companies occasionally may conflict with ours |
| We have entered into agreements, including most of our management agreements, with a number of entities that are owned or controlled by Mr |
| Under these agreements, we provide management and other services to senior housing and assisted living communities owned by these entities and we have material agreements with these entities relating to the purchase, sale, and financing of a number of our operating communities |
| There is a risk that the administration of these and any future arrangements could be adversely affected by these continuing relationships because our interests and those of Mr |
| Baty may not be congruent at all times |
| Some of our recent transactions and the operations of certain communities that we manage are supported financially by Mr |
| Baty with limited guarantees and through his direct and indirect ownership of such communities; we would be unable to benefit from these transactions and managed communities without this support |
| The company manages 11 communities owned by entities controlled by Mr |
| Baty which involve limited guarantees by Mr |
| Baty and rely on his direct and indirect ownership of the communities involved |
| Baty is also guarantor of a portion of the debt of our Fretus Lease and is the administrative member of Fretus |
| As described under "e HCP Transaction "e and in accordance with an amendment to the lease, effective July 30, 2004, Mr |
| Baty unconditionally and irrevocably guaranteed the payment when due of all costs, expense, fees, rents and other sums payable by us in the full, faithful and prompt performance when due |
| The guaranty is limited to an aggregate amount of dlra3dtta0 million |
| Baty has not been called upon for any payments |
| The company has paid no consideration to Mr |
| Baty for the 13 _________________________________________________________________ [81]Table of Contents guaranty |
| As described under "e Emeritrust I Communities Lease "e and in accordance with an amendment to the lease, effective September 30, 2004, Mr |
| Baty personally guaranteed the prompt payment and performance of the lease obligations |
| Baty has not been called upon for any payments |
| Baty consideration based upon the cash flow agreement as described under "e Emeritrust I Communities Lease "e |
| We believe that we would be unable to take advantage of these transactions and management opportunities without Mr |
| The ongoing administration of these transactions, however, could be adversely affected by these continuing relationships because our interests and those of Mr |
| Baty may not be congruent at all times |
| In addition, we cannot guarantee that such support will be available in the future |
| We may be unable to attract and retain key management personnel |
| We depend upon, and will continue to depend upon, the services of Mr |
| Baty’s services, in part or in whole, could adversely affect our business and our results of operations |
| Baty has financial interests and management responsibilities with respect to Holiday and its related partnerships |
| We may be unable to attract and retain other qualified executive personnel critical to the success of our business |
| Federal, state, and local authorities heavily regulate the healthcare industry |
| Regulations change frequently, and sometimes require us to make expensive changes in our operations |
| A number of legislative and regulatory initiatives relating to long-term care are proposed or under study at both the federal and state levels that, if enacted or adopted, could adversely affect our business and operating results |
| We cannot predict to what extent legislative or regulatory initiatives will be enacted or adopted or what effect any initiative would have on our business and operating results |
| Changes in applicable laws and new interpretations of existing laws can significantly affect our operations, as well as our revenues, particularly those from governmental sources, and our expenses |
| Our residential communities are subject to varying degrees of regulation and licensing by local and state health and social service agencies and other regulatory authorities |
| While these regulations and licensing requirements often vary significantly from state to state, they typically address: · fire safety, · sanitation, · staff training, · staffing patterns, · living accommodations such as room size, number of bathrooms, and ventilation, and · health-related services |
| We may be unable to satisfy all regulations and requirements or to acquire and maintain any required licenses on a cost-effective basis |
| In addition, with respect to our residents who receive financial assistance from governmental sources for their assisted living services, we are subject to federal and state regulations that prohibit certain business practices and relationships |
| Failure to comply with these regulations could prevent reimbursement for our healthcare services under Medicaid or similar state reimbursement programs |
| Our failure to comply with such regulations also could result in fines and the suspension or inability to renew our operating licenses |
| Federal, state, and local governments occasionally conduct unannounced investigations, audits, and reviews to determine whether violations of applicable rules and regulations exist |
| Devoting management and staff time and legal resources to such investigations, as well as any material violation by us that is discovered in any such investigation, audit or review, could strain our resources and affect our profitability |
| In addition, regulatory oversight of construction efforts associated with refurbishment could cause us to lose residents and disrupt community operations |
| 14 _________________________________________________________________ [82]Table of Contents Our stock price has been highly volatile, and a number of factors may cause our common stock price to decline |
| The market price of our common stock has fluctuated and could fluctuate significantly in the future in response to various factors and events, including, but not limited to: · the liquidity of the market for our common stock; · variations in our operating results; · variations from analysts’ expectations; and · new statutes or regulations, or changes in the interpretation of existing statutes or regulations, affecting the healthcare industry generally or the assisted living residence business in particular |
| In addition, the stock market in recent years has experienced broad price and volume fluctuations that often have been unrelated to the operating performance of particular companies |
| These market fluctuations also may cause the market price of our common stock to decline |
| Our share ownership and certain other factors may impede a proposed takeover of our business |
| As of February 28, 2006, Mr |
| Baty controls about 30dtta2prca of our outstanding common stock |
| Together, our directors and executive officers own, directly and indirectly, over 65dtta6prca of the voting power of our outstanding common stock |
| Accordingly, Mr |
| Baty and the other members of our board and management would have significant influence over the outcome of matters submitted to our shareholders for a vote, including matters that would involve a change of control of Emeritus |
| Further, our Articles of Incorporation require a two-thirds supermajority vote to approve a business combination of Emeritus with another company that is not approved by the board of directors |
| Accordingly, the current management group and board of directors could prevent approval of such a business combination |
| We currently have a staggered board in which only one-third of the board stands for election each year |
| Thus, absent removals and resignations, a complete change in board membership could not be accomplished in fewer than approximately two calendar years |