| FIVE STAR QUALITY CARE INC FULLY UNDER “ITEM 1A RISK FACTORS” |
| IN ANY SUCH EVENT, OUR FUTURE FINANCIAL PERFORMANCE MAY BE ADVERSELY AFFECTED AND WE MAY EXPERIENCE LOSSES IF OUR FINANCIAL RESULTS DO NOT IMPROVE, OUR STOCK PRICE LIKELY WILL DECLINE YOU SHOULD NOT PLACE UNDUE RELIANCE UPON FORWARD LOOKING STATEMENTS ______________________________________________________________________ EXCEPT AS MAY BE REQUIRED BY APPLICABLE LAW, WE DO NOT INTEND TO IMPLY THAT WE WILL RELEASE PUBLICLY THE RESULT OF ANY REVISION TO THE FORWARD LOOKING STATEMENTS CONTAINED IN THIS ANNUAL REPORT TO REFLECT THE FUTURE OCCURRENCE OF PRESENTLY UNANTICIPATED EVENTS ______________________________________________________________________ FIVE STAR QUALITY CARE, INC 2005 FORM 10-K ANNUAL REPORT Table of Contents [1]PART I [2]Item 1 |
| Additional risks that we do not yet know of, or that we currently think are immaterial, may also impair our business operations or financial results |
| If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could suffer and the trading price of our common shares could decline |
| Investors should consider the following risks and the information contained under the heading “Warning Concerning Forward Looking Statements” before deciding to invest in our common shares or other securities |
| A small percentage decline in our revenues or increase in our expenses could have a material negative impact upon our operating results |
| For the year ended December 31, 2005, our revenues were dlra757dtta5 million and our operating expenses were dlra836dtta2 million (including our SLS termination expense of approximately dlra86dtta3 million) |
| A small percentage decline in our revenues or increase in our expenses could have a material negative impact upon our operating results |
| SLS’s continuing management of some of our communities may have adverse consequences to us |
| In 2004, we and SLS closed one of these communities by mutual agreement because of the poor financial results at that community |
| In 11 ______________________________________________________________________ November 2005, we terminated SLS management agreements for an additional 12 communities |
| In February 2006, we terminated the management agreement for one additional community |
| As a result of these terminations, SLS may be unwilling to operate, or may not be able to profitably operate, the remaining 17 communities which it operates for our account and the income we realize from these operations may decline |
| We cannot predict the effect that our terminations of these management agreements will have on our ongoing relationship with SLS Our growth strategy may not succeed |
| Since our spin-off from Senior Housing on December 31, 2001, we have grown rapidly through acquisitions |
| Our business plan includes acquiring additional senior living communities, pharmacies and rehabilitation hospitals |
| Our growth strategy involves risks including the following: • we may be unable to locate senior living communities or pharmacies available for purchase at acceptable prices; • we may be unable to access capital to make acquisitions or operate acquired businesses; • acquired operations may not perform in line with expectations; • acquired operations may subject us to unanticipated contingent liabilities or regulatory problems; • to the extent we incur acquisition debt or leases, our operating leverage may increase and, to the extent we issue additional equity, our shareholders’ percentage of ownership will be diluted; and • combining our present operations with newly acquired operations may disrupt operations or cost more than anticipated |
| For these reasons and others: • our business plan to grow may not succeed; • the benefits which we hope to achieve by growing may not be achieved; • we may suffer declines in profitability or suffer recurring losses; and • our existing operations may suffer from a lack of management attention or financial resources if such attention and resources are devoted to a failed growth strategy |
| When we acquire new communities, we frequently see a decline in community occupancy and it often takes some period of time for us to stabilize acquired community operations |
| For example, occupancy levels for the Gordon communities we acquired in June 2005 are still somewhat below their historical levels |
| Our efforts to restore occupancy or stabilize acquired communities’ operations may not be successful |
| In addition, we have recently expanded into the institutional and mail order pharmacy businesses and plan to operate two rehabilitation hospitals |
| These are businesses with which we have limited experience, and our initiatives in these areas may not be successful |
| We may be unable to lease the two hospitals from Senior Housing, and, if we are able to lease these hospitals, we may not achieve the anticipated benefits of our operation of these hospitals |
| We may not receive the required regulatory approvals to lease the two hospitals from Senior Housing and our lease with Senior Housing may not become effective |
| Also, Healthsouth’s appeal of the Massachusetts Superior Court’s order to cooperate in the transfer of these two hospitals may be successful, Healthsouth’s lease of these hospitals may be reinstated and our tenancy may be terminated |
| The historical operating and financial information concerning the two hospitals’ operations that we received from Healthsouth may not be accurate |
| Also, recent changes in Medicare rate formulas applicable to rehabilitation hospitals make it difficult to project the hospitals’ future financial results |
| In these circumstances, our projection that our future operation of these hospitals will be profitable may prove to be inaccurate |
| In fact, we may be unable to operate these hospitals profitably and we may experience losses from our operation of these hospitals |
| If we are unable to operate these hospitals successfully, our reputation as a provider of health and rehabilitation services may be damaged |
| Even if we successfully operate these hospitals, these operations may have little or no benefit to our other operations |
| 12 ______________________________________________________________________ We may not achieve the anticipated benefits of our acquisition of the Gordon communities |
| The financial benefits we expect to realize from our 2005 acquisition of the Gordon communities are largely dependent upon our ability to increase the occupancy of the Gordon communities and to realize cost savings by combining the Gordon communities’ operations and our existing operations |
| Changing management at senior living communities sometimes results in decreased occupancy, declining revenues and increased costs |
| If our management of the Gordon communities does not increase occupancy, increase revenues and lower costs, we may not achieve the anticipated benefits and we may experience losses |
| We may not achieve the anticipated benefits of our termination of management agreements for 13 communities that SLS managed for us |
| The financial benefits we expect to realize from our termination of management agreements for 13 communities that SLS managed for us are largely dependent upon our ability to maintain the occupancy of the 13 communities and to lower certain operating costs |
| Changing management at senior living communities sometimes results in decreased occupancy, declining revenues and increased costs |
| The transition of operations at senior living communities is often complicated and we can provide no assurance that the benefits we hope to achieve by terminating these SLS management agreements will be realized |
| The nature of our business exposes us to litigation risks |
| As a result, our insurance costs have increased and may continue to increase, and we self insure a large portion of our litigation risks |
| In several well publicized instances, private litigation by residents of senior living communities for alleged abuses has resulted in large damage awards against other operating companies |
| Today, some lawyers and law firms specialize in bringing litigation against senior living companies |
| As a result of this litigation and potential litigation, our cost of liability insurance has increased dramatically during the past few years |
| Medical liability insurance reform has become a topic of political debate and some states have enacted legislation to limit future liability awards |
| However, unless such reforms are not generally adopted, we expect our insurance costs may continue to increase |
| To reduce costs, we self insure a significant amount of our litigation liability risks |
| Although our reserves for liability self insurance have been determined with guidance from third party professionals, our reserves may prove inadequate |
| Increasing liability insurance costs and increasing self insurance reserves may materially negatively affect our results of operations |
| Our business is subject to extensive regulation which increases our costs and may result in losses |
| Licensing and Medicare and Medicaid laws require operators of senior living communities to comply with extensive standards governing operations |
| There are also various laws prohibiting fraud by senior living operators, including criminal laws that prohibit false claims for Medicare and Medicaid and that regulate patient referrals |
| In recent years, the federal and state governments have devoted increased resources to monitoring the quality of care at senior living communities and to anti-fraud investigations |
| When quality of care deficiencies are identified or improper billing is uncovered, various sanctions may be imposed, including denial of new admissions, exclusion from Medicare or Medicaid program participation, monetary penalties, governmental oversight or loss of licensure |
| Our communities receive notices of sanctions from time to time |
| As a result of this extensive regulatory system and increasing enforcement initiatives, we have increased our costs of monitoring quality of care compliance and billing procedures, and we expect these costs may continue to increase |
| Also, if we become subject to regulatory sanctions, our business may be adversely affected and we might experience financial losses |
| The failure of Medicare and Medicaid rates to match our costs will reduce our income |
| Some of our operations, especially our nursing homes, receive significant revenues from the Medicare and Medicaid programs |
| During the year ended December 31, 2005, approximately 36prca of our net revenues from residents were received from these programs |
| The federal government and some states are now experiencing fiscal deficits |
| Historically, when governmental deficits have increased, cut backs in Medicare and Medicaid funding have often followed |
| These cut backs sometimes include rate reductions, but more often result in a failure of Medicare and Medicaid rates to increase by sufficient amounts to offset increasing costs |
| We cannot now predict whether future Medicare and Medicaid rates will be sufficient to cover our future cost increases |
| Future Medicare and Medicaid rate declines or a 13 ______________________________________________________________________ failure of these rates to cover increasing costs could result in our experiencing lower earnings or losses |
| The rehabilitation hospitals that we expect to begin operating in 2006 receive a significant part of their revenues from the Medicare programs, and these operations will increase our exposure to Medicare rate risks |
| Compliance with Sarbanes-Oxley will continue to increase our accounting costs and reduce our income |
| Section 404 of Sarbanes-Oxley requires that our independent auditors audit our internal control over financial reporting for the year ended December 31, 2005 and thereafter |
| Section 404 also requires our management to assess the effectiveness of our internal control over financial reporting as of December 31, 2005 and to report the results of that assessment in our annual report |
| These additional requirements have increased our accounting costs and we expect that these increased costs will continue to reduce our income |
| A significant increase in our labor costs may have a material adverse effect on us |
| We compete with other operators of senior living communities with respect to attracting and retaining qualified personnel responsible for the day to day operations of each of our communities |
| A shortage of nurses or other trained personnel may require us to increase the wages and benefits offered to our employees in order to attract and retain these personnel or to hire more expensive temporary personnel |
| Also, we have to compete for lesser skilled workers with numerous other employers |
| Employment statistics recently published by the government indicate a tightening job market |
| Historically, these statistics have often foretold increased wage pressures |
| Although we have not yet experienced any recent significant wage pressures, such wage pressures may occur in the near future |
| Employee benefits costs, including employee health insurance and workers compensation insurance costs, have materially increased in recent years |
| To help control these costs, we partially self insure our workers compensation insurance and fully self insure our employee health insurance |
| Although our self insurance reserves have been determined with guidance from third party professionals, our reserves may be inadequate |
| Increasing employee health and workers compensation insurance costs and increasing self insurance reserves for this type of insurance may materially negatively affect our earnings |
| No assurance can be given that our labor costs will not increase or that any increase will be matched by corresponding increases in rates charged to residents |
| Any significant failure by us to control our labor costs or to pass on any increased labor costs to residents through rate increases could have a material adverse effect on our business, financial condition and results of operations |
| Our business may require regular capital expenditures |
| Physical characteristics of senior living communities are mandated by various governmental authorities |
| Changes in these regulations may require us to make significant expenditures |
| In the future, our communities may require significant expenditures to address ongoing required maintenance and to make them attractive to residents |
| Our available financial resources may be insufficient to fund these expenditures |
| Our business is highly competitive and we may be unable to operate profitably |
| We compete with numerous other companies that provide senior living services, including home healthcare companies and other real estate based service providers |
| Historically, nursing homes have been somewhat protected from competition by state laws requiring certificates of need to develop new communities; however, these barriers have been eliminated in many states |
| Also, there are few barriers to competition for home healthcare or for independent and assisted living services |
| Growth in the availability of nursing home alternatives, including assisted living communities, has had and may in the future have the effect of reducing the occupancy or profitability at nursing homes, including those we operate |
| Many of our existing competitors are larger and have greater financial resources than us |
| Accordingly, we cannot provide any assurances that we will be able to attract a sufficient number of residents to our communities or that we will be able to attract employees and keep wages and other employee benefits, insurance costs and other operating expenses at levels which will allow us to compete successfully or to operate profitably |
| We are subject to possible conflicts of interest; we have engaged in, and expect to continue to have, transactions with related parties |
| Our business is subject to possible conflicts of interest as follows: 14 ______________________________________________________________________ • our Chief Executive Officer, Evrett W Benton, and our Chief Financial Officer, Bruce J Mackey Jr, are also part-time employees of Reit Management and Research LLC, or RMR RMR is the manager for Senior Housing and we purchase various services from RMR pursuant to a shared services agreement; • our managing directors, Barry M Portnoy and Gerard M Martin, are also managing trustees of Senior Housing |
| Portnoy also is the majority beneficial owner of RMR and another entity that leases office space to us and Mr |
| Martin is a director of RMR; • under our shared services agreement with RMR, in the event of a conflict between Senior Housing and us, RMR may act on behalf of Senior Housing rather than on our behalf; and • we lease 135 of the 153 senior living communities that we operate from Senior Housing for total annual minimum rent of dlra103dtta5 million |
| On December 31, 2001, Senior Housing distributed substantially all of its ownership of our shares to its shareholders |
| Simultaneously with the spin off, we entered into agreements with Senior Housing which, among other things, limit ownership of more than 9dtta8prca of our voting shares, restrict our ability to take any action that could jeopardize the tax status of Senior Housing as a real estate investment trust and limit our ability to acquire real estate of types which are owned by Senior Housing or other real estate investment trusts managed by RMR As a result of these agreements, our leases with Senior Housing and our shared services agreement with RMR, Senior Housing, RMR and their respective affiliates have significant roles in our business and we do not anticipate any changes to those roles in the future |
| Future business dealings between us, Senior Housing, RMR and their respective affiliates may be on terms less favorable to us than we could achieve on an arm’s length basis |
| Although we do not believe these conflicts have adversely affected, or will adversely affect, our business, not everyone may agree with our position |
| The limitations on the ownership of our shares and other anti-takeover provisions in our governing documents and in our material agreements may prevent our shareholders from receiving a takeover premium for their shares |
| Our charter places restrictions on the ability of any person or group to acquire beneficial ownership of more than 9dtta8prca (in number of shares or value, whichever is more restrictive) of any class of our equity securities |
| The terms of our leases with Senior Housing and our shared services agreement with RMR provide that our rights under these agreements may be cancelled by Senior Housing and RMR, respectively, upon the acquisition by any person or group of more than 9dtta8prca of our voting stock, and upon other change in control events, as defined in those documents |
| If the breach of these ownership limitations causes a lease default, shareholders causing the default may become liable to us or to other shareholders for damages |
| Additionally, on March 10, 2004, we entered into a rights agreement whereby in the event a person or group of persons acquires or attempts to acquire 10prca or more of our outstanding common shares, our shareholders, other than such person or group, will be entitled to purchase additional shares or other securities or property at a discount |
| These agreements and other provisions in our charter and bylaws may increase the difficulty of acquiring control of us by means of a tender offer, open market purchases, a proxy fight or otherwise, if the acquisition is not approved by our board of directors |
| Other provisions in our governing documents which may deter takeover proposals include the following: • staggered terms for members of our board of directors; • the power of our board of directors, without a shareholders’ vote, to authorize and issue additional shares and classes of shares on terms that it determines; • a 75prca shareholder vote and cause requirements for removal of directors; and • advance notice procedures with respect to nominations of directors and shareholder proposals |
| For all of these reasons, shareholders may be unable to cause a change of control of us or to realize a change of control premium for their common shares |
| The price of our common shares has fluctuated, and a number of factors may cause our common share price to decline |
| The market price of our common shares has fluctuated and could fluctuate significantly in the future in response to various factors and events, including, but not limited to, the risks set out in this Annual Report on form 10-K, as well as: 15 ______________________________________________________________________ • the liquidity of the market for our common shares; • variations in our operating results; • variations from analysts’ expectations; and • general economic and industry trends and conditions |
| 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 may also cause the market price of our common shares to decline |
| Investors may be unable to resell their common shares at or above the offering price |
| Circumstances that adversely affect the ability of seniors to pay for our services could have a material adverse effect on us |
| Approximately 64prca of our net revenues from residents from our communities for the year ended December 31, 2005 were paid by residents from their private resources |
| We expect to continue to rely on the ability of our residents to pay for our services from their own financial resources |
| Inflation or other circumstances that adversely affect the ability of the elderly to pay for our services could have a material adverse effect on our business, financial condition and results of operations |