CAPITAL SENIOR LIVING CORP - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

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

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 1-13445
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CAPITAL SENIOR LIVING CORPORATION
(Exact name of registrant as specified in its charter)

DELAWARE 75-2678809
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

14160 DALLAS PARKWAY, SUITE 300
DALLAS, TEXAS 75254
(Address of principal executive offices) (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(972) 770-5600
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]

The aggregate market value of the 9,429,764 shares of the Registrant's
Common Stock, par value $0.01 per share ("Common Stock"), held by nonaffiliates,
based upon the closing price of the Registrant's Common Stock as reported by the
New York Stock Exchange on June 28, 2002 was approximately $30,646,733. For
purposes of this computation, all officers, directors and 10% beneficial owners
of the Registrant are deemed to be affiliates. Such determination should not be
deemed an admission that such officers, directors or 10% beneficial owners are,
in fact, affiliates of the Registrant. As of March 21, 2003, 19,737,837 shares
of Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant's definitive proxy statement pertaining to the 2002 Annual
Meeting of Stockholders (the "Proxy Statement") and filed or to be filed not
later than 120 days after the end of the fiscal year pursuant to Regulation 14A
is incorporated herein by reference into Part III.
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CAPITAL SENIOR LIVING CORPORATION

TABLE OF CONTENTS

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PART I

ITEM 1. BUSINESS

OVERVIEW

Capital Senior Living Corporation, a Delaware corporation (together with
its subsidiaries, the "Company"), is one of the largest operators of senior
living communities in the United States in terms of resident capacity. As of
December 31, 2002, the Company owned interests in 43 communities in 20 states
with a capacity of approximately 6,900 residents. As of December 31, 2002, the
Company also operated one home care agency. During 2002 approximately 96% of
total revenues for the senior living communities owned and managed by the
Company were derived from private pay sources. As of December 31, 2002, the
stabilized communities (defined as communities not in initial lease-up) that the
Company operated and in which it owned interests had an average occupancy rate
of approximately 93%. The Company and its predecessors have provided senior
living services since 1990.

The Company's operating strategy is to provide high quality senior living
communities and services at an affordable price to its residents, while
achieving and sustaining a strong, competitive position within its chosen
markets, as well as to continue to enhance the performance of its operations.
The Company provides a wide array of senior living services to the elderly at
its communities, including independent living, assisted living (with special
programs and living units at some of its communities for residents with
Alzheimer's and other forms of dementia), skilled nursing and home care
services. Many of the Company's communities offer a continuum of care, to meet
its residents needs as they change over time. This continuum of care, which
integrates independent living and assisted living and is bridged by home care,
sustains residents' autonomy and independence based on their physical and mental
abilities.

INDUSTRY BACKGROUND

The senior living industry encompasses a broad and diverse range of living
accommodations and supportive services that are provided primarily to persons 75
years of age or older. For the elderly who require limited services, independent
living residences supplemented at times by home health care, offers a viable
option. Most independent living communities typically offer community living
packaged with basic services consisting of meals, housekeeping, laundry, 24-hour
staffing, transportation, social and recreational activities and health care
monitoring.

As a senior's need for assistance increases, care in an assisted living
residence is often preferable and more cost-effective than home-based care or
nursing home care. Typically, assisted living represents a combination of
housing and support services designed to aid elderly residents with activities
of daily living ("ADLs"), such as ambulation, bathing, dressing, eating,
grooming, personal hygiene, and monitoring or assistance with medications.
Certain assisted living residences may also provide assistance to residents with
low acuity medical needs, or may offer higher levels of personal assistance for
incontinent residents or residents with Alzheimer's disease or other cognitive
or physical frailties. Generally, assisted living residents require higher
levels of care than residents of independent living residences and retirement
living centers, but require lower levels of care than patients in skilled
nursing facilities. For seniors who need the constant attention of a skilled
nurse or medical practitioner, a skilled nursing facility may be required.

The National Investment Conference estimates that as of 2000, 50% of senior
housing properties with supportive services in the U.S. are assisted living
communities, 34% are skilled nursing facilities, 7% are independent living
communities, 4% are continuing care retirement communities and 5% offer a
combination of property types.

The senior living industry is highly fragmented and characterized by
numerous small operators. Moreover, the scope of senior living services varies
substantially from one operator to another. Many smaller senior living providers
do not operate purpose-built residences, do not have professional training for
staff and provide only limited assistance with ADLs. The Company believes that
few senior living operators provide the

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required comprehensive range of senior living services designed to permit
residents to "age in place" within the community as residents develop further
physical or cognitive frailties.

The Company believes that the senior living industry will require large
capital infusions over the next 10 years to meet the growing demand for senior
living communities. The National Investment Conference has estimated that
capital demand for private pay independent living communities will increase by
$38 billion between 2000 and 2010, while estimated capital demand for private
pay assisted living communities will increase by $29 billion during the same
ten-year period. As a result, the Company believes there will continue to be
growth opportunities in the senior living market for providing services to the
elderly.

The Company believes that a number of demographic, regulatory, and other
trends will contribute to the continued growth in the senior living market
including the following:

CONSUMER PREFERENCE

The Company believes that senior living communities are increasingly
becoming the setting preferred by prospective residents and their families for
the care of the elderly. Senior living offers residents greater independence and
allows them to "age in place" in a residential setting, which the Company
believes results in a higher quality of life than that experienced in more
institutional or clinical settings.

The likelihood of living alone increases with age. Most of this increase is
due to an aging population in which women outlive men. In 1993, eight out of 10
noninstitutionalized elderly who lived alone were women. According to the United
States Bureau of Census, based on 1993 data, the likelihood of women living
alone increases from 32% for 65 to 74-year-olds to 57% for those women aged 85
and older. Men show similar trends with 13% of the 65 to 74-year-olds living
alone rising to 29% of the men aged 85 and older living alone. Societal changes,
such as high divorce rates and the growing numbers of persons choosing not to
marry, have further increased the number of Americans living alone. This growth
in the number of elderly living alone has resulted in an increased demand for
services that historically have been provided by a spouse, other family members
or live-in caregivers.

DEMOGRAPHICS

The primary market for the Company's senior living services is comprised of
persons aged 75 and older. This age group is one of the fastest growing segments
of the United States population and is expected to more than double between the
years 2000 and 2030. The population of seniors aged 85 and over has increased
from approximately 3.1 million in 1990 to over 4.3 million by 2000, an increase
of 39%. This age cohort is expected to grow to approximately 6.0 million by 2010
and approximately 8.9 million by 2030. As the number of persons aged 75 and over
continues to grow, the Company believes that there will be corresponding
increases in the number of persons who need assistance with ADLs. According to
industry analyses, approximately 19% of persons aged 75 to 79, approximately 24%
of persons aged 80 to 84 and approximately 45% of persons aged 85 and older need
assistance with ADLs.

SENIOR AFFLUENCE

The average net worth of senior citizens is higher than non-senior
citizens, partially as a result of accumulated equity through home ownership.
The Company believes that a substantial portion of the senior population thus
has significant resources available for their retirement and long-term care
needs. The Company's target population is comprised of moderate- to upper-income
seniors who have, either directly or indirectly through familial support, the
financial resources to pay for senior living communities, including an assisted
living alternative to traditional long-term care.

REDUCED RELIANCE ON FAMILY CARE

Historically, the family has been the primary provider of care for seniors.
The Company believes that the increase in the percentage of women in the work
force, the reduction of average family size, and overall increased mobility in
society is reducing the role of the family as the traditional caregiver for
aging parents.

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The Company believes that these factors will make it necessary for many seniors
to look outside the family for assistance as they age.

RESTRICTED SUPPLY OF NURSING BEDS

The majority of states in the United States have adopted Certificate of
Need or similar statutes generally requiring that, prior to the addition of new
skilled nursing beds, the addition of new services, or the making of certain
capital expenditures, a state agency must determine that a need exists for the
new beds or the proposed activities. The Company believes that this Certificate
of Need process tends to restrict the supply and availability of licensed
nursing facility beds. High construction costs, limitations on government
reimbursement for the full costs of construction, and start-up expenses also act
to constrain growth in the supply of such facilities. At the same time, nursing
facility operators are continuing to focus on improving occupancy and expanding
services to subacute patients generally of a younger age and requiring
significantly higher levels of nursing care. As a result, the Company believes
that there has been a decrease in the number of skilled nursing beds available
to patients with lower acuity levels and that this trend should increase the
demand for the Company's senior living communities, including, particularly, the
Company's assisted living communities.

COST-CONTAINMENT PRESSURES

In response to rapidly rising health care costs, governmental and private
pay sources have adopted cost containment measures that have reduced admissions
and encouraged reduced lengths of stays in hospitals and other acute care
settings. The federal government had previously acted to curtail increases in
health care costs under Medicare by limiting acute care hospital reimbursement
for specific services to pre-established fixed amounts. Private insurers have
begun to limit reimbursement for medical services in general to predetermined
charges, and managed care organizations (such as health maintenance
organizations) are attempting to limit hospitalization costs by negotiating for
discounted rates for hospital and acute care services and by monitoring and
reducing hospital use. In response, hospitals are discharging patients earlier
and referring elderly patients, who may be too sick or frail to manage their
lives without assistance, to nursing homes and assisted living residences where
the cost of providing care is typically lower than hospital care. In addition,
third-party payors are increasingly becoming involved in determining the
appropriate health care settings for their insureds or clients, based primarily
on cost and quality of care. Based on industry data, the typical day-rate in an
assisted living facility is two-thirds of the cost for comparable care in a
nursing home.

OPERATING STRATEGY

The Company's operating strategy is to provide high quality, senior living
services at an affordable price to its residents, while achieving and sustaining
a strong, competitive position within its chosen markets, as well as continuing
to enhance the performance of its operations. The Company is implementing its
operating strategy principally through the following methods.

PROVIDE A BROAD RANGE OF HIGH-QUALITY PERSONALIZED CARE

Central to the Company's operating strategy is its focus on providing
high-quality care and services that are personalized and tailored to meet the
individual needs of each community resident. The Company's residences and
services are designed to provide a broad range of care that permits residents to
"age in place" as their needs change and as they develop further physical or
cognitive frailties. By creating an environment that maximizes resident autonomy
and provides individualized service programs, the Company seeks to attract
seniors at an earlier stage, before they need the higher level of care provided
in a skilled nursing facility. The Company also maintains a comprehensive
quality assurance program designed to ensure the satisfaction of its residents
and their family members. The Company conducts annual resident satisfaction
surveys that allow residents at each community to express whether they are "very
satisfied," "satisfied" or "dissatisfied" with all major areas of a community,
including, housekeeping, maintenance, activities and transportation, food
service, security and management. In both 2002 and 2001, the Company achieved a
97% overall approval rating from the residents' satisfaction survey.

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OFFER SERVICES ACROSS A RANGE OF PRICING OPTIONS

The Company's range of products and services is continually expanding to
meet the evolving needs of its residents. The Company has developed a menu of
products and service programs that may be further customized to serve both the
moderate and upper income markets of a particular targeted geographic area. By
offering a range of pricing options that are customized for each target market,
the Company believes that it can develop synergies, economies of scale and
operating efficiencies in its efforts to serve a larger percentage of the
elderly population within a particular geographic market.

MAINTAIN AND IMPROVE OCCUPANCY RATES

The Company continually seeks to maintain and improve occupancy rates by:
(i) retaining residents as they "age in place" by extending optional care and
service programs; (ii) attracting new residents through the on-site marketing
programs focused on residents and family members; (iii) selecting sites in
underserved markets; (iv) aggressively seeking referrals from professional
community outreach sources, including area religious organizations, senior
social service programs, civic and business networks, as well as the medical
community; and (v) continually refurbishing and renovating its communities.

IMPROVE OPERATING EFFICIENCIES

The Company seeks to improve operating efficiencies at its communities by
actively monitoring and managing operating costs. By having an established
national portfolio of communities with regional management in place, the Company
believes it has established a platform to achieve operating efficiencies through
economies of scale in the purchase of bulk items, such as food, and in the
spreading of fixed costs, such as corporate overhead, over a larger revenue
base, and to provide more effective management supervision and financial
controls. The Company's growth strategy includes regional clustering of new
communities to achieve further efficiencies.

EMPHASIZE EMPLOYEE TRAINING AND RETENTION

The Company devotes special attention to the hiring, screening, training,
supervising and retention of its employees and caregivers to ensure that quality
standards are achieved. In addition to normal on-site training, the Company
conducts annual national management meetings and encourages sharing of expertise
among managers. The Company's commitment to the total quality management concept
is emphasized throughout its training program. This commitment to the total
quality management concept means identification of the "best practices" in the
senior living market and communication of those "best practices" to the
Company's executive directors and their staff. The identification of best
practices is realized by a number of means, including: emphasis on regional and
executive directors keeping up with professional trade journals; interaction
with other professionals and consultants in the senior living industry through
seminars, conferences and consultations; visits to other properties; leadership
and participation at national and local trade organization events; and
information derived from marketing studies and resident satisfaction surveys.
This information is continually processed by regional managers and the executive
directors and communicated to the Company's employees as part of their training.
The Company's staffing of each community with an executive director allows it to
hire more professional employees at these positions, while the Company's
developed career path helps it to retain the professionals it hires. The Company
hires an executive director for each of its communities and provides them with
autonomy, responsibility and accountability. The Company believes its commitment
to and emphasis on employee training and retention differentiates the Company
from many of its competitors.

UTILIZE COMPREHENSIVE INFORMATION SYSTEMS

The Company employs comprehensive proprietary information systems to manage
financial and operating data in connection with the management of its
communities. Utilizing the Company's PC-based network, the Company is able to
collect and monitor, on a regular basis, key operating data for its communities.
Reports are routinely prepared and distributed to on-site, district and regional
managers for use in managing the

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profitability of the Company's communities. The Company's management information
systems provide senior management with the ability to identify emerging trends,
monitor and control costs and develop current pricing strategies. The Company
believes that its proprietary information systems are scalable to support future
growth.

SENIOR LIVING SERVICES

The Company provides a wide array of senior living services to the elderly
at its communities, including independent living, assisted living (with special
programs and living units at some of its communities for residents with
Alzheimer's and other forms of dementia), skilled nursing and home care
services. By offering a variety of services and encouraging the active
participation of the resident and the resident's family and medical consultants,
the Company is able to customize its service plan to meet the specific needs and
desires of each resident. As a result, the Company believes that it is able to
maximize customer satisfaction and avoid the high cost of delivering unnecessary
services to residents.

The Company's operating philosophy is to provide affordable, quality living
communities and services to senior citizens and deliver a continuum of care for
its residents as their needs change over time. This continuum of care, which
integrates independent living and assisted living and is bridged by home care,
sustains residents' autonomy and independence based on their physical and mental
abilities. As residents age, in many of the Company's communities, they are able
to obtain the additional needed services within the same community, avoiding the
disruptive and often traumatic move to a different facility.

INDEPENDENT LIVING SERVICES

The Company provides independent living services to seniors who do not yet
need assistance or support with ADLs, but who prefer the physical and
psychological comfort of a residential community that offers health care and
other services. As of December 31, 2002, the Company had ownership interests in
39 communities that provide independent living services, with an aggregate
capacity for 5,925 residents.

Independent living services provided by the Company include daily meals,
transportation, social and recreational activities, laundry, housekeeping,
24-hour staffing and health care monitoring. The Company also fosters the
wellness of its residents by offering health screenings (such as blood pressure
checks), periodic special services (such as influenza inoculations), dietary and
similar programs, as well as ongoing exercise and fitness classes. Classes are
given by health care professionals to keep residents informed about health and
disease management. Subject to applicable government regulation, personal care
and medical services are available to independent living residents through
either the community staff or through the Company's or other independent home
care agencies. The Company's independent living residents pay a fee ranging from
$950 to $3,950 per month, in general, depending on the specific community,
program of services, size of the unit and amenities offered. The Company's
contracts with its independent living residents are generally for a term of one
year and are typically terminable by the resident upon 30 days notice.

ASSISTED LIVING SERVICES

The Company offers a wide range of assisted living care and services,
including personal care services, 24 hour staffing, support services, and
supplemental services. As of December 31, 2002, the Company had ownership
interests in 16 communities, which include communities that have independent
living and other services, that provide assisted living services, with an
aggregate capacity for 795 residents. The residents of the Company's assisted
living residences generally need help with some or all ADLs, but do not require
the more acute medical care traditionally given in nursing homes. Upon admission
to the Company's assisted living communities, and in consultation with the
resident, the resident's family and medical consultants, each resident is
assessed to determine his or her health status, including functional abilities
and need for personal care services. The resident also completes a lifestyles
assessment to determine the resident's preferences. From these assessments, a
care plan is developed for each resident to ensure that all staff members who
render care meet the specific needs and preferences of each resident where
possible. Each resident's care plan is reviewed periodically to determine when a
change in care is needed.

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The Company has adopted a philosophy of assisted living care that allows a
resident to maintain a dignified independent lifestyle. Residents and their
families are encouraged to be partners in the residents' care and to take as
much responsibility for their well being as possible. The basic types of
assisted living services offered by the Company include the following:

Personal Care Services. These services include assistance with ADLs
such as ambulation, bathing, dressing, eating, grooming, personal hygiene,
and monitoring or assistance with medications.

Support Services. These services include meals, assistance with
social and recreational activities, laundry services, general housekeeping,
maintenance services and transportation services.

Supplemental Services. These services include extra transportation
services, personal maintenance, extra laundry services, non-routine care
services, and special care services, such as services for residents with
certain forms of dementia. Certain of these services require an extra
charge in addition to the pricing levels described below.

In pricing its services, the Company has developed the following three
levels or tiers of assisted living care:

- Level I typically provides for minimum levels of care and service, for
which the Company generally charges a monthly fee per resident ranging
from $1,475 to $4,815, depending upon unit size and the project design
type. Typically, Level I residents need minimal assistance with ADLs.

- Level II provides for relatively higher levels and increased frequency of
care, for which the Company generally charges a monthly fee per resident
ranging from $1,775 to $4,815, depending upon the unit size and the
project design type. Typically, Level II residents require moderate
assistance with ADLs and may need additional personal care, support and
supplemental services.

- Level III provides for the highest level of care and service, for which
the Company generally charges a monthly fee per resident ranging from
$2,125 to $4,815, depending upon the unit size and the project design
type. Typically, Level III residents are either very frail or impaired
and utilize many of the Company's services on a regular basis.

The Company maintains programs and special units at some of its assisted
living communities for residents with certain forms of dementia, which provide
the attention, care and services needed to help those residents maintain a
higher quality of life. Specialized services include assistance with ADLs,
behavior management and a life skills based activities program, the goal of
which is to provide a normalized environment that supports residents' remaining
functional abilities. Whenever possible, residents assist with meals, laundry
and housekeeping. Special units for residents with certain forms of dementia are
located in a separate area of the community and have their own dining
facilities, resident lounge areas, and specially trained staff. The special care
areas are designed to allow residents the freedom to ambulate as they wish,
while keeping them safely contained within a secure area with a minimum of
disruption to other residents. Special nutritional programs are used to help
ensure caloric intake is maintained by residents. Resident fees for these
special units are dependent on the size of the unit, the design type and the
level of services provided.

SKILLED NURSING SERVICES

In its skilled nursing facilities, the Company provides traditional
long-term care through 24-hour-per-day skilled nursing care by registered
nurses, licensed practical nurses and certified nursing assistants. The Company
also offers a comprehensive range of restorative nursing and rehabilitation
services in its communities including, but not limited to, physical,
occupational, speech and medical social services. As of December 31, 2002, the
Company had ownership interests in two facilities providing a continuum of care
that provide nursing services with an aggregate capacity for 170 residents.

HOME CARE SERVICES

As of December 31, 2002, the Company provided private pay, home care
services to clients at one of its senior living communities through the
Company's on-site, home care agency and made private pay, home care
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services available to clients at a majority of its senior living communities
through third-party providers. The Company believes that the provision of
private pay, home care services is an attractive adjunct to its independent
living services because it allows the Company to provide more services to its
residents as they age in place and increases the length of stay in the Company's
communities. In addition, the Company makes available to residents certain
customized physician, dentistry, podiatry and other health-related services that
may be offered by third-party providers.

OPERATING COMMUNITIES

The table below sets forth certain information with respect to senior
living communities owned and managed by the Company as of December 31, 2002.

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(1) Independent living (IL) residences, assisted living (AL) residences and
skilled nursing (SN) beds.

(2) Those communities shown as 10% owned represent the Company's ownership of
approximately 10% of the member interests in BRE/CSL (as defined below).
Those communities shown as 1% owned represent the Company's ownership of
approximately 1% of the partnership interests in the Triad Entities (as
defined below). Those communities shown as 19% owned represent the Company's
ownership of approximately 19% of the member interests in the four joint
ventures which own the Spring Meadows Communities (as defined below). The
community shown as 57% owned represents the Company's ownership of
approximately 57% of the limited partner interests in HCP.

(3) Indicates the date on which the Company acquired each of its owned
communities or commenced operating its managed communities. The Company
operated certain of its communities pursuant to management agreements prior
to acquiring interests in the communities.

(4) The Company's home care agency is on-site at The Harrison at Eagle Valley
community.

(5) The Company acquired its member interests in the four joint ventures, which
own the Spring Meadows communities from LCOR (as defined below) on December
20, 2002.

THIRD-PARTY MANAGEMENT CONTRACTS

The Company is a party to a series of property management agreements (the
"BRE/CSL Management Agreements") with two joint ventures (collectively
"BRE/CSL") owned 90% by an affiliate of Blackstone Real Estate Advisors
("Blackstone") and 10% by the Company, which collectively own and operate five
senior living communities. The BRE/CSL Management Agreements extend until June
2007. The BRE/CSL Management Agreements provide for management fees of 5% of
gross revenue plus reimbursement for costs and expenses related to the
communities. The Company earned $0.5 million under the terms of the BRE/CSL
Management Agreements for the year ended December 31, 2002.

The Company is a party to a series of property management agreements (the
"Triad Management Agreements") with five partnerships affiliated with Triad
Senior Living, Inc. (the "Triad Entities"), which collectively own and operate
17 communities and two expansions. The Company has an approximate 1% limited
partnership interest in each of the Triad Entities. The Triad Management
Agreements extend until September 2022. The Triad Management Agreements provide
for a base management fee of the greater of

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$5,000 per month or 5% of gross revenue plus reimbursement for costs and
expenses related to the communities. The Company earned $1.5 million under the
terms of the Triad Management Agreements for the year ended December 31, 2002.

The Company was party to property management agreements (the "LCOR
Agreements") with affiliates of LCOR Incorporated ("LCOR") to operate four
independent living and assisted living communities (the "Spring Meadows
Communities") owned by joint ventures in which LCOR was a member. The locations
covered by the agreements were: Trumbull, Connecticut, Libertyville, Illinois,
Summit, New Jersey and Naperville, Illinois. Three LCOR Agreements provided for
a base management fee of the greater of $15,000 per month or 5% of gross
revenues, plus an incentive fee equal to 25% of the excess cash flow over
budgeted amounts. The remaining LCOR Agreement provided for a base management
fee of the greater of $13,321 per month or 5% of gross revenues, plus an
incentive fee equal to 25% of the excess cash flow over budgeted amounts. The
terms of the LCOR Agreements were for 10 years with a five-year renewal at the
Company's option. The Company earned $0.8 million under the terms of the LCOR
Agreements for the year ended December 31, 2002. During the fourth quarter of
2002, the Company acquired LCOR's approximate 19% interest in the four joint
ventures which own the Spring Meadows Communities as well as loans made by LCOR
to the joint ventures for $0.9 million in addition to funding $0.4 million for
working capital and anticipated negative cash requirements of the communities.
The Company will continue to manage the communities under long-term management
contracts, which extend until December 2010 with a five-year renewal at the
Company's option. In addition, the Company will receive an asset management fee
of 0.75% of annual revenues relating to each of the four communities. The
Company recorded its initial advances of $1.3 million to the ventures as notes
receivable as the amount assigned for the 19% member interests was nominal.

The Company was a party to a property management agreement (the "ILM II
Management Agreement") with ILM II Lease Corporation, a corporation formed by
ILM II, that operated five senior living communities. The ILM II Management
Agreement commenced on July 29, 1996. The ILM II Management Agreement was
originally scheduled to expire on March 31, 2001. Subsequent to March 31, 2001,
the Company managed the ILM II communities on a month-to-month basis under the
terms of the original ILM II Management Agreement. The Company earned management
fees and incentive fees of $0.2 million under the terms of the ILM II Management
Agreement for the year ended December 31, 2002. During 2002, ILM II sold the
five communities and terminated the ILM II Management Agreement effective April
1, 2002.

The Company was party to three separate property management agreements (the
"Buckner Agreements") with Buckner Retirement Services, Inc. ("Buckner"), a
not-for-profit corporation that operates three senior living communities. The
Buckner Agreements commenced in April 1996, January 1998 and June 2000 and were
scheduled to expire in March 2001, December 2002 and May 2005, respectively,
except that either party could terminate the agreements for cause under limited
circumstances.

The Buckner Agreement for the Westminister Place facility expired on its
own terms in March of 2001. With respect to the Calderwoods facility, the
Company and Buckner entered into a Management Termination, Consulting, Licensing
and Transfer Agreement (the "Calderwoods Termination Agreement") effective
September 30, 2001 whereby the Company and Buckner mutually agreed to terminate
the Management Agreement then in place between the parties. Under the terms of
the Calderwoods Termination Agreement, the Company will continue to provide
certain consulting services and earn a consulting/licensing fee of three and
one-half percent of the facility's gross revenues through December 31, 2001 and
three percent of the facility's gross revenues beginning on January 1, 2002 and
continuing through May 31, 2005. During 2002, the Company earned $0.1 million
under the Calderwoods Termination Agreement. Subsequent to December 31, 2002,
the Company and Buckner entered into an agreement whereby Buckner paid the
Company $0.3 million to terminate Buckner's future consulting/licensing fee
obligations under the Calderwoods Termination Agreement.

With respect to the Parkway Place facility, the Company terminated for
cause its Management Agreement with Buckner at that facility effective December
31, 2001 due to Buckner's failure to reimburse

10

the Company for certain health benefits paid by the Company for the employees of
that particular facility. The Company filed a claim with the American
Arbitration Association seeking reimbursement of certain health care expenses,
as well as severance compensation pursuant to the Management Agreement. On
October 9, 2002, the Company entered into a settlement agreement (the
"Agreement") with Buckner relating to the Company's claim for reimbursement of
health care expenses pursuant to the Management Agreement between the parties.
Pursuant to the Agreement, Buckner waived any claims against the Company for
early termination by the Company of its Management Agreement with Buckner at
Parkway Place and additionally agreed to pay certain damages to the Company.

GROWTH STRATEGIES

The Company believes that the fragmented nature of the senior living
industry and the limited capital resources available to many small, private
operators provide an attractive opportunity for the Company to expand its
existing base of senior living operations. The Company believes that its current
operations throughout the United States serve as the foundation on which the
Company can build senior living networks in targeted geographic markets and
thereby provide a broad range of high quality care in a cost-efficient manner.

The following are the principal elements of the Company's growth strategy:

PURSUE MANAGEMENT AGREEMENTS

The Company intends to pursue single or portfolio management opportunities
for senior living communities. The Company believes that its management
infrastructure and proven operating track record will allow the Company to take
advantage of increased opportunities in the senior living market for new
management contracts and other transactions. In addition, the Company will
manage the communities acquired by BRE/CSL under long-term management contracts.

PURSUE STRATEGIC ACQUISITIONS

The Company intends to continue to pursue single or portfolio acquisitions
of senior living communities and, to a lesser extent, other assisted living
communities. Through strategic acquisitions, the Company will seek to enter new
markets or acquire communities in existing markets as a means to increase market
share, augment existing clusters, strengthen its ability to provide a broad
range of care, and create operating efficiencies. As the industry continues to
consolidate, the Company believes that opportunities will arise to acquire other
senior living companies. The Company believes that the current fragmented nature
of the senior living industry, combined with the Company's financial resources,
national presence, and extensive contacts within the industry, can be expected
to provide it with the opportunity to evaluate a number of potential acquisition
opportunities in the future. In reviewing acquisition opportunities, the Company
will consider, among other things, geographic location, competitive climate,
reputation and quality of management and communities, and the need for
renovation or improvement of the communities.

The Company formed BRE/CSL with Blackstone in December 2001, and the joint
venture seeks to acquire in excess of $200 million of senior housing properties.
BRE/CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms
of the joint venture, each of the Company and Blackstone must approve any
acquisitions made by BRE/CSL. Each party must also contribute its pro rata
portion of the costs of any acquisition. In December 2001, BRE/CSL acquired
Amberleigh, a 394 resident capacity independent living facility. In connection
with the acquisition of Amberleigh by BRE/CSL, the Company contributed $1.8
million to BRE/CSL. During the second quarter of 2002, BRE/CSL obtained
permanent financing for the Amberleigh community and the Company recovered $1.4
million of its contribution to BRE/CSL.

In addition, on June 13, 2002, the Company contributed to BRE/CSL four of
its senior living communities with a capacity of approximately 600 residents. As
a result of the contribution, the Company repaid $29.1 million of long-term debt
to GMAC Commercial Mortgage Corporation ("GMAC"), received $7.3 million in cash
from BRE/CSL, has a 10% equity interest in the venture of $1.2 million and
wrote-off $0.5 million in deferred loan costs.
11

The Company manages the five communities owned by BRE/CSL under long-term
management contracts. The Company accounts for the BRE/CSL investment under the
equity method of accounting. The Company has deferred $50,000 of management fee
income as a result of its 10% interest in the BRE/CSL joint venture.

During the fourth quarter of 2002, the Company acquired LCOR's interests in
four joint ventures which own the Spring Meadows Communities from LCOR as well
as loans made by LCOR to the joint ventures for $0.9 million in addition to
funding $0.4 million to the venture for working capital and anticipated negative
cash requirements of the communities. The Company's interests in the four joint
ventures which own the Spring Meadows Communities include interests in certain
loans to the ventures and an approximate 19% member interest in each venture.
The Company has managed the Spring Meadows Communities since the opening of each
community in late 2000 and early 2001 and will continue to manage the
communities under long-term management contracts. In addition, the Company will
receive an asset management fee relating to each of the four communities. The
Company recorded its initial advances of $1.3 million to the ventures as notes
receivable as the amount assigned for the 19% member interests was nominal. The
Company accounts for its investment in the Spring Meadows Communities under the
equity method of accounting based on the provisions of the partnership
agreements. The Company has the obligation to fund certain future operating
deficits of the Spring Meadows Communities to the extent of its 19% member
interest.

DEVELOP NEW SENIOR LIVING COMMUNITIES

General. The Company intends to continue to expand its operations through
the development, construction, marketing and management of new senior living
communities in selected markets that provide a quality lifestyle that is
affordable to a large segment of seniors.

Triad Entities. The Company has opened, in connection with its management
agreements, 17 new Waterford and Wellington communities and two expansions in
the last four years. The Waterford and Wellington community models are designed
to provide middle-income residents with a senior living community having
amenities typical of higher-priced communities. This is accomplished through
more efficient space design, emphasizing common areas and providing more
efficient layouts of the living areas. The Company believes that the Waterford
and Wellington designs meet the desire of many of the Company's residents to
move into a new residence that approximates, as nearly as possible, the comfort
of their prior home.

The development agreements between each Triad Entity and the Company
generally provided for a development fee of 4% of project costs, plus
reimbursements for expenses and overhead not to exceed 4% of project costs. The
Company has the option, but not the obligation, to purchase the partnership
interests of the other partners in the Triad Entities for an amount equal to the
amount paid for the partnership interest by the other partners, plus a
noncompounded return of 12% per annum, except for Triad I. The property
management agreements also provide the Company with an option, but not the
obligation, to purchase the communities developed by the Triad Entities, other
than Triad I, upon their completion for an amount equal to the fair market
value, based on a third-party appraisal, but not less than hard and soft costs
and lease-up costs. In December 1999, Triad I completed a recapitalization in
which an affiliate of Lehman Brothers ("Lehman") purchased from a third party
80% of the limited partnership interests in Triad I for an investment of
$12,000,000. Lehman's investment enabled Triad I to repay the Company
approximately $9,000,000 in loans. The Company increased its equity contribution
in Triad I to $3,000,000 and owned a 19% limited partnership interest in Triad I
until the fourth quarter of fiscal 2000. On October 1, 2000, the Company reduced
its ownership interest in each of the Triad Entities to 1%. This reduction was
accomplished by converting a portion of the Company's investment in each of the
Triad Entities to notes receivable. The Company has the option, but not the
obligation, to purchase the Triad I communities for an amount specified in the
partnership agreement. Furthermore, Lehman has agreed to withdraw as a partner
in the Triad I partnership to the extent it has received, on or before November
1, 2004, distributions in an amount equal to its capital contributions of $12.4
million. The Company continues to manage the communities in Triad I. See "Recent
Developments" under Item 1. Business for a description of the Company's
agreements to purchase the partnership interests in Triads II, III, IV and V
owned by non-Company parties.
12

EXPAND REFERRAL NETWORKS

The Company intends to continue to develop relationships with local and
regional hospital systems, managed care organizations and other referral sources
to attract new residents to the Company's communities. In certain circumstances
these relationships may involve strategic alliances or joint ventures. The
Company believes that such arrangements or alliances, which could range from
joint marketing arrangements to priority transfer agreements, will enable it to
be strategically positioned within the Company's markets if, as the Company
believes, senior living programs become an integral part of the evolving health
care delivery system.

OPERATIONS

CENTRALIZED MANAGEMENT

The Company centralizes its corporate and other administrative functions so
that the community-based management and staff can focus their efforts on
resident care. The Company maintains centralized accounting, finance, human
resources, training and other operational functions at its national corporate
office in Dallas, Texas. The Company's corporate office is generally responsible
for: (i) establishing Company-wide policies and procedures relating to, among
other things, resident care and operations; (ii) performing accounting
functions; (iii) developing employee training programs and materials; (iv)
coordinating human resources; (v) coordinating marketing functions; and (vi)
providing strategic direction. In addition, financing, development, construction
and acquisition activities, including feasibility and market studies, and
community design, development, and construction management are conducted by the
Company's corporate offices.

The Company seeks to control operational expenses for each of its
communities through standardized management reporting and centralized controls
of capital expenditures, asset replacement tracking, and purchasing for larger
and more frequently used supplies. Community expenditures are monitored by
regional and district managers who are accountable for the resident satisfaction
and financial performance of the communities in their region.

REGIONAL MANAGEMENT

The Company provides oversight and support to each of its senior living
communities through experienced regional and district managers. A district
manager will oversee the marketing and operations of two to four communities
clustered in a small geographic area. A regional manager will cover a larger
geographic area consisting of five to twelve communities. In most cases, the
district and regional managers will office out of the Company's senior living
communities. Currently there are regional managers based in the Northeast,
Southeast, Midwest, Southwest and West regions.

The executive director at each community reports to a regional or district
manager. The regional and district managers report directly to the President and
Chief Operating Officer of the Company. The district and regional managers make
regular site visits to each of their communities. The site visits involve a
physical plant inspection, quality assurance review, staff training, financial
and systems audits, regulatory compliance, and team building.

COMMUNITY-BASED MANAGEMENT

An executive director manages the day-to-day operations at each senior
living community, including oversight of the quality of care, delivery of
resident services, and monitoring of financial performance. The executive
director is also responsible for all personnel, including food service,
maintenance, activities, security, assisted living, housekeeping, and, where
applicable, nursing. In most cases, each community also has department managers
who direct the environmental services, nursing or care services, business
management functions, dining services, activities, transportation, housekeeping,
and marketing functions.

The assisted living and skilled nursing components of the senior living
communities are managed by licensed professionals, such as a nurse and/or a
licensed administrator. These licensed professionals have many of the same
operational responsibilities as the Company's executive directors, but their
primary responsibility is to oversee resident care. Many of the Company's senior
living communities and all of its
13

skilled nursing facilities are part of a campus setting, which include
independent living. This campus arrangement allows for cross-utilization of
certain support personnel and services, including administrative functions that
result in greater operational efficiencies and lower costs than freestanding
facilities.

The Company actively recruits personnel to maintain adequate staffing
levels at its existing communities and hires new staff for new or acquired
communities prior to opening. The Company has adopted comprehensive recruiting
and screening programs for management positions that utilize corporate office
team interviews and thorough background and reference checks. The Company offers
system-wide training and orientation for all of its employees at the community
level through a combination of Company-sponsored seminars and conferences.

QUALITY ASSURANCE

Quality assurance programs are coordinated and implemented by the Company's
corporate and regional staff. The Company's quality assurance is targeted to
achieve maximum resident and resident family member satisfaction with the care
and services delivered by the Company. The Company's primary focus in quality
control monitoring includes routine in-service training and performance
evaluations of caregivers and other support employees. Additional quality
assurance measures include:

Resident and Resident's Family Input. On a routine basis the Company
provides residents and their family members the opportunity to provide valuable
input regarding the day-to-day delivery of services. On-site management at each
community has fostered and encouraged active resident councils and resident
committees who meet independently. These resident bodies meet with on-site
management on a monthly basis to offer input and suggestions as to the quality
and delivery of services. Additionally, at each community the Company conducts
annual resident satisfaction surveys to further monitor the satisfaction levels
of both residents and their family members. These surveys are sent directly to
the corporate headquarters for tabulation and distribution to on-site staff and
residents. For both 2002 and 2001, the Company achieved a 97% approval rating
from its residents. For any departmental area of service scoring below a 90%, a
plan of correction is developed jointly by on-site, regional and corporate staff
for immediate implementation.

Regular Community Inspections. On a monthly basis, a community inspection
is conducted by regional and/or corporate staff. Included, as part of this
inspection is the monitoring of the overall appearance and maintenance of the
community interiors and grounds. The inspection also includes monitoring staff
professionalism and departmental reviews of maintenance, housekeeping,
activities, transportation, marketing, administration and food and health care
services, if applicable. The monthly inspection also includes observing of
residents in their daily activities and the community's compliance with
government regulations.

Independent Service Evaluations. The Company engages the services of
outside professional independent consulting firms to evaluate various components
of the community operations. These services include mystery shops, competing
community analysis, pricing recommendations and product positioning. This
provides management with valuable unbiased product and service information. A
plan of action regarding any areas requiring improvement or change is
implemented based on information received. At communities where health care is
delivered, these consulting service reviews include the on-site handling of
medications, record keeping and general compliance with all governmental
regulations.

MARKETING

Each community is staffed by on-site sales directors and additional
marketing/sales staff depending on the community size and occupancy status. The
primary focus of the on-site marketing staff is to create awareness of the
Company and its services among prospective residents and family members,
professional referral sources and other key decision makers. These efforts
incorporate an aggressive marketing plan to include monthly and annual goals for
leasing, new lead generation, prospect follow up, community outreach and
resident and family referrals. Additionally, the marketing plan includes a
calendar of promotional events and a comprehensive media program. On-site
marketing departments perform a competing community assessment quarterly.
Corporate and regional marketing directors monitor the on-site marketing
departments' effectiveness and productivity on a monthly basis. Routine detailed
marketing department audits are
14

performed on an annual basis or more frequently if deemed necessary. Corporate
and regional personnel assist in the development of marketing strategies for
each community and produce creative media, assist in direct mail programs and
necessary marketing collateral. Ongoing sales training of on-site
marketing/sales staff is implemented by corporate and regional marketing
directors.

In the case of new development, the corporate and regional staff develops a
comprehensive community outreach program that is implemented at the start of
construction. A marketing pre-lease program is developed and on-site marketing
staff are hired and trained to begin the program implementation six to nine
months prior to the community opening. Extensive use of media, including radio,
television, print, direct mail and telemarketing, is implemented during this
pre-lease phase.

After the community is opened and sustaining occupancy levels are attained,
the on-site marketing staff is more heavily focused on resident and resident
family referrals, as well as professional referrals. A maintenance program of
print media and direct mail is then implemented.

RECENT DEVELOPMENTS

The Company has recently made the election to exercise its options to
purchase the partnership interests in the Triad Entities owned by non-Company
parties, with the exception of Triad I. The Company and the Triad Entities, with
the exception of Triad I, entered into Partnership Interest Purchase Agreements
("Purchase Agreements") on March 25, 2003, whereby the Company will purchase the
partnership interests of the general partners and other third party limited
partnership interests for an aggregate of approximately $1.7 million. Upon
completion of these transactions, which the Company expects to take place by the
end of the Company's second fiscal quarter of 2003, the Company will wholly own
each partnership, other than Triad I. The Company will treat these transactions
as a purchase of real estate and therefore does not expect any goodwill or other
intangibles to be recognized related to these transactions. The Purchase
Agreements are subject to customary terms and conditions.

Summary financial information regarding the financial position of the Triad
Entities as of December 31, 2002 and 2001 and results of operations for the
years ended December 31, 2002 and 2001 of the Triad Entities is presented below.
The Company is also presenting unaudited pro forma financial information as if
the Company's purchase of the Triad Entities (except Triad I) were effective
January 1, 2002. In addition, the unaudited pro forma financial information
includes consolidating Triad I as if the provisions of FASB Interpretation No.
46 were effective January 1, 2002. Beginning in the third quarter of 2003, FASB
Interpretation No. 46 will require the Company to consolidate the financial
position and results of operation of Triad I with the Company's financial
information. The unaudited pro forma financial information, which may not be
indicative of future results, includes the elimination of significant
intercompany balances and assumes incomes taxes at a 39% effective tax rate (in
thousands):

The unaudited pro forma consolidated amounts are presented for
informational purposes only and do not necessarily reflect the financial
position or results of operations of the Company that would have actually
occurred had the transactions occurred on January 1, 2002.

GOVERNMENT REGULATION

Changes in existing laws and regulations, adoption of new laws and
regulations and new interpretations of existing laws and regulations could have
a material effect on the Company's operations. Failure by the Company to comply
with applicable regulatory requirements could have a material adverse effect on
the Company's business, financial condition, and results of operations.
Accordingly, the Company monitors legal and regulatory developments on local and
national levels.

The health care industry is subject to extensive regulation and frequent
regulatory change. At this time, no federal laws or regulations specifically
regulate assisted or independent living residences. While a number of states
have not yet enacted specific assisted living regulations, certain of the
Company's assisted living communities are subject to regulation, licensing,
Certificate of Need and permitting by state and local health care and social
service agencies and other regulatory authorities. While such requirements vary
from state to state, they typically relate to staffing, physical design,
required services and resident characteristics. The Company believes that such
regulation will increase in the future. In addition, health care providers are
receiving increased scrutiny under anti-trust laws as integration and
consolidation of health care delivery increases and affects competition. The
Company's communities are also subject to various zoning restrictions, local
building codes, and other ordinances, such as fire safety codes. Failure by the
Company to comply with applicable regulatory requirements could have a material
adverse effect on the Company's business, financial condition, and results of
operations. Regulation of the assisted living industry is evolving. The Company
is unable to predict the content of new regulations and their effect on its
business. There can be no assurance that the Company's operations will not be
adversely affected by regulatory developments.

The Company believes that its communities are in substantial compliance
with applicable regulatory requirements. However, in the ordinary course of
business, one or more of the Company's communities could be cited for
deficiencies. In such cases, the appropriate corrective action would be taken.
To the Company's knowledge, no material regulatory actions are currently pending
with respect to any of the Company's communities.

Under the Americans with Disabilities Act of 1990, all places of public
accommodation are required to meet certain 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
properties to permit access to the properties by disabled persons. While 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 ("HIPAA"),
among other things, established standards for the use and access to health
information. Known as the administrative simplification requirements, these
provisions, as implemented by regulations published by the United States
Department of Health and Human Services, established among other things,
standards for the security and privacy of health

16

information. Additionally, the rules provide for the use of uniform standard
codes for electronic transactions and require the use of uniform employer
identification codes. Penalties for violations can range from civil fines to
criminal sanctions for the most serious offenses. Compliance with the rules is
phased in beginning in October 2002 and extending until April 2005. These rules
are complicated, and there are still a number of unanswered questions with
respect to the extent and manner in which the HIPAA rules apply to businesses
such as those operated by the Company. However, the Company continues to
evaluate the regulations to ensure that where they are applicable, required
systems are in place in order to comply with the HIPAA regulations.

In addition, the Company is subject to various federal, state and local
environmental laws and regulations. Such laws and regulations often impose
liability whether or not the owner or operator knew of, or was responsible for,
the presence of hazardous or toxic substances. The costs of any required
remediation or removal of these substances could be substantial and the
liability of an owner or operator as to any property is generally not limited
under such laws and regulations and could exceed the property's value and the
aggregate assets of the owner or operator. The presence of these substances or
failure to remediate such contamination properly may also adversely affect the
owner's ability to sell or rent the property, or to borrow using the property as
collateral. Under these laws and regulations, an owner, operator or an entity
that arranges for the disposal of hazardous or toxic substances, such as
asbestos-containing materials, at a disposal site may also be liable for the
costs of any required remediation or removal of the hazardous or toxic
substances at the disposal site. In connection with the ownership or operation
of its properties, the Company could be liable for these costs, as well as
certain other costs, including governmental fines and injuries to persons or
properties. The Company has completed Phase I environmental audits of
substantially all of the communities in which the Company owns interests, and
such surveys have not revealed any material environmental liabilities that exist
with respect to these communities.

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 such property, and may be held liable to a governmental
entity or to third parties for property damage and for investigation and clean
up costs. The Company is not aware of any environmental liability with respect
to any of its owned, leased or managed communities that the Company believes
would have a material adverse effect on its business, financial condition, or
results of operations. The Company believes that its communities are in
compliance in all material respects with all federal, state and local laws,
ordinances and regulations regarding hazardous or toxic substances or petroleum
products. The Company has not been notified by any governmental authority, and
is not otherwise aware of any material non-compliance, liability, or claim
relating to hazardous or toxic substances or petroleum products in connection
with any of the communities the Company currently operates.

The Company believes that the structure and composition of government and,
specifically, health care regulations will continue to change and, as a result,
regularly monitors developments in the law. The Company expects to modify its
agreements and operations from time to time as the business and regulatory
environments change. While the Company believes it will be able to structure all
its agreements and operations in accordance with applicable law, there can be no
assurance that its arrangements will not be successfully challenged.

COMPETITION

The senior living industry is highly competitive, and the Company expects
that all segments of the industry will become increasingly competitive in the
future. Although there are a number of substantial companies active in the
senior living industry and in the markets in which the Company operates, the
industry continues to be very fragmented and characterized by numerous small
operators. The Company competes with American Retirement Corporation, ARV
Assisted Living, Inc., Brookdale Living Communities, Emeritus Corporation,
Holiday Retirement Corporation and Sunrise Assisted Living, Inc. The Company
believes that the primary competitive factors in the senior living industry are:
(i) reputation for and commitment to a high quality of service; (ii) quality of
support services offered (such as food services); (iii) price of services; (iv)
physical appearance and amenities associated with the communities; and (v)
location. The Company
17

competes with other companies providing independent living, assisted living,
skilled nursing, home health care, and other similar service and care
alternatives, some of whom may have greater financial resources than the
Company. Because seniors tend to choose senior living communities near their
homes, the Company's principal competitors are other senior living and long-term
care communities in the same geographic areas as the Company's communities. 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.

EMPLOYEES

As of December 31, 2002, the Company employed 2,244 persons, of which 1,167
were full-time employees (48 of whom are located at the Company's corporate
offices) and 1,077 were part-time employees. None of the Company's employees is
currently represented by a labor union and the Company is not aware of any union
organizing activity among its employees. The Company believes that its
relationship with its employees is good.

EXECUTIVE OFFICERS AND KEY EMPLOYEES

The following table sets forth certain information concerning each of the
Company's executive officers and key employees as of December 31, 2002:

Lawrence A. Cohen has served as a director and Vice Chairman of the Board
since November 1996. He has served as Chief Executive Officer since May 1999 and
was Chief Financial Officer from November 1996 to May 1999. From 1991 to 1996,
Mr. Cohen served as President and Chief Executive Officer of Paine Webber
Properties Incorporated, which controlled a real estate portfolio having a cost
basis of approximately $3.0 billion, including senior living facilities of
approximately $110.0 million. From 1991 to 1998, Mr. Cohen was President and a
member of the board of directors of ILM and ILM II. Mr. Cohen serves on the
boards of various charitable organizations, and was a founding member and is on
the executive committee of the Board of the American Seniors Housing
Association. Mr. Cohen has earned a Masters in Law, is a licensed attorney and
is also a Certified Public Accountant. Mr. Cohen has had positions with
businesses involved in senior living for 18 years.

James A. Stroud has served as a director and officer of the Company and its
predecessors since January 1986. He currently serves as Chairman and Secretary
of the Company and Chairman of the Board. Mr. Stroud also serves on the boards
of various educational and charitable organizations, and in varying capacities
with several trade organizations, including as a member of the Founder's Council
and Leadership Council of the Assisted Living Federation of America. Mr. Stroud
also serves as an Owner/Operator Advisory Group member to the National
Investment Conference and as a Founding Sponsor of The Johns Hopkins University
Senior Housing and Care Program. Mr. Stroud was the past President and Member of
the board of directors

18

of the National Association for Senior Living Industry Executives. He also was a
founder of the Texas Assisted Living Association and served as a member of its
board of directors. Mr. Stroud has earned a Masters in Law, is a licensed
attorney and is also a Certified Public Accountant. Mr. Stroud has had positions
with businesses involved in senior living for 18 years.

Keith N. Johannessen has served as President of the Company and its
predecessors since March 1994, and previously served as Executive Vice President
from May 1993 until February 1994. Mr. Johannessen has served as a director and
Chief Operating Officer since May 1999. From 1992 to 1993, Mr. Johannessen
served as Senior Manager in the health care practice of Ernst & Young. From 1987
to 1992, Mr. Johannessen was Executive Vice President of Oxford Retirement
Services, Inc. Mr. Johannessen has served on the State of the Industry and Model
Assisted Living Regulations Committees of the American Seniors Housing
Association. Mr. Johannessen has been active in operational aspects of senior
housing for 24 years.

Ralph A. Beattie joined the Company as Executive Vice President and Chief
Financial Officer in May 1999. From 1997 to 1999, he served as Executive Vice
President and the Chief Financial Officer of Universal Sports America, Inc.,
which was honored as the number one growth company in Dallas for 1998. For the
eight years prior to that he was Executive Vice President and Chief Financial
Officer for Haggar Clothing Company, during which time Haggar successfully
completed its initial public offering. Mr. Beattie has earned his Masters of
Business Administration and is both a Certified Management Accountant and a
Certified Financial Planner.

Rob L. Goodpaster has served as Vice President -- National Marketing of the
Company and its predecessors since December 1992. From 1990 to 1992, Mr.
Goodpaster was National Director for Marketing for Autumn America, an owner and
operator of senior housing facilities. Mr. Goodpaster has been active in
professional industry associations and formerly served on the Board of Directors
for the National Association For Senior Living Industries. Mr. Goodpaster has
been active in the operational, development and marketing aspects of senior
housing for 26 years.

David W. Beathard, Sr. has served as Vice President -- Operations of the
Company and its predecessors since August 1996. From 1992 to 1996, Mr. Beathard
owned and operated a consulting firm, which provided operational, marketing, and
feasibility consulting regarding senior housing facilities. Mr. Beathard has
been active in the operational, sales and marketing, and construction oversight
aspects of senior housing for 29 years.

David R. Brickman has served as Vice President and General Counsel of the
Company and its predecessors since July 1992. From 1989 to 1992, Mr. Brickman
served as in-house counsel with LifeCo Travel Management Company, a corporation
that provided travel services to U.S. corporations. Mr. Brickman has also earned
a Masters of Business Administration and a Masters in Health Administration. Mr.
Brickman has either practiced law or performed in-house counsel functions for 16
years.

Paul T. Lee has served as Vice President -- Finance since February 1999.
From 1992 to 1998, Mr. Lee served in various management positions of Chief Auto
Parts Inc., which was one of the nation's largest automotive aftermarket retail
chains. From 1995 to 1998, he held the position of Assistant Treasurer. Prior to
joining Chief Auto Parts, Mr. Lee held various positions in the finance
department of Brice Foods, Inc. from 1988 to 1992.

Jerry D. Lee, a Certified Public Accountant, has served as Corporate
Controller since April 1999. Prior to joining the Company, Mr. Lee served as the
Senior Vice President of Finance, from 1997 to 1999, for Universal Sports
America, Inc., which produced sporting events and provided sports marketing
services for collegiate conferences and universities. From 1984 to 1997, Mr. Lee
held various accounting management positions with Haggar Clothing Company. Mr.
Lee is a member of the Financial Executives International, the American
Institute of Certified Public Accountants and is also a member of the Texas
Society of Certified Public Accountants.

Robert F. Hollister, a Certified Public Accountant, has served as Property
Controller for the Company and its predecessors since April 1992. From 1985 to
1992, Mr. Hollister was Chief Financial Officer and Controller of Kavanaugh
Securities, Inc., a National Association of Securities Dealers broker dealer.
19

Mr. Hollister is a Certified Financial Planner. Mr. Hollister is a member of the
American Institute of Certified Public Accountants and is also a member of the
Texas Society of Certified Public Accountants.

ITEM 2. PROPERTIES

The executive and administrative offices of the Company are located at
14160 Dallas Parkway, Suite 300, Dallas, Texas 75254, and consist of
approximately 20,000 square feet. The lease on the premises extends through
February 2008. The Company believes that its corporate office facilities are
adequate to meet its requirements through at least fiscal 2003 and that suitable
additional space will be available, as needed, to accommodate further physical
expansion of corporate operations. The Company also leases executive office
space in New York, New York pursuant to an annual lease agreement.

As of December 31, 2002, the Company owned and/or managed the senior living
communities referred to in Item 1 above under the caption "Operating
Communities."

ITEM 3. LEGAL PROCEEDINGS

On or about October 23, 1998, Robert Lewis filed a putative class action
complaint on behalf of certain holders of assignee interests (the "Assignee
Interests") in NHP Retirement Housing Partners I Limited Partnership ("NHP") in
the Delaware Court of Chancery, Civil Action No. 16725 (the "Delaware Action")
against NHP, the general partner of NHP ("General Partner"), the Company and
Capital Senior Living Properties 2-NHPCT, Inc. (collectively, the "Defendants").
The complaint alleged, among other things, that the Defendants breached, or
aided and abetted a breach of, the express and implied terms of the NHP
Partnership Agreement in connection with the sale of four properties by NHP to
Capital Senior Living Properties 2-NHPCT, Inc. in September 1998 (the "1998
Transaction"). The complaint sought, among other relief, rescission of the 1998
Transaction and unspecified damages. Subsequently, the plaintiff amended his
complaint adding allegations challenging the terms of the sale in December 2001
of the Amberleigh retirement facility to BRE/CSL. On December 6, 2001, Leonard
Kalmenson filed a motion to intervene in the Delaware Action on behalf of a
putative class of holders of Pension Notes of NHP in the event the Court of
Chancery determined that the claims asserted in the Delaware Action were
derivative in nature.

On October 18, 2002, the Delaware Court of Chancery entered a Final Order
and Judgment (i) certifying a class consisting of all record and beneficial
holders of Assignee Interests of NHP as of September 30, 1998 or any time
thereafter, (ii) approving as fair, reasonable and adequate a settlement of the
Delaware Action calling for the creation of a settlement fund in the amount of
approximately $0.8 million, (iii) dismissing the Delaware Action with prejudice
and releasing, among other things, all the claims asserted therein, and (iv)
awarding attorneys' fees and expenses in the amount of $0.3 million to be paid
from the settlement fund to counsel for the class. NHP previously contributed
$0.3 million to the creation of the settlement fund, which is the amount of the
deductible of NHP's directors and officers' liability insurance policy at the
time the Delaware Action was filed (the "D&O Policy"). Virtually all of the
balance of the settlement fund was contributed by various insurance brokers and
agents, and their insurers, in connection with the resolution of certain claims
for coverage under the D&O Policy. In accordance with the settlement,
approximately $0.6 million (the amount of the settlement fund minus the award
for attorneys' fees and expenses) was distributed to the class of Assignee
Holders on a pro rata basis after the settlement became final.

On October 9, 2002, the Company entered into a settlement agreement (the
"Agreement") with Buckner Retirement Services, Inc. ("Buckner") relating to the
Company's claim for reimbursement of health care expenses pursuant to the
Management Agreement between the parties. Pursuant to the Agreement, Buckner
waived any claims against the Company for early termination by the Company of
its Management Agreement with Buckner at the Parkway Place facility ("Parkway
Place") and additionally agreed to pay certain damages to the Company.

In the fourth quarter of 2002, the Company (and two of its management
subsidiaries), Buckner, and a related Buckner entity, and other unrelated
entities were named as defendants in a lawsuit in district court in Fort Bend
County, Texas brought by the heir of a former resident who obtained nursing home
services at
20

Parkway Place. The Company managed Parkway Place for Buckner through December
31, 2001. The Company's insurers have hired counsel to investigate and defend
this claim. The Company is unable at this time to estimate its liability, if
any, related to this claim.

The Company has other pending claims not mentioned above ("Other Claims")
incurred in the course of its business. Most of these Other Claims are believed
by management to be covered by insurance, subject to normal reservations of
rights by the insurance companies and possibly subject to certain exclusions in
the applicable insurance policies. Whether or not covered by insurance, these
claims, in the opinion of management, based on advice of legal counsel, should
not have a material effect on the financial statements of the Company if
determined adversely to the Company.

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

There were no matters submitted to a vote of the Company's security holders
during the fourth quarter ended December 31, 2002.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY; RELATED STOCKHOLDER MATTERS

(a) The Company's shares of common stock are listed for trading on the New
York Stock Exchange ("NYSE") under the symbol "CSU". The following table sets
forth, for the periods indicated, the high and low sales prices for the
Company's common stock, as reported on the NYSE. At March 24, 2002 there were
approximately 3,700 stockholders of record of the Company's common stock.

It is the policy of the Company's Board of Directors to retain all future
earnings to finance the operation and expansion of the Company's business.
Accordingly, the Company has not and does not anticipate declaring or paying
cash dividends on the Common Stock in the foreseeable future. The payment of
cash dividends in the future will be at the sole discretion of the Company's
Board of Directors and will depend on, among other things, the Company's
earnings, operations, capital requirements, financial condition, restrictions in
then existing financing agreements, and other factors deemed relevant by the
Board of Directors.

21

The following table presents information relating to the Company equity
compensation plans as of December 31, 2002:

(b) Recent Sales of Unregistered Securities; Use of Proceeds from
Registered Securities. Not Applicable.

22

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected financial data of the Company. The
selected financial data for the years ended December 31, 2002, 2001, 2000, 1999
and 1998 are derived from the audited consolidated financial statements of the
Company.

- ---------------

(1) In fiscal 2000, the Company wrote off $1.6 million in notes receivable and
$1.4 million in development fees receivable relating to certain communities
that were under development for the Triad Entities. In addition, the Company
recorded a write-down on a house and five parcels of land of $1.0 million to
record these assets at their estimated net realizable value. In fiscal 1999,
the Company wrote off $3.9 million in notes receivable and $10.5 million in
development fees receivable from Triad Entities that were unable to secure
financing on favorable terms for the development of their senior living
communities. These joint ventures were in various stages of developing 19
Waterford communities.

(2) The Company recognized an extraordinary charge, net of minority interest and
income tax benefit, of $0.2 million. The charge resulted from a loan
foreclosure on HCP's McCurdy property.

(3) The Company refinanced $20.0 million of collateralized loans reflected as
short-term in fiscal 2001 to long-term variable rate debt in fiscal 2002.
The Company refinanced $47.7 million of mortgage loans reflected as
short-term debt in fiscal 1998 to long term fixed rate mortgage loans in
fiscal 1999.

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

OVERVIEW

The following discussion and analysis addresses the Company's results of
operations on a historical consolidated basis for the years ended December 31,
2002, 2001 and 2000. The following should be read in conjunction with the
Company's historical consolidated financial statements and the selected
financial data contained elsewhere in this report.

The Company is one of the largest operators of senior living communities in
the United States in terms of resident capacity. The Company's operating
strategy is to provide high quality senior living services at an affordable
price to its residents, while achieving and sustaining a strong, competitive
position within its chosen markets, as well as to continue to enhance the
performance of its operations. The Company provides a wide array of senior
living services to the elderly at its communities, including independent living,
assisted living (with special programs and living units at some of its
communities for residents with Alzheimer's and other forms of dementia), skilled
nursing and home care services.

The Company has acquired interests in and operates 43 senior living
communities.

The Company generates revenue from a variety of sources. For the year ended
December 31, 2002, the Company's revenues were derived as follows: 93.6% from
the operation of 18 owned communities; 0.1% from lease rentals from triple net
leases; 5.1% from management fees arising from management services provided for
24 affiliate-owned senior living communities and 11 third-party owned senior
living communities; and 1.2% from development fees earned for managing the
development and construction of new senior living communities for affiliate
owned senior living communities.

The Company believes that the factors affecting the financial performance
of communities managed under contracts with third parties do not vary
substantially from the factors affecting the performance of owned and leased
communities, although there are different business risks associated with these
activities.

24

The Company's third-party management fees are primarily based on a
percentage of gross revenues. As a result, the cash flow and profitability of
such contracts to the Company are more dependent on the revenues generated by
such communities and less dependent on net cash flow than for owned communities.
Further, the Company is not responsible for capital investments in managed
communities. While the management contracts are generally terminable only for
cause and upon the sale of a community, subject to the Company's rights to offer
to purchase such community.

The Company's current management contracts expire on various dates through
September 2022 and provide for management fees based generally upon 5% of net
revenues. In addition, certain of the contracts provide for supplemental
incentive fees that vary by contract based upon the financial performance of the
managed community. The Company's development fees are generally based upon a
percentage of construction cost and are earned over the period commencing with
the initial development activities and ending with the opening of the community.

The Company owns 57% of the HealthCare Properties, LP ("HCP") partnership
and the assets, liabilities, minority interest, and the results of operations of
HCP have been consolidated in the Company's financial statements. The Company,
through its ownership in HCP, leased two properties under triple net leases both
of which were sold in the first quarter of 2002. After the sale of these two
communities, HCP owns one community that is currently classified as held for
sale.

The Company owned 33.1% of the NHP Pension Notes ("NHP Notes"). The Company
classified its investment in the NHP Notes as held to maturity. The NHP Notes
bore simple interest at 13% per annum and matured on December 31, 2001. Interest
was paid quarterly at a rate of 7%, with the remaining 6% interest deferred.
During the fourth quarter of 2001, the Company reevaluated its assumptions
related to the NHP Notes, and as a result reduced interest income by $0.5
million. At December 31, 2001, the Company's effective interest rate on the NHP
Notes was 16.7%. In January 2002, NHP distributed its available cash and
proceeds from the sale of its remaining community to the NHP Note holders. The
Company received $5.6 million of this distribution. NHP has been dissolved and
is currently being liquidated.

The Company formed BRE/CSL with Blackstone in December 2001, and the joint
venture seeks to acquire in excess of $200 million of senior housing properties.
BRE/CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms
of the joint venture, each of the Company and Blackstone must approve any
acquisitions made by BRE/CSL. Each party must also contribute its pro rata
portion of the costs of any acquisition. In December 2001, BRE/CSL acquired
Amberleigh, a 394 resident capacity independent living facility. In connection
with the acquisition of Amberleigh by BRE/CSL, the Company contributed $1.8
million to BRE/CSL. During the second quarter of 2002, BRE/CSL obtained
permanent financing for the Amberleigh community and the Company recovered $1.4
million of its contribution to BRE/CSL.

In addition, on June 13, 2002, the Company contributed to BRE/CSL four of
its senior living communities with a capacity of approximately 600 residents. As
a result of the contribution, the Company repaid $29.1 million of long-term debt
to GMAC, received $7.3 million in cash from BRE/CSL, has a 10% equity interest
in the venture of $1.2 million and wrote-off $0.5 million in deferred loan
costs.

The Company manages the five communities owned by BRE/CSL under long-term
management contracts. The Company accounts for the BRE/CSL investment under the
equity method of accounting. The Company has deferred $50,000 of management fee
income as a result of its 10% interest in BRE/CSL.

During the fourth quarter of 2002, the Company acquired LCOR's interests in
the four joint ventures that own the Spring Meadows Communities from LCOR as
well as loans made by LCOR to the joint ventures for $0.9 million in addition to
funding $0.4 million to the venture for working capital and anticipated negative
cash requirements of the communities. The Company's interests in the joint
ventures that own the Spring Meadows Communities include interests in certain
loans to the ventures and an approximate 19% member interest in each venture.
The Company has managed the Spring Meadows Communities since the opening of each
community in late 2000 and early 2001 and will continue to manage the
communities under long-term management contracts. In addition, the Company will
receive an asset management fee relating to each of the four communities. The
Company recorded its initial advances of $1.3 million to the ventures as notes

25

receivable as the amount assigned for the 19% member interests was nominal. The
Company accounts for its investment in the Spring Meadows Communities under the
equity method of accounting based on the provisions of the partnership
agreements. The Company has the obligation to fund certain future operating
deficits of the Spring Meadows Communities to the extent of its 19% member
interest.

RECENT DEVELOPMENTS

The Company has recently made the election to exercise its options to
purchase the partnership interests in the Triad Entities owned by non-Company
parties, with the exception of Triad I. The Company and the Triad Entities, with
the exception of Triad I, entered into Partnership Interest Purchase Agreements
("Purchase Agreements") on March 25, 2003, whereby the Company will purchase the
partnership interests of the general partners and other third party limited
partnership interests for an aggregate of approximately $1.7 million. Upon
completion of these transactions, which the Company expects to take place by the
end of the Company's second fiscal quarter of 2003, the Company will wholly own
each partnership, other than Triad I. The Company will treat these transactions
as a purchase of real estate and therefore does not expect any goodwill or other
intangibles to be recognized related to these transactions. The Purchase
Agreements are subject to customary terms and conditions.

Summary financial information regarding the financial position of the Triad
Entities as of December 31, 2002 and 2001 and results of operations for the
years ended December 31, 2002 and 2001 of the Triad Entities is presented below.
The Company is also presenting unaudited pro forma financial information as if
the Company's purchase of the Triad Entities (except Triad I) were effective
January 1, 2002. In addition, the unaudited pro forma financial information
includes consolidating Triad I as if the provisions of FASB Interpretation No.
46 were effective January 1, 2002. Beginning in the third quarter of 2003, FASB
Interpretation No. 46 will require the Company to consolidate the financial
position and results of operation of Triad I with the Company's financial
information. The unaudited pro forma financial information, which may not be
indicative of future results, includes the elimination of significant
intercompany balances and assumes incomes taxes at a 39% effective tax rate (in
thousands):

26

The unaudited pro forma consolidated amounts are presented for
informational purposes only and do not necessarily reflect the financial
position or results of operations of the Company that would have actually
occurred had the transactions occurred on January 1, 2002.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
financial statements and related footnotes. Management bases its estimates and
assumptions on historical experience, observance of industry trends and various
other sources of information and factors, the results of which form the basis
for making judgments about the carrying value of assets and liabilities that are
not readily apparent from other sources. Actual results could differ from these
estimates. Critical accounting policies are defined as those that are reflective
of significant judgments and uncertainties, and potentially could result in
materially different results under different assumptions and conditions. The
Company believes the following critical accounting policies require managements
most difficult, subjective and complex judgments.

REVENUE RECOGNITION

Resident and health care revenue is recognized at estimated net realizable
amounts, based on historical experiences, due from residents in the period to
which the rental and other services are provided.

Revenues from the Medicare and Medicaid programs accounted for 8% of the
Company's net revenues in 2002. Under the Medicare program, payments are
determined based on established rates that differ from private pay rates.
Revenue from the Medicare program is recorded at established rates and adjusted
for differences between such rates and estimated amounts payable from the
program. Any differences between estimated and actual reimbursements are
included in operations in the year of settlement, which have not been material.
Under the Medicaid program, communities are entitled to reimbursement at
established rates that are lower than private pay rates. Patient service revenue
for Medicaid patients is recorded at the reimbursement rates as the rates are
set prospectively by the state upon the filing of an annual cost report.

Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations. Regulatory inquiries occur
in the ordinary course of business and compliance with such laws and regulations
can be subject to future government review and interpretation as well as
significant regulatory action including fines, penalties, and exclusion from the
Medicare and Medicaid programs.

Management services revenue and development fees are recognized when
earned. Management services revenue relates to providing certain management and
administrative support services under management contracts. The Company's
management contracts include contingent management services revenue, usually
based on exceeding certain gross revenue targets. These contingent revenues are
recognized based on actual results according to the calculations specified in
the various management agreements.

INVESTMENTS IN PARTNERSHIPS AND AMOUNTS DUE FROM AFFILIATES

Triad Entities: The Company has opened, in connection with its management
agreements, seventeen new Waterford and Wellington communities and two
expansions in the last four years pursuant to arrangements with the Triad
Entities. The Company has an approximate 1% limited partnership interest in each
of the Triad Entities and is accounting for these investments under the equity
method of accounting based on the provisions of the Triad Entities partnership
agreements. The Company defers 1% of its interest income, development fee income
and management fee income earned from the Triad Entities. As of December 31,
2002, the Company had deferred income of $1.1 million relating to the Triad
Entities.

The Company has loan commitments to the Triad Entities for construction and
pre-marketing expenses, in addition to requirements to fund the Triad Entities'
operating deficits through operating deficit guarantees provided for in its
management agreements with the Triad Entities and other advances, totaling $85.2
million

27

at December 31, 2002. The Company evaluates the carrying value of these
receivables by comparing the cash flows expected from the operations of the
Triad Entities to the carrying value of the receivables. These cash flow models
consider lease-up rates, expected operating costs, debt service requirements and
various other factors. In addition, the Company entered into a support agreement
with the Triad Entities during the third quarter of 2002, whereby, each of Triad
II, Triad III, Triad IV and Triad V agreed to loan excess cash flow of such
Triad to any one or more of Triad I, Triad II, Triad III, Triad IV and Triad V.
The carrying value of the notes receivable from the Triad Entities could be
adversely affected by a number of factors including the Triad communities
experiencing slower than expected lease-up, lower than expected lease rates,
higher than expected operating costs, increases in interest rates, issues
involving debt service requirements, general adverse market conditions, other
economic factors and changes in accounting guidelines. Management believes that
the carrying value of the notes receivable are fully recoverable, based on the
support agreement, factors within its control and the future achievement of the
assumptions used in these cash flow models, which are consistent with the
Company's operating experience.

Deferred interest income is being amortized into income over the life of
the loan commitment that the Company has with each of the Triad Entities.
Deferred development and management fee income is being amortized into income
over the expected remaining life of the Triad partnerships.

Under equity accounting, the Company has recognized losses in the Triad
Entities of $0.2 million and $0.5 million as of December 31, 2002 and 2001,
respectively. The recognition of these losses has reduced the Company's
investments in the Triad Entities to zero and additional losses of $0.4 million
have been recorded as a reduction to the Company's notes receivable from the
Triad Entities. The Company's share of future losses will also be recorded as a
reduction of notes receivable from the Triad Entities.

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities" an
interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective for the first fiscal year
or interim period beginning after June 15, 2003 for variable interest entities
that existed prior to February 1, 2003. The Company will adopt the provisions of
this interpretation, in the third quarter of 2003, and its adoption will result
in the Company consolidating the financial statements of the Triad Entities,
currently accounted for separately under the equity method of accounting. The
Company expects the implementation of FASB Interpretation No. 46 will have a
material effect on the Company's earnings and financial position. However, see
"Recent Developments" under Item 1. Business for a description of the Company's
agreements to purchase the partnership interests in Triads II, III, IV and V
owned by non-Company parties.

BRE/CSL: The Company formed BRE/CSL with an affiliate of Blackstone in
December 2001, and the joint venture seeks to acquire in excess of $200 million
of senior housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the
Company. The Company accounts for its investment in this joint venture under the
equity method of accounting. The Company recorded its investment at cost and
adjusts its investment for its share of earnings and losses of BRE/CSL. The
Company defers 10% of its management fee income earned from BRE/CSL. As of
December 31, 2002, the Company had deferred income of $50,000 relating to
BRE/CSL.

Deferred management fee income is being amortized into income over the term
of the Company's management contract.

Spring Meadows: During the fourth quarter of 2002, the Company acquired
LCOR's interest in the four joint ventures which own the Spring Meadows
Communities from LCOR as well as loans made by LCOR to the joint ventures for
$0.9 million in addition to funding $0.4 million to the venture for working
capital and anticipated negative cash requirements of the communities. The
Company's interests in the four joint ventures which own the Spring Meadows
Communities include interests in certain loans to the ventures and an
approximate 19% member interest in each venture. The Company has managed these
communities since the opening of each community in late 2000 and early 2001 and
will continue to manage the communities under long-term management contracts. In
addition, the Company will receive an asset management fee relating to each of
the four communities. The Company recorded its initial advances of $1.3 million
to the ventures as notes receivable as the amount assigned for the 19% member
interests was nominal. The Company accounts
28

for its investment in the Spring Meadows Communities under the equity method of
accounting based on the provisions of the partnership agreements. The Company
has the obligation to fund certain future operating deficits of the Spring
Meadows Communities to the extent of its 19% member interest.

ASSETS HELD FOR SALE

The Company determines the fair value, net of costs of disposal, of an
asset on the date the asset is categorized as held for sale, and the asset is
recorded at the lower of its fair value, net of cost of disposal, or carrying
value on that date. The Company periodically reevaluates assets held for sale to
determine if the assets are still recorded at the lower of fair value, net of
cost of disposal, or carrying value. The Company currently has one community and
six parcels of land held for sale. The fair value of these properties is
generally determined based on market rates, industry tends and recent comparable
sales transactions. The actual sales price of these assets could differ
significantly from the Company's estimates.

29

RESULTS OF OPERATIONS

The following tables set forth, for the periods indicated, selected
historical consolidated statements of income data in thousands of dollars and
expressed as a percentage of total revenues.

YEAR ENDED DECEMBER 31, 2002 COMPARED TO THE YEAR ENDED DECEMBER 31, 2001

Revenues. Total revenues decreased $9.0 million or 12.8% to $61.5 million
in 2002 compared to $70.5 million in 2001. Resident and health care revenue
decreased $5.2 million or 8.3% to $57.6 million in 2002 compared to $62.8
million in the prior year. This decrease in resident and healthcare revenue
reflects the loss of revenue on the four communities contributed to BRE/CSL in
June 2002 of $5.8 million, the loss of revenue from HCP's Cambridge community of
$3.1 million, which was sold in August 2001, offset by an overall increase in
revenue at the Company's other communities of $3.7 million. Rental and lease
income

30

decreased by $3.6 million due to the expiration of triple net leases on four
communities leased to HealthSouth Rehabilitation Corporation ("HealthSouth"),
along with the sale by HCP of its two communities that were previously leased to
third parties. Unaffiliated management services revenue decreased $0.9 million
or 45.8%, primarily due to the termination of the Company's management contracts
with Buckner and ILM II. Affiliated management services revenue increased $0.3
million or 18.3% due to increases in management fees earned on the management of
19 Triad communities in 2002 compared to 17 Triad communities in 2001 along with
management fees earned on the four communities owned by BRE/CSL. Affiliated
development fee revenue reflects fees earned related to the completion of two
communities under development for the Triad Entities.

Expenses. Total expenses decreased $6.8 million or 11.8% to $50.5 million
in 2002 compared to $57.3 million in 2001. Operating expenses decreased to $32.9
million in 2002 compared to $37.2 million in the prior year. This 11.7% decrease
primarily resulted from the contribution of the four communities to BRE/CSL and
the sale of the Cambridge facility offset by a writedown on a community held for
sale of $0.8 million. General and administrative expenses decreased 3.7% or $0.4
million to $11.6 million in 2002 compared to $12.0 million in the prior year.
This reduction primarily results from the contribution of the four communities
to BRE/CSL and the sale of the Cambridge community. Provision for bad debts of
$0.3 in fiscal 2002 primarily relates to normal write-offs of resident
receivables compared to provision for bad debts in 2001 of $1.0 million which
relates to writing off $0.6 million in receivables related to one of the
Company's triple net leases, along with normal write offs of resident
receivables. Depreciation and amortization expenses decreased 17.5% to $5.8
million in 2002 compared to $7.1 million in 2001, reflecting the contribution of
the four communities to BRE/CSL and the sale of the Cambridge community.

Other income and expenses. Interest expense decreased $4.2 million to
$10.7 million in 2002 compared to $14.9 million in 2001. This 27.8% decrease in
interest expense is the result of the repayment of $29.1 million of debt related
to the communities contributed to BRE/CSL and lower interest rates in the
current year on the Company's variable rate debt. Gain on sale of assets
decreased by $0.7 million in the current year compared to the prior year. In
2002, the Company sold two communities and one parcel of land for $6.7 million,
which resulted in the recognition of a gain of $2.4 million and net proceeds to
the Company of $5.2 million. In addition in 2002, the Company contributed four
communities to BRE/CSL, and as a result, the Company repaid $29.1 million of
long-term debt, received $7.3 million in cash and has a 10% equity interest in
the venture, and wrote-off $0.5 million in deferred loan costs, resulting in the
recognition of a loss of $0.5 million. In 2001, the Company sold one community,
two parcels of land and a house for $5.2 million, which resulted in the
recognition of a gain of $2.6 million and net proceeds to the Company of $4.8
million. Interest income primarily represents interest earned on loans the
Company made to the Triad Entities. Equity in the earnings of affiliates
represents the Company's share of the losses incurred by the Triad Entities
offset by the Company's share of earnings from the five communities owned by
BRE/CSL.

Provision for income taxes. Provision for income taxes in 2002 was $3.0
million or 39.2% effective tax rate compared to $1.9 million or 39.1% effective
tax rate in 2001. The effective tax rates for 2001 and 2000 differ from the
statutory tax rates because of state income taxes and permanent tax differences.

Minority interest. Minority interest decreased $1.2 million to $0.4
million in 2002 compared to $1.6 million in 2001 due to lower earnings at HCP.
HCP currently owns one asset, which is held for sale.

Net income. As a result of the foregoing factors, net income increased
$1.9 million to $4.7 million for 2002, as compared to $2.8 million for 2001.

YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000

Revenues. Total revenues increased $10.9 million or 18.3% to $70.5 million
in 2001 compared to $59.7 million in 2000. Resident and health care revenue
increased $13.6 million or 27.7% to $62.8 million in 2001 compared to $49.2
million in the prior year. This increase in resident and healthcare revenue was
primarily due to a full year of revenue from the eight communities acquired in
August 2000, that were formerly owned by ILM and ILM II. These eight communities
increased the Company's resident capacity of owned communities by approximately
1,300 units. Rental and lease income decreased by $1.0 million due to
31

the expiration of triple net leases on four communities leased to HealthSouth,
along with lease income that was earned in the prior year on the ILM
communities. Unaffiliated management services revenue decreased $0.3 million or
13.2%, primarily due to the acquisition of the eight communities from ILM and
ILM II, that were formerly managed by the Company. Affiliated management
services revenue increased $0.7 million or 67.6%, due to management fees earned
on the management of 17 Triad communities in 2001 compared to 14 Triad
communities in 2000. In addition, the Company received a full year of management
fees in 2001 on 11 Triad communities that were opened during the fourth quarter
of 2000. The Company did not earn any unaffiliated development fees during 2001,
resulting in a reduction in unaffiliated development fees of $0.6 million.
Affiliated development fee revenue decreased $1.6 million to $0.4 million,
reflecting the completion of one and 11 Triad communities in 2001 and 2000,
respectively.

Expenses. Total expenses increased $7.1 million or 14.2% to $57.3 million
in 2001 compared to $50.2 million in 2000. Operating expenses increased to $37.2
million in 2001 compared to $29.5 million in the prior year. This 26.0% increase
primarily resulted from a full year of operations from the eight ILM communities
acquired in August 2000. General and administrative expenses increased 8.0% or
$0.9 million primarily as a result of the ILM acquisition. Bad debt expense
decreased from $4.3 million in 2000 to $1.0 million in 2001. Provision for bad
debts in fiscal 2001 primarily related to writing off $0.6 million in
receivables related to one of the Company's triple net leases, along with normal
write offs of resident receivables. The provision for bad debts in 2000 relates
to writing off or reserving $1.2 million in development fees receivable, $2.2
million in notes receivable and $0.8 million in valuation adjustments on five
parcels of land held for sale. Depreciation and amortization expenses increased
36.7% to $7.1 million in 2001 compared to $5.2 million in 2000, reflecting a
full year of depreciation on the communities acquired from ILM and ILM II.

Other income and expenses. Interest expense increased $2.9 million to
$14.9 million in 2001 compared to $12.0 million in 2000. This 24.3% increase in
interest expense was the result of a full year of interest incurred on the debt
used to acquire the ILM communities and refinancing three of the Company's owned
communities compared to a partial year of interest in the prior year, as the ILM
assets were acquired in August 2000, partially offset by lower interest rates on
the Company's variable rate loans in the current fiscal year. Gain (loss) on
sale of assets increased by $2.9 million in the current year compared to the
prior year. In 2001, the Company sold one community, two parcels of land and a
house for $5.2 million, which resulted in the recognition of a gain of $2.6
million and net proceeds to the Company of $4.8 million. In 2000, the Company
sold two communities and a house for $4.8 million, that resulted in the
recognition of a loss of $0.4 million and net cash proceeds of $4.5 million.
Interest income primarily represents interest earned on loans the Company made
to the Triad Entities along with interest earned on the Company's investment in
the NHP Notes. Equity in the earnings of affiliates represents the Company's
share of the losses incurred by the Triad Entities.

Provision for income taxes. Provision for income taxes in 2001 was $1.9
million or 39.1% effective tax rate compared to $0.8 million or 38.1% effective
tax rate in 2000. The effective tax rates for 2001 and 2000 differ from the
statutory tax rates because of state income taxes and permanent tax differences.

Minority interest. Minority interest increased $0.4 million to $1.6
million in 2001 compared to $1.2 million in 2000 primarily due to the gains on
sale of two HCP properties partially offset by a decrease in operating income at
HCP.

Extraordinary charge. The Company recognized an extraordinary charge, net
of minority interest and income tax benefit, of $0.2 million. The charge
resulted from a loan foreclosure on HCP's McCurdy property.

Net income. As a result of the foregoing factors, net income increased
$1.5 million to $2.8 million for 2001, as compared to $1.2 million for 2000.

QUARTERLY RESULTS

The following table presents certain quarterly financial information for
the four quarters ended December 31, 2002 and 2001. This information has been
prepared on the same basis as the audited

32

Consolidated Financial Statements of the Company appearing elsewhere in this
report and include, in the opinion of management, all adjustments (consisting of
normal recurring adjustments) necessary to present fairly the quarterly results
when read in conjunction with the audited Consolidated Financial Statements of
the Company and the related notes thereto.

LIQUIDITY AND CAPITAL RESOURCES

In addition to approximately $11.8 million of cash balances on hand as of
December 31, 2002, the Company's principal source of liquidity is expected to be
cash flows from operations, proceeds from the sale of noncore assets, and cash
flows from BRE/CSL. Of the $11.8 million in cash balances, $0.6 million relates
to cash held by HCP. The Company expects its available cash and cash flows from
operations, proceeds from the sale of assets, and cash flows from BRE/CSL to be
sufficient to fund its short-term working capital requirements. The Company's
long-term capital requirements, primarily for acquisitions, the payment of
operating deficit guarantees, and other corporate initiatives, will be dependent
on its ability to access additional funds through joint ventures and the debt
and/or equity markets. There can be no assurance that the Company will continue
to generate cash flows at or above current levels or that the Company will be
able to obtain the capital necessary to meet the Company's long-term capital
requirements.

The Company had net cash provided by operating activities of $13.9 million
in fiscal 2002 compared to $14.9 million and $15.7 million in fiscal 2001 and
2000, respectively. In fiscal 2002, net income provided by

33

operating activities was primarily derived from net income of $4.7 million, net
noncash charges of $8.1 million, a decrease in prepaid and other assets of $0.9
million, and an increase in accrued expenses of $1.3 million offset by an
increase in accounts receivable of $0.5 million, a decrease in accounts payable
of $0.5 million and an increase in customer deposits of $0.1 million. In fiscal
2001, the net cash provided by operating activities was primarily derived from
net income of $2.8 million along with net noncash charges of $8.4 million, a
decrease in accounts receivable of $0.8 million, a decrease in federal and state
taxes receivable of $2.7 million, a decrease in prepaid and other assets of $0.7
million, offset by a net decrease in accounts payable and accrued expenses of
$0.5 million. In fiscal 2000, the net cash provided by operating activities was
primarily derived from net income of $1.2 million along with net noncash charges
of $12.3 million, increases in accounts payable and accrued expenses of $2.5
million, a decrease in federal and state taxes receivable of $2.3 million and a
decrease in other assets and customer deposits of $0.3 million, offset by an
increase in accounts receivable of $1.0 million, an increase in notes receivable
of $0.6 million and an increase in prepaid and other assets of $1.4 million.

The Company had net cash used in investing activities of $4.8 million,
$16.3 million, and $112.2 million in fiscal 2002, 2001, and 2000, respectively.
In fiscal 2002, the Company net cash used in investing activities was primarily
the result of advances to the Triad Entities of $22.4 million, capital
expenditures of $2.2 million offset by proceeds from the sale of two communities
and one parcel of land for $5.2 million net of selling costs, proceeds from the
contribution of assets to BRE/CSL of $7.3 million and distributions from limited
partnerships of $7.3 million. In fiscal 2001, the Company's net cash used in
investing activities was primarily the result of advances to Triad Entities of
$17.7 million for operating deficits and capital expenditures and capital
expenditures of $2.1 million, investments in limited partnerships of $1.3
million, offset by the proceeds from the sale of one community and two parcels
of land for $4.8 million, net of selling costs. In fiscal 2000, the Company's
net cash used in investing activities was primarily the result of acquisition
costs of $102.0 million for the eight ILM communities, advances to Triad
Entities of $14.2 million for operating deficits and capital expenditures and
capital expenditures of $3.1 million, offset by the proceeds of the sale of HCP
assets of $4.5 million and a distribution from a limited partnership of $2.6
million.

The Company had net cash used in financing activities of $7.3 million in
fiscal 2002 compared to net cash used by financing activities of $11.5 million
in fiscal 2001 and net cash provided by financing activities of $86.4 million in
fiscal 2000. For fiscal 2002 the net cash used in financing activities primarily
results from repayments of notes payable of $6.8 million, cash restrictions of
$2.4 million under the terms of one of the Company's loan agreements,
distributions to minority partners of $2.1 million, deferred loan charges paid
of $0.8 million offset by proceeds from the issuance of notes payable of $4.8
million. For fiscal 2001, net cash used in financing activities was primarily
the result of distributions to minority partners of $7.6 million, net repayments
on notes of $2.9 million and cash restrictions of $1.0 million under the terms
of one of the Company's loan agreements. For fiscal 2000, the net cash provided
by financing activities was primarily the result of increase in debt outstanding
as a result of the Company's acquisition of the eight ILM communities and
refinancing of three owned communities, offset by repayments on the Company's
line of credit of $30.0 million, distributions of $4.0 million to minority
partners and $3.7 million in loan costs and the restriction of $1.1 million
under the terms of a certain loan agreement.

The Company derives the benefits and bears the risks related to the
communities it owns. The cash flows and profitability of owned communities
depends on the operating results of such communities and are subject to certain
risks of ownership, including the need for capital expenditures, financing and
other risks such as those relating to environmental matters.

The cash flows and profitability of the Company's owned communities that
are leased to third parties depend on the ability of the lessee to make timely
lease payments. During 2001, HCP leased four communities to HealthSouth under a
master lease agreement that expired on November 30, 2001. Three of the four
communities were closed by the lessee and effective August 25, 1999, HealthSouth
agreed to transfer control of the closed communities to the Company. The assets
of one of the two communities, with the exception of two houses, were sold on
September 29, 1999. On January 11, 2000, the Company sold the HCP community in
Martin, Tennessee to HealthSouth for $2.4 million. On July 12, 2000, the Company
sold the house owned by HCP in Gallatin, Tennessee for $0.4 million. On August
4, 2000, the Company sold HCP's community in
34

Mt. Dora, Florida for $2.0 million. On September 25, 2001, HCP sold the
remaining house in Goodlettsville, Tennessee for $0.3 million. Notwithstanding
the sales, HealthSouth continued to make its full lease payments to HCP with no
reduction in rent for its four leases until the lease expired in November 2001.
The remaining property leased to HealthSouth was reclassified during the fourth
quarter of 2001 to held for sale. In addition to the HealthSouth leases, there
were four other skilled nursing facilities leased by HCP. During 2001, the
lessee on a triple net leased community in Evansville, Indiana defaulted on its
minimum lease payments. HCP made the decision not to put additional money into
the property, which was built in 1916, and notified the lender that it would not
continue paying the lender's mortgage payment on the property. Consequently,
during the third quarter of 2001, the lender foreclosed on the property. The
foreclosure resulted in the Company recognizing an extraordinary charge, net of
minority interest and income tax benefit of $0.2 million. During 2001, HCP
operated, through a lease to an affiliate, one skilled nursing community in
Cambridge, Massachusetts, until it was sold on August 15, 2001 for $3.6 million.
On January 1, 2002, HCP sold its Hearthstone community for net proceeds of $2.7
million, after the payment of settlement costs, resulting in a gain of $1.8
million. On February 28, 2002, HCP sold its Trinity Hills community for net
proceeds of $1.7 million, after the payment of settlement costs, resulting in a
gain of $0.5 million. In addition, during fiscal 2002, HCP recorded a write-down
of $0.8 million on its remaining community, which, it classifies as held for
sale.

The cash flows and profitability of the Company's management fees are
dependent upon the revenues and profitability of the communities the Company
manages. While the management contracts are generally terminable only for cause,
in certain cases contracts can be terminated upon the sale of a community,
subject to the Company's rights to offer to purchase such community.

The Company formed BRE/CSL with Blackstone in December 2001, and the joint
venture seeks to acquire in excess of $200 million of senior housing properties.
BRE/CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms
of the joint venture, each of the Company and Blackstone must approve any
acquisitions made by BRE/CSL. Each party must also contribute its pro rata
portion of the costs of any acquisition. In December 2001, BRE/CSL acquired
Amberleigh, a 394 resident capacity independent living facility. In connection
with the acquisition of Amberleigh by BRE/CSL, the Company contributed $1.8
million to BRE/CSL. During the second quarter of 2002, BRE/CSL obtained
permanent financing for the Amberleigh community and the Company recovered $1.4
million of its contribution to BRE/CSL.

In addition, on June 13, 2002, the Company contributed to BRE/CSL four of
its senior living communities with a capacity of approximately 600 residents. As
a result of the contribution, the Company repaid $29.1 million of long-term debt
to GMAC, received $7.3 million in cash from BRE/CSL, has a 10% equity interest
in the venture of $1.2 million and wrote-off $0.5 million in deferred loan
costs.

The Company manages the five communities owned by BRE/CSL under long-term
management contracts. The Company accounts for the BRE/CSL investment under the
equity method of accounting. The Company has deferred $50,000 of management fee
income as a result of its 10% interest in the BRE/CSL joint venture.

During the fourth quarter of 2002, the Company acquired LCOR's interests in
the four joint ventures which own the Spring Meadows Communities from LCOR as
well as loans made by LCOR to the joint ventures for $0.9 million in addition to
funding $0.4 million to the venture for working capital and anticipated negative
cash requirements of the communities. The Company's interests in the four joint
ventures which own the Spring Meadows Communities include interests in certain
loans to the ventures and an approximate 19% member interest in each venture.
The Company has managed the Spring Meadows Communities since the opening of each
community in late 2000 and early 2001 and will continue to manage the
communities under long-term management contracts. In addition, the Company will
receive an asset management fee relating to each of the four communities. The
Company recorded its initial advances of $1.3 million to the ventures as notes
receivable as the amount assigned for the 19% member interests was nominal. The
Company accounts for its investment in the Spring Meadows Communities under the
equity method of accounting based on the provisions of the partnership
agreements. The Company has the obligation to fund certain future operating
deficits of the Spring Meadows Communities to the extent of its 19% member
interest.

35

The Company has entered into development and management agreements with the
Triad Entities for the development and management of new senior living
communities. The Triad Entities own and finance the construction of new senior
living communities. These communities are primarily Waterford communities. The
development of senior living communities typically involves a substantial
commitment of capital over an approximate 12-month construction period, during
which time no revenues are generated, followed by a 24 to 36 month lease up
period.

The Company has opened, in connection with its management agreements,
seventeen new Waterford and Wellington communities and two expansions in the
last four years pursuant to arrangements with the Triad Entities. The Company
has an approximate 1% limited partnership interest in each of the Triad Entities
and is accounting for these investments under the equity method of accounting
based on the provisions of the Triad Entities partnership agreements. The
Company defers 1% of its interest income, development fee income and management
fee income earned from the Triad Entities. As of December 31, 2002, the Company
had deferred income of $1.1 million relating to the Triad Entities.

The Company has loan commitments to the Triad Entities for construction and
pre-marketing expenses, in addition to requirements to fund the Triad Entities'
operating deficits through operating deficit guarantees provided for in its
management agreements with the Triad Entities and other advances, totaling $85.2
million at December 31, 2002. The Company evaluates the carrying value of these
receivables by comparing the cash flows expected from the operations of the
Triad Entities to the carrying value of the receivables. These cash flow models
consider lease-up rates, expected operating costs, debt service requirements and
various other factors. In addition, the Company entered into a support agreement
with the Triad Entities during the third quarter of 2002, whereby each of Triad
II, Triad III, Triad IV and Triad V agreed to loan excess cash flow of such
Triad to any one or more of Triad I, Triad II, Triad III, Triad IV and Triad V.
The carrying value of the notes receivable from the Triad Entities could be
adversely affected by a number of factors, including the Triad communities
experiencing slower than expected lease-up, lower than expected lease rates,
higher than expected operating costs, increases in interest rates, issues
involving debt service requirements, general adverse market conditions, other
economic factors and changes in accounting guidelines. Management believes that
the carrying value of the notes receivable are fully recoverable, based on the
support agreement, factors within its control and the future achievement of the
assumptions used in these cash flow models, which are consistent with the
Company's operating experience. .

Under equity accounting, the Company has recognized losses in the Triad
Entities of $0.2 million and $0.5 million as of December 31, 2002 and 2001,
respectively. The recognition of these losses have reduced the Company's
investments in the Triad Entities to zero and additional losses of $0.4 million
have been recorded as a reduction to the Company's notes receivable from the
Triad Entities. The Company's share of future losses will also be recorded as a
reduction of notes receivable from the Triad Entities.

36

The following table sets forth, as of December 31, the capital invested in
each of the Triad Entities, information related to loans made by the Company to
each Triad Entity and information on deferred income related to each Triad
Entity (dollars in thousands):

The Company could be required in the future to revise the terms of its
notes with the Triad Entities to extend the maturity dates, change the interest
rate earned on the notes or modify other terms and conditions of the notes.

The Company has typically received a development fee of 4% of project
costs, as well as reimbursement of expenses and overhead not to exceed 4% of
project costs. These fees were recorded over the term of the development project
on a basis approximating the percentage of completion method. In addition, when
the properties became operational, the Company typically receives management
fees in an amount equal to the greater of 5% of gross revenues or $5,000 per
month per community, plus overhead expenses.

Deferred interest income is being amortized into income over the life of
the loan commitment that the Company has with each of the Triad Entities.
Deferred development and management fee income is being amortized into income
over the expected remaining life of the Triad partnerships.

The Company has the option, but not the obligation, to purchase the
partnership interests of the other partners in the Triad Entities, except for
Triad I, for an amount equal to the amount paid for the partnership interest by
the other partners, plus a noncompounded return of 12% per annum. In addition,
each Triad Entity except Triad I provides the Company with an option, but not
the obligation, to purchase the communities developed by the applicable
partnership upon their completion for an amount equal to the fair market value
(based on a third-party appraisal but not less than hard and soft costs and
lease-up costs) of the applicable community. See "Recent Developments" under
Item 1. Business for a description of the Company's agreements to purchase the
partnership interests in Triads II, III, IV and V owned by non-Company parties.

The Company has the option, but not the obligation, to purchase the Triad I
communities for an amount specified in the partnership agreement. Furthermore,
Lehman Brothers has agreed to withdraw as a partner in the Triad I partnership
to the extent it has received, on or before November 1, 2004, distributions in
an amount equal to its capital contributions of $12.4 million.

37

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities" an
interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective for the first fiscal year
or interim period beginning after June 15, 2003 for variable interest entities
that existed prior to February 1, 2003. The Company will adopt the provisions of
this interpretation in the third quarter of 2003, and its adoption will result
in the Company consolidating the financial statements of the Triad Entities,
currently accounted for separately under the equity method of accounting. The
Company expects the implementation of FASB Interpretation No. 46 will have a
material effect on the Company's earnings and financial position. However, see
"Recent Developments" under Item 1. Business for a description of the Company's
agreements to purchase the partnership interests in Triads II, III, IV and V
owned by non-Company parties.

Each of the Triad Entities finances the development of new communities
through a combination of equity funding, traditional construction loans and
permanent financing with institutional lenders secured by first liens on the
communities and unsecured loans from the Company. The Company loans may be
prepaid without penalty. The financings from institutional lenders are secured
by first liens on the communities, as well as assignment to the lenders of the
construction contracts and the development and management agreements with the
Company. Each development and management agreement assigned to an institutional
lender is also guaranteed by the Company and those guarantees are also assigned
to the lenders. The Company's management agreements contain an obligation of the
Company to fund operating deficits to the Triad Entities if the other financing
sources of the Triad Entities have been fully utilized. These operating
deficit-funding obligations are guaranteed by the Company and include making
loans to fund debt service obligations to the Triad Entities' lenders. Amounts
funded to date under these operating deficit agreements are disclosed in the
table above. The Company expects to be required to fund additional amounts under
these operating deficit agreements in the future.

Set forth below is information on the construction/permanent loan
facilities entered into by each of the Triad Entities as of December 31, 2002
(dollars in thousands):

During 2002 Triad II was notified by the lender of its failure to comply
with certain terms of its loan agreement with the lender. The lender, however,
has expressed its intention to work with the borrower, and the parties have
signed a term sheet to modify the original loan agreement. The Company, under
the terms of its management agreement, is responsible for funding the operating
deficits of Triad II. If the lender and Triad II are unable to finalize a
mutually agreeable forbearance agreement with respect to this loan and the
lender exercises its rights under its loan agreement with Triad II, the outcome
could result in the impairment of the Company's notes receivable with Triad II.

The Company has recently made the election to exercise its options to
purchase the partnership interests in the Triad Entities owned by non-Company
parties, with the exception of Triad I. The Company and the Triad Entities, with
the exception of Triad I, entered into Partnership Interest Purchase Agreements
("Purchase Agreements") on March 25, 2003, whereby the Company will purchase the
partnership interests of the general partners and other third party limited
partnership interests for an aggregate of approximately $1.7 million. Upon
completion of these transactions, which the Company expects to take place by the
end of the Company's second fiscal quarter of 2003, the Company will wholly own
each partnership, other than Triad I. The Company will treat these transactions
as a purchase of real estate and therefore does not expect

38

any goodwill or other intangibles to be recognized related to these
transactions. The Purchase Agreements are subject to customary terms and
conditions.

Summary financial information regarding the financial position of the Triad
Entities as of December 31, 2002 and 2001 and results of operations for the
years ended December 31, 2002 and 2001 of the Triad Entities is presented below.
The Company is also presenting unaudited pro forma financial information as if
the Company's purchase of the Triad Entities (except Triad I) were effective
January 1, 2002. In addition, the unaudited pro forma financial information
includes consolidating Triad I as if the provisions of FASB Interpretation No.
46 were effective January 1, 2002. Beginning in the third quarter of 2003, FASB
Interpretation No. 46 will require the Company to consolidate the financial
position and results of operation of Triad I with the Company's financial
information. The unaudited pro forma financial information, which may not be
indicative of future results, includes the elimination of significant
intercompany balances and assumes incomes taxes at a 39% effective tax rate (in
thousands):

39

Long-term debt relates to the aggregate maturities of the Company's notes
payable. The Company leases its corporate headquarters, an executive office in
New York, and certain equipment used at the Company's communities.

The Company's management agreements with the Triad Entities contain an
obligation of the Company to fund operating deficits to the Triad Entities if
the other financing sources of the Triad Entities have been fully utilized.
These operating deficit-funding obligations are guaranteed by the Company and
include making loans to fund debt service obligations to the Triad Entities'
lenders. The Company has funded operating deficits of the Triad Entities and
expects to be required to fund additional amounts under these operating deficit
agreements in the future. In addition, the Company has a requirement to fund
certain operating deficits related to the Spring Meadows Communities. However,
see "Recent Developments" under Item 1. Business for a description of the
Company's agreements to purchase the partnership interests in Triads II, III, IV
and V owned by non-Company parties.

IMPACT OF INFLATION

To date, inflation has not had a significant impact on the Company.
However, inflation could affect the Company's future revenues and results of
operations because of, among other things, the Company's dependence on senior
residents, many of whom rely primarily on fixed incomes to pay for the Company's
services. As a result, during inflationary periods, the Company may not be able
to increase resident service fees to account fully for increased operating
expenses. In structuring its fees, the Company attempts to anticipate inflation
levels, but there can be no assurance that the Company will be able to
anticipate fully or otherwise respond to any future inflationary pressures.

FORWARD-LOOKING STATEMENTS

Certain information contained in this report constitutes "Forward-Looking
Statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
which can be identified by the use of forward-looking terminology such as "may,"
"will," "expect," "anticipate," "estimate" or "continue" or the negative thereof
or other variations thereon or comparable terminology. The Company cautions
readers that forward-looking statements, including, without limitation, those
relating to the Company's future business prospects, revenues, working capital,
liquidity, capital needs, interest costs, and income, are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those indicated in the forward-looking statements, due to several important
factors herein identified, among others, and other risks and factors identified
from time to time in the Company's reports filed with the SEC.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's primary market risk is exposure to changes in interest rates
on debt instruments. As of December 31, 2002, the Company had $150.1 million in
outstanding debt comprised of various fixed and variable rate debt instruments
of $53.8 million and $96.3 million, respectively.

Changes in interest rates would affect the fair market value of the
Company's fixed rate debt instruments but would not have an impact on the
Company's earnings or cash flows. Fluctuations in interest rates on the
Company's variable rate debt instruments, that are tied to either LIBOR or the
prime rate, would affect the Company's earnings and cash flows but would not
affect the fair market value of the variable rate debt. For each percentage
point change in interest rates, the Company's annual interest expense would
increase by approximately $1.0 million based on the Company's outstanding
variable debt as of December 31, 2002. In addition, an increase in interest
rates could result in operating deficit obligations, relating to the Triad
Entities, that could require funding by the Company. The Triad Entities, as of
December 31, 2002, have $158.3 million in outstanding bank debt comprised of
various fixed and variable rate debt instruments of $26.3 million and $132.0
million, respectively.

40

The following table summarizes information on the Company's debt
instruments outstanding as of December 31, 2002. The table presents the
principal due and weighted average interest rates for the Company's various debt
instruments by fiscal year. Weighted average variable interest rates are based
on the Company's floating rate as of December 31, 2002.

INTEREST RATE RISK

Principal Amount and Average Interest Rate by Expected Maturity Date ($ in
thousands)

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements are included under Item 15 of this Annual Report.

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

The Company had no disagreements on accounting or financial disclosure
matters with its independent accountants to report under this Item 9.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information contained under the caption "Election of Directors" in the
Proxy Statement is incorporated herein by reference in response to this Item 10.
See also Item 1.

ITEM 11. EXECUTIVE COMPENSATION

Information contained under the captions "Executive Compensation" and
"Election of Directors" in the Proxy Statement is incorporated herein by
reference in response to this Item 11.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information contained under the caption "Principal Stockholders and Stock
Ownership of Management" in the Proxy Statement is incorporated herein by
reference in response to this Item 12.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information contained under the caption "Certain Relationships and Related
Transactions" in the Proxy Statement is incorporated herein by reference in
response to this Item 13.

ITEM 14. CONTROLS AND PROCEDURES

The Company's management, including its Chief Executive Officer and Chief
Financial Officer, after evaluating the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15-d-14(c)
under the Securities Exchange Act of 1934) as of a date (the "Evaluation Date"),
which was within 90 days of this annual report on Form 10-K, have concluded in
their judgment that,

41

as of the Evaluation Date, the Company's disclosure controls and procedures were
adequate and designed to ensure that material information relating to the
Company and its subsidiaries would be made known to them.

There were no significant changes in the Company's internal controls or, to
its knowledge, in other factors that could significantly affect its disclosure
controls and procedures subsequent to the Evaluation Date.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

The following documents are filed as part of this Report:

(1) Financial Statements:

The response to this portion of Item 15 is submitted as a separate
section of this Report. See Index to Financial Statements at page F-1.

(2) Financial Statement Schedules:

All schedules have been omitted as the required information is
inapplicable or the information is presented in the financial statements or
related notes.

(3) Exhibits:

The exhibits listed on the accompanying Index To Exhibits at page E-1
are filed as part of this Report.

(4) The Company did not file any reports on Form 8-K during the quarterly
period ended December 31, 2002.

42

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, hereunto duly authorized, on March 26, 2003.

CAPITAL SENIOR LIVING CORPORATION

By: /s/ LAWRENCE A. COHEN
------------------------------------
Lawrence A. Cohen
Vice Chairman of the Board
and Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated. Each person whose signature to
this report appears below hereby appoints Lawrence A. Cohen and James A. Stroud
and each of them, any one of whom may act without the joinder of the other, as
his or her attorney-in-fact to sign on his behalf, individually and in each
capacity stated below, and to file all amendments to this report, which
amendment or amendments may make such changes in and additions to the report as
any such attorney-in-fact may deem necessary or appropriate.

43

CAPITAL SENIOR LIVING CORPORATION
DECEMBER 31, 2002

CERTIFICATIONS

I, Lawrence A. Cohen, Chief Executive Officer of Capital Senior Living
Corporation, certify that:

1. I have reviewed this annual report on Form 10-K of Capital Senior Living
Corporation ("Registrant");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.

5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit committee
of the Registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's internal
controls; and

6. The Registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ LAWRENCE A. COHEN
--------------------------------------
Lawrence A. Cohen
Chief Executive Officer
March 26, 2003

44

CAPITAL SENIOR LIVING CORPORATION
DECEMBER 31, 2002

CERTIFICATIONS

I, Ralph A. Beattie, Chief Financial Officer of Capital Senior Living
Corporation, certify that:

1. I have reviewed this annual report on Form 10-K of Capital Senior Living
Corporation ("Registrant");

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations, and cash flows of the
Registrant as of, and for, the periods presented in this annual report;

4. The Registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:

a) designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

b) evaluated the effectiveness of the Registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and

c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.

5. The Registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Registrant's auditors and the audit committee
of the Registrant's board of directors:

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrant's ability to record,
process, summarize and report financial data and have identified for the
Registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrant's internal
controls; and

6. The Registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ RALPH A. BEATTIE
--------------------------------------
Ralph A. Beattie
Chief Financial Officer
March 26, 2003

45

INDEX TO FINANCIAL STATEMENTS

F-1

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Shareholders
Capital Senior Living Corporation

We have audited the accompanying consolidated balance sheets of Capital
Senior Living Corporation as of December 31, 2002 and 2001, and the related
consolidated statements of income, shareholders' equity, and cash flows for each
of the three years in the period ended December 31, 2002. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Capital Senior
Living Corporation as of December 31, 2002 and 2001, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States.

As discussed in Note 2 to the financial statements, the Company changed its
method of accounting for goodwill.

ERNST & YOUNG LLP

Dallas, Texas
February 14, 2003
except for Note 3, as to which the date is
March 25, 2003

F-2

CAPITAL SENIOR LIVING CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes.
F-3

CAPITAL SENIOR LIVING CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes.
F-4

CAPITAL SENIOR LIVING CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

See accompanying notes.
F-5

CAPITAL SENIOR LIVING CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.
F-6

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001

1. ORGANIZATION

Capital Senior Living Corporation, a Delaware corporation (together with
its subsidiaries, the "Company"), is one of the largest operators of senior
living communities in the United States in terms of resident capacity. The
Company owns, operates, develops and manages senior living communities
throughout the United States. As of December 31, 2002, the Company owned
interests in 43 communities in 20 states with a capacity of approximately 6,900
residents. In addition, the Company operates one home care agency. The
accompanying consolidated financial statements include the financial statements
of Capital Senior Living Corporation and its subsidiaries. All material
intercompany balances and transactions have been eliminated in consolidation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

CASH AND CASH EQUIVALENTS AND RESTRICTED CASH

The Company considers all highly liquid investments with original
maturities of three months or less at the date of acquisition to be cash
equivalents. The Company has deposits in banks that exceed Federal Deposit
Insurance Corporation insurance limits. Management believes that credit risk
related to these deposits is minimal. Cash and cash equivalents, at December 31,
2002 and 2001, includes the cash and cash equivalents of the HealthCare
Properties, L.P. ("HCP") of $0.6 million and $1.7 million, respectively.
Restricted cash represents amounts held in deposits that are required as
collateral under the terms of certain loan agreements.

LONG-LIVED ASSETS

Property and equipment are stated at cost and depreciated on a
straight-line basis over the estimated useful lives of the assets. The estimated
useful lives are 30 to 40 years for buildings and building improvements, 20
years for land improvements and 5 to 10 years for furniture, equipment and
automobiles.

At each balance sheet date, the Company reviews the carrying value of its
property and equipment to determine if facts and circumstances suggest that they
may be impaired or that the depreciation period may need to be changed. The
Company considers external factors relating to each asset, including contract
changes, local market developments, and other publicly available information.
The carrying value of a long-lived asset is considered impaired when the
anticipated undiscounted cash flows from such asset is separately identifiable
and is less than its carrying value. In that event, a loss is recognized based
on the amount the carrying value exceeds the fair market value, generally based
on discounted cash flows, of the long-lived asset. The Company does not believe
there are any indicators that would require an adjustment to the carrying value
of the property and equipment or their remaining useful lives as of December 31,
2002 and 2001.

ASSETS HELD FOR SALE

The Company determines the fair value, net of costs of disposal, of an
asset on the date the asset is categorized as held for sale, and the asset is
recorded at the lower of its fair value, net of cost of disposal, or carrying
value on that date. The Company periodically reevaluates assets held for sale to
determine if the assets are still recorded at the lower of fair value, net of
cost of disposal, or carrying value. The Company has one community and six
parcels of land held for sale at December 31, 2002. The fair value of these
properties is generally determined based on market rates, industry trends and
recent comparable sales transactions. The actual sales price of these assets
could differ significantly from the Company's estimates.

During 2000, the Company sold two communities and one house that were held
for sale. In addition, during 2000 the Company forgave $3.2 million of notes
receivable with certain partnerships in exchange for five parcels of land, which
the Company classified as held for sale. During the fourth quarter of 2000, the
Company recorded a write-down on the house and five parcels of land, held for
sale, of $1.0 million to record
F-7

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

these assets at their estimated net realizable value. This write-down is
reflected as provision for bad debts in the statements of income.

During 2001, the Company reclassified one of HCP's communities to held for
sale and sold the house that had been classified as held for sale. In addition,
during 2001 a lender foreclosed on a property owned by HCP that had been
classified as held for sale resulting in an extraordinary charge of $0.2
million, net of minority interest and income tax benefit. During 2001, the
Company forgave $1.2 million in notes receivable with a partnership in exchange
for two parcels of land and the Company sold one of the parcels of land that had
been classified as held for sale.

During 2002, the Company sold one parcel of land and forgave $0.7 million
of notes receivable with a certain partnership in exchange for one parcel of
land, which the Company classified as held for sale. In addition, the Company
recorded a write-down of $0.8 million on a community owned by HCP. This write-
down is reflected as operating expenses in the income statement.

The Company estimates the six parcels of land and the one remaining
community that were held for sale at December 31, 2002, have an aggregate fair
value, net of costs of disposal, of $4.1 million. The amounts the Company will
ultimately realize could differ materially from this estimate.

INVESTMENTS IN PARTNERSHIPS AND JOINT VENTURES

Triad Entities: The Company has opened, in connection with its management
agreements, seventeen new Waterford and Wellington communities and two
expansions in the last four years pursuant to arrangements with affiliates of
Triad Senior Living Inc., (the "Triad Entities"). The Company has an approximate
1% limited partnership interest in each of the Triad Entities and is accounting
for these investments under the equity method of accounting based on the
provisions of the Triad Entities partnership agreements. The Company defers 1%
of its interest income, development fee income and management fee income earned
from the Triad Entities. As of December 31, 2002, the Company had deferred
income of $1.1 million relating to the Triad Entities.

The Company has loan commitments to the Triad Entities for construction and
pre-marketing expenses, in addition to requirements to fund the Triad Entities'
operating deficits through operating deficit guarantees provided for in its
management agreements with the Triad Entities and other advances, totaling $85.2
million and $65.1 million at December 31, 2002 and 2001, respectively. The
Company evaluates the carrying value of these receivables by comparing the cash
flows expected from the operations of the Triad Entities to the carrying value
of the receivables. These cash flow models consider lease-up rates, expected
operating costs, debt service requirements and various other factors. In
addition, the Company entered into a support agreement with the Triad Entities
during the third quarter of 2002, whereby each of Triad II, Triad III, Triad IV
and Triad V agreed to loan excess cash flow of such Triad to any one or more of
Triad I, Triad II, Triad III, Triad IV and Triad V. The carrying value of the
notes receivable from the Triad Entities could be adversely affected by a number
of factors, including the Triad communities experiencing slower than expected
lease-up, lower than expected lease rates, higher than expected operating costs,
increases in interest rates, issues involving debt service requirements, general
adverse market conditions, other economic factors and changes in accounting
guidelines. Management believes that the carrying value of the notes receivable
are fully recoverable, based on the support agreement, factors within its
control and the future achievement of the assumptions used in these cash flow
models, which are consistent with the Company's operating experience.

Deferred interest income is being amortized into income over the life of
the loan commitment that the Company has with each of the Triad Entities.
Deferred development and management fee income is being amortized into income
over the expected remaining life of the Triad partnerships.

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities" an
interpretation of ARB No. 51, effective immediately for
F-8

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

variable interest entities created after January 31, 2003 and effective for the
first fiscal year or interim period beginning after June 15, 2003 for variable
interest entities that existed prior to February 1, 2003. The Company will adopt
the provisions of this interpretation in the third quarter of 2003, and its
adoption will result in the Company consolidating the financial statements of
the Triad Entities, currently accounted for separately under the equity method
of accounting. The Company expects the implementation of FASB Interpretation No.
46 will have a material effect on the Company's earnings and financial position.
However, see Note 3 for a description of the Company's agreements to purchase
the partnership interests in Triads II, III, IV and V owned by non-Company
parties.

Under equity accounting, the Company has recognized losses in the Triad
Entities of $0.2 million and $0.5 million as of December 31, 2002 and 2001,
respectively. The recognition of these losses have reduced the Company's
investments in the Triad Entities to zero and additional losses of $0.4 million
have been recorded as a reduction to the Company's notes receivable from the
Triad Entities. The Company's share of future losses will also be recorded as a
reduction of notes receivable from the Triad Entities.

BRE/CSL: The Company formed two joint ventures (collectively "BRE/CSL")
with an affiliate of Blackstone Real Estate Advisors ("Blackstone") in December
2001, and the joint venture seeks to acquire in excess of $200 million of senior
housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the Company.
The Company accounts for its investment in BRE/CSL under the equity method of
accounting. The Company recorded its investment at cost and will adjust its
investment for its share of earnings and losses of BRE/CSL. The Company defers
10% of its management fee income earned from BRE/CSL. As of December 31, 2002,
the Company had deferred income of $50,000 relating to BRE/CSL.

Deferred management fee income is being amortized into income over the term
of the Company's management contract.

Spring Meadows: During the fourth quarter of 2002, the Company acquired
from affiliates of LCOR Incorporated ("LCOR") interests in the four joint
ventures which own four independent and assisted living communities (the "Spring
Meadows Communities") as well as loans made by LCOR to the joint ventures for
$0.9 million in addition to funding $0.4 million to the ventures for working
capital and anticipated negative cash requirements of the communities. The
Company's interests in the four joint ventures which own the Spring Meadows
Communities include interests in certain loans to the ventures and an
approximate 19% member interest in each venture. The Company has managed the
Spring Meadows Communities since the opening of each community in late 2000 and
early 2001 and will continue to manage the communities under long-term
management contracts. In addition, the Company will receive an asset management
fee relating to each of the four communities. The Company recorded its initial
advances of $1.3 million to the ventures as notes receivable as the amount
assigned for the 19% member interests was nominal. The Company accounts for its
investment in the Spring Meadows Communities under the equity method of
accounting based on the provisions of the partnership agreements. The Company
has the obligation to fund certain future operating deficits of the Spring
Meadows Communities to the extent of its 19% member interest.

INCOME TAXES

The Company accounts for income taxes under the liability method. Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Management regularly evaluates the
future realization of deferred tax assets and provides a valuation allowance, if
considered necessary, based on such evaluation.

F-9

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

REVENUE RECOGNITION

Resident and health care revenue is recognized at estimated net realizable
amounts, based on historical experiences, due from residents in the period to
which the rental and other services are provided.

Revenues from the Medicare and Medicaid programs accounted for 8%, 9%, and
12% in 2002, 2001 and 2000, respectively of the Company's net revenues. One
community (two in 2001 and 2000) are providers of services under the Medicaid
program. Accordingly, the community is entitled to reimbursement under the
foregoing program at established rates that are lower than private pay rates.
Patient service revenue for Medicaid patients is recorded at the reimbursement
rates as the rates are set prospectively by the state upon the filing of an
annual cost report. Two communities (three in 2001 and 2000) are providers of
services under the Medicare program and are entitled to payment under the
foregoing programs in amounts determined based on established rates that differ
from private pay rates. Revenue from the Medicare program is recorded at
established rates and adjusted for differences between such rates and estimated
amounts payable from the program. Any differences between estimated and actual
reimbursements are included in operations in the year of settlement and have not
been material.

Laws and regulations governing the Medicare and Medicaid programs are
complex and subject to interpretation. The Company believes that it is in
compliance with all applicable laws and regulations and is not aware of any
pending or threatened investigations involving allegations of potential
wrongdoing. While no such regulatory inquiries have been made, compliance with
such laws and regulations can be subject to future government review and
interpretation as well as significant regulatory action including fines,
penalties, and exclusion from the Medicare and Medicaid programs.

Management services revenue, resident and healthcare revenue and
development fees are recognized when earned. Management services revenue relates
to providing certain management and administrative support services under
management contracts, which have terms expiring through 2022. Management
services revenue is shown net of reimbursed expenses. The reimbursed expenses
from affiliates were $18.5 million, $10.7 million and $5.1 million, for the
years ended December 31, 2002, 2001, and 2000, respectively. Reimbursed expenses
from unaffiliated parties were $6.9 million, $13.0 million, and $11.4 million,
for the years ended December 31, 2002, 2001 and 2000, respectively.

The Company's management contracts include contingent management services
revenue, usually based on exceeding certain gross revenue targets. These
contingent revenues are recognized based on actual results according to the
calculations specified in the various management agreements.

CREDIT RISK

The Company's resident receivables are generally due within 30 days and
development fee receivables are due through completion of construction, which is
generally one year. The Company does not require collateral. Credit losses on
resident receivables have been within management's expectations, and management
believes that the allowance for doubtful accounts adequately provides for any
expected losses.

ADVERTISING

Advertising is expensed as incurred. Advertising expenses for the years
ended December 31, 2002, 2001 and 2000 were $2.5 million, $2.8 million and $2.7
million, respectively.

NET INCOME PER SHARE

Basic net income per share is calculated by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
net income per share considers the dilutive effect of outstanding options
calculated using the treasury stock method.

F-10

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table set forth the computation of basic and diluted net
income per share (in thousands, except for per share amounts):

STOCK-BASED COMPENSATION

The Company has elected to follow the intrinsic value method in Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
("APB 25") and related interpretations in accounting for its employee and
director stock options. In accordance with APB 25, since the exercise price of
the Company's employee stock options equals the market price of the underlying
stock on the date of grant, generally no compensation expense is recognized.
Stock option grants to non-employees are accounted for in accordance with the
fair value method of FASB 123.

The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 148 "Accounting for Stock-Based
Compensation -- Transition and Disclosures" ("SFAS 148") in December 2002. SFAS
148 amends the disclosure provisions and transition alternatives of Statement of
Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation"
and is effective for fiscal years ending after December 15, 2002. The Company
adopted the disclosure provisions of SFAS 148 effective December 31, 2002. The
Company does not anticipate a material impact on their results of operations or
financial position from the adoption of SFAS 148.

SEGMENT INFORMATION

The Company evaluates the performance and allocates resources of its senior
living facilities based on current operations and market assessments on a
property-by-property basis. The Company does not have a concentration of
operations geographically or by product or service as its management functions
are integrated at the property level.

F-11

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

RECLASSIFICATIONS

Certain reclassifications have been made to prior year amounts to conform
to current year presentation.

CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the accompanying
financial statements and related footnotes. Management bases its estimates and
assumptions on historical experience, observance of industry trends and various
other sources of information and factors, the results of which form the basis
for making judgments about the carrying value of assets and liabilities that are
not readily apparent from other sources. Actual results could differ from these
estimates. Critical accounting policies are defined as those that are reflective
of significant judgments and uncertainties, and potentially could result in
materially different results under different assumptions and conditions. The
Company believes revenue recognition, investments in partnerships, amounts due
from affiliates and assets held for sale are its most critical accounting
policies and require management's most difficult, subjective and complex
judgments.

NEW ACCOUNTING STANDARDS

In April 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 145, "Rescission of FASB Statements No. 4,
44 and 62, Amendment of FASB No. 13, and Technical Corrections", which is
required to be applied in fiscal years beginning after May 15, 2002. This
statement will require gains and losses on the extinguishments of debt to be
classified as income or loss from continuing operations rather than as
extraordinary items as previously required under Statement No. 4. The Company
does not expect the adoption of this statement to have a material effect on the
Company's earnings or financial position.

In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, "Business Combinations", and No. 142,
"Goodwill and Other Intangible Assets", effective for years beginning after
December 15, 2001. Under the new rules, goodwill and intangible assets deemed to
have indefinite lives are no longer amortized but are subject to annual
impairment tests in accordance with the Statements. Other intangible assets
continue to be amortized over their useful lives. The Company adopted this
statement on January 1, 2002, and the application of the non-amortization
provisions of the Statement did not result in a material effect on the Company's
earnings.

In July 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 146, "Accounting for Costs Associated with
Exit or Disposal Activities" which is effective for exit or disposal activities
initiated after December 31, 2002. This statement establishes an accounting
model for costs associated with exit or disposal activities. Under this
statement, a liability for costs associated with exit or disposal activities
should be initially recognized when it is incurred and be measured at fair
value. The Company does not expect the adoption of this statement to have a
material effect on the Company's earnings or financial position.

In October 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 144, "Accounting for the Impairment of
Long-Lived Assets." This statement which, was adopted by the Company on January
1, 2002 established a single accounting model for the impairment of long-lived
assets and provided further guidance relating to discontinued operations. The
adoption of this statement did not have a material effect on the Company's
earnings or financial position.

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities", an
interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective for the first fiscal year
or interim period
F-12

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

beginning after June 15, 2003, for variable interest entities that existed prior
to February 1, 2003. The Company will adopt the provisions of this
interpretation, in the third quarter of 2003, and its adoption will result in
the Company consolidating the financial statements of the Triad Entities,
currently accounted for separately under the equity method of accounting. The
Company expects the implementation FASB Interpretation No. 46 will have a
material effect on the Company's earnings and financial position. However, see
Note 3 for a description of the Company's agreements to purchase the partnership
interests in Triads II, III, IV and V owned by non-Company parties.

3. TRANSACTIONS WITH AFFILIATES

Triad Entities: The Company has entered into development and management
agreements with the Triad Entities for the development and management of new
senior living communities. The Triad Entities own and finance the construction
of new senior living communities. These communities are primarily Waterford
communities. The development of senior living communities typically involves a
substantial commitment of capital over an approximate 12-month construction
period, during which time no revenues are generated, followed by a 24 to 36
month lease up period.

The Company has opened, in connection with its management agreements,
seventeen new Waterford and Wellington communities and two expansions in the
last four years pursuant to arrangements with the Triad Entities. The Company
has an approximate 1% limited partnership interest in each of the Triad Entities
and is accounting for these investments under the equity method of accounting
based on the provisions of the Triad Entities partnership agreements. The
Company defers 1% of its interest income, development fee income and management
fee income earned from the Triad Entities. As of December 31, 2002, the Company
had deferred income of $1.1 million relating to the Triad Entities.

The Company has loan commitments to the Triad Entities for construction and
pre-marketing expenses, in addition to requirements to fund the Triad Entities'
operating deficits through operating deficit guarantees provided for in its
management agreements with the Triad Entities and other advances, totaling $85.2
million at December 31, 2002. The Company evaluates the carrying value of these
receivables by comparing the cash flows expected from the operations of the
Triad Entities to the carrying value of the receivables. These cash flow models
consider lease-up rates, expected operating costs, debt service requirements and
various other factors. In addition, the Company entered into a support agreement
with the Triad Entities during the third quarter of 2002, whereby each of Triad
II, Triad III, Triad IV and Triad V agreed to loan excess cash flow of such
Triad to any one or more of Triad I, Triad II, Triad III, Triad IV and Triad V.
The carrying value of the notes receivable from the Triad Entities could be
adversely affected by a number of factors, including the Triad communities
experiencing slower than expected lease-up, lower than expected lease rates,
higher than expected operating costs, increases in interest rates, issues
involving debt service requirements, general adverse market conditions, other
economic factors and changes in accounting guidelines. Management believes that
the carrying value of the notes receivable are fully recoverable, based on the
support agreement, factors within its control and the future achievement of the
assumptions used in these cash flow models, which are consistent with the
Company's operating experience. .

Under equity accounting, the Company has recognized losses in the Triad
Entities of $0.2 million and $0.5 million as of December 31, 2002 and 2001,
respectively. The recognition of these losses have reduced the Company's
investments in the Triad Entities to zero and additional losses of $0.4 million
have been recorded as a reduction to the Company's notes receivable from the
Triad Entities. The Company's share of future losses will also be recorded as a
reduction of notes receivable from the Triad Entities.

Deferred interest income is being amortized into income over the life of
the loan commitment that the Company has with each of the Triad Entities.
Deferred development and management fee income is being amortized into income
over the expected remaining life of the Triad partnerships.

F-13

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table sets forth, as of December 31, the capital invested in
each of the Triad Entities, information related to loans made by the Company to
each Triad Entity and information on deferred income related to each Triad
Entity (dollars in thousands):

The Company could be required in the future to revise the terms of its
notes with the Triad Entities to extend the maturity dates, change the interest
rate earned on the notes or modify other terms and conditions of the notes.

The Company has typically received a development fee of 4% of project
costs, as well as reimbursement of expenses and overhead not to exceed 4% of
project costs. These fees were recorded over the term of the development project
on a basis approximating the percentage of completion method. In addition, when
the properties became operational, the Company typically receives management
fees in an amount equal to the greater of 5% of gross revenues or $5,000 per
month per community, plus overhead expenses.

The Company has the option, but not the obligation, to purchase the
partnership interests of the other partners in the Triad Entities, except for
Triad I, for an amount equal to the amount paid for the partnership interest by
the other partners, plus a noncompounded return of 12% per annum. In addition,
each Triad Entity except Triad I provides the Company with an option, but not
the obligation, to purchase the communities developed by the applicable
partnership upon their completion for an amount equal to the fair market value
(based on a third-party appraisal but not less than hard and soft costs and
lease-up costs) of the applicable community. See below for a description of the
Company's agreements to purchase the partnership interests in Triads II, III, IV
and V owned by non-Company parties.

The Company has the option, but not the obligation, to purchase the Triad I
communities for an amount specified in the partnership agreement. Furthermore,
Lehman Brothers has agreed to withdraw as a partner in the Triad I partnership
to the extent it has received, on or before November 1, 2004, distributions in
an amount equal to its capital contributions of $12.4 million.

F-14

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities" an
interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective for the first fiscal year
or interim period beginning after June 15, 2003 for variable interest entities
that existed prior to February 1, 2003. The Company will adopt the provisions of
this interpretation in the third quarter of 2003, and its adoption will result
in the Company consolidating the financial statements of the Triad Entities,
currently accounted for separately under the equity method of accounting. The
Company expects the implementation of FASB Interpretation No. 46 will have a
material effect on the Company's earnings and financial position. However, see
below for a description of the Company's agreements to purchase the partnership
interests in Triads II, III, IV and V owned by non-Company parties.

Each of the Triad Entities finances the development of new communities
through a combination of equity funding, traditional construction loans and
permanent financing with institutional lenders secured by first liens on the
communities and unsecured loans from the Company. The Company loans may be
prepaid without penalty. The financings from institutional lenders are secured
by first liens on the communities, as well as assignment to the lenders of the
construction contracts and the development and management agreements with the
Company. Each development and management agreement assigned to an institutional
lender is also guaranteed by the Company and those guarantees are also assigned
to the lenders. The Company's management agreements contain an obligation of the
Company to fund operating deficits to the Triad Entities if the other financing
sources of the Triad Entities have been fully utilized. These operating
deficit-funding obligations are guaranteed by the Company and include making
loans to fund debt service obligations to the Triad Entities' lenders. Amounts
funded to date under these operating deficit agreements are disclosed in the
table above. The Company expects to be required to fund additional amounts under
these operating deficit agreements in the future.

Set forth below is information on the construction/permanent loan
facilities entered into by each of the Triad Entities as of December 31, 2002
(dollars in thousands):

During 2002 Triad II was notified by the lender of its failure to comply
with certain terms of its loan agreement with the lender. The lender, however,
has expressed its intention to work with the borrower, and the parties have
signed a term sheet to modify the original loan agreement. The Company, under
the terms of its management agreement, is responsible for funding the operating
deficits of Triad II. If the lender and Triad II are unable to finalize a
mutually agreeable forbearance agreement with respect to this loan and the
lender exercises its rights under its loan agreement with Triad II, the outcome
could result in the impairment of the Company's notes receivable with Triad II.

The Company has recently made the election to exercise its options to
purchase the partnership interests in the Triad Entities owned by non-Company
parties, with the exception of Triad I. The Company and the Triad Entities, with
the exception of Triad I, entered into Partnership Interest Purchase Agreements
("Purchase Agreements") on March 25, 2003, whereby the Company will purchase the
partnership interests of the general partners and other third party limited
partnership interests for an aggregate of approximately

F-15

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

$1.7 million. Upon completion of these transactions, which the Company expects
to take place by the end of the Company's second fiscal quarter of 2003, the
Company will wholly own each partnership, other than Triad I. The Company will
treat these transactions as a purchase of real estate and therefore does not
expect any goodwill or other intangibles to be recognized related to these
transactions. The Purchase Agreements are subject to customary terms and
conditions.

Summary financial information regarding the financial position of the Triad
Entities as of December 31, 2002 and 2001 and results of operations for the
years ended December 31, 2002 and 2001 of the Triad Entities is presented below.
The Company is also presenting unaudited pro forma financial information as if
the Company's purchase of the Triad Entities (except Triad I) were effective
January 1, 2002. In addition, the unaudited pro forma financial information
includes consolidating Triad I as if the provisions of FASB Interpretation No.
46 were effective January 1, 2002. Beginning in the third quarter of 2003, FASB
Interpretation No. 46 will require the Company to consolidate the financial
position and results of operation of Triad I with the Company's financial
information. The unaudited pro forma financial information, which may not be
indicative of future results, includes the elimination of significant
intercompany balances and assumes incomes taxes at a 39% effective tax rate (in
thousands):

In 2002, the Company sold two communities and one parcel of land for $6.7
million, which resulted in the recognition of a gain of $2.4 million and net
proceeds of $5.2 million. In addition in 2002, the Company contributed to
BRE/CSL four of its senior living communities with a capacity of approximately
600 residents. As a result of the contribution, the Company repaid $29.1 million
of long-term debt to GMAC, received $7.3 million in cash from BRE/CSL, has a 10%
equity interest in the venture of $1.2 million and wrote off $0.5 million in
deferred loan costs, resulting in the recognition of a loss of $0.5 million. In
2001, the Company sold one community, two parcels of land and a house for $5.2
million, which resulted in the recognition of a gain of $2.6 million and net
proceeds of $4.8 million. The two parcels of land and the house were classified
as held for sale. In 2000, the Company sold two communities and a house for $4.8
million, which resulted in the recognition of a net loss of $0.4 million and net
cash proceeds of $4.5 million. These assets were classified as held for sale.

F-18

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. ACCRUED EXPENSES

Accrued expenses consists of the following (in thousands):

7. NOTES PAYABLE

Notes payable consists of the following:

F-19

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The aggregate maturities of notes payable at December 31, 2002, are as
follows (in thousands):

2003........................................................ $ 9,715
2004........................................................ 17,917
2005........................................................ 66,387
2006........................................................ 8,153
2007........................................................ 6,331
Thereafter.................................................. 41,597
--------
$150,100
========

In connection with obtaining the loan commitments above the Company
incurred $0.8 million and $3.7 million in fiscal 2002 and 2000, respectively, in
financing charges that were deferred and amortized over the life of the notes.
Accumulated amortization was $1.9 million and $1.4 million at December 31, 2002
and 2001, respectively.

The Company must maintain certain levels of tangible net worth and comply
with other restrictive covenants under the terms of the notes. The Company was
in compliance with its debt covenants at December 31, 2002 and 2001.

8. EQUITY

The Company is authorized to issue preferred stock in series and to fix and
state the voting powers and such designations, preferences and relative
participating, optional or other special rights of the shares of each such
series and the qualifications, limitations and restrictions thereof. Such action
may be taken by the Board without stockholder approval. The rights, preferences
and privileges of holders of common stock are subject to the rights of the
holders of preferred stock.

Net income (loss) of HCP is generally allocated 98% to the limited partners
and 2% to the general partner. The net income of HCP from the disposition of a
property is allocated: (i) to partners with deficit capital accounts on a pro
rata basis; (ii) to limited partners until they have been paid an amount equal
to the amount of their adjusted investment (as defined); (iii) to the limited
partners until they have been allocated income equal to their 12% Liquidation
Preference; and (iv) thereafter, 80% to the limited partners and 20% to the
general partner. The net loss of HCP from the disposition of a property is
allocated: (i) to partners with positive capital accounts on a pro rata basis
and (ii) thereafter, 98% to the limited partners and 2% to the general partner.
Distributions of available cash flow are generally distributed 98% to the
limited partners and 2% to the general partner, until the limited partners have
received an annual preferential distribution, as defined. Thereafter, available
cash flow is distributed 90% to the limited partners and 10% to the general

F-20

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

partner. HCP made distributions of $2.1 million, $7.6 million and $4.0 million
to minority partners in 2002, 2001 and 2000, respectively.

9. STOCK OPTIONS

The Company adopted a stock option plan during 1997, providing for the
grant of incentive and nonqualified stock options to employees and directors.
This plan was amended during fiscal 2000 to increase the number of options
available for grant under the plan from 1.6 million to 2.0 million shares and
2.0 million shares of common stock are reserved for future issuance. The option
exercise price and vesting provisions of such options are fixed when the option
is granted. The options expire four to ten years from the date of grant and vest
from zero to five years. The option exercise price is the fair market value of a
share of common stock on the date the option is granted.

A summary of the Company's stock option activity, and related information
for the years ended December 31, 2002, 2001 and 2000 is presented below:

The weighted average fair values of stock options granted during the year
ended 2002, 2001 and 2000 was $3.45, $1.80 and $3.63 per option granted.
Unoptioned shares available for the granting of options at December 31, 2002,
2001 and 2000, were 378,198, 407,605, and 275,000, respectively.

F-21

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes information relating to the Company's
options outstanding and options exercisable as of December 31, 2002.

In January 2001, certain employees of the Company elected to forfeit
640,500 options originally priced between $10.19 and $13.50. These options were
added back to the pool of options available to grant in January 2001.

During 2002, the Company recorded compensation expense of $14,000 relating
to certain options accounted for using variable accounting. These options are
included in the table above.

The average daily price of the stock during 2002, 2001 and 2000 was $2.39,
$2.06 and $3.09, respectively, per share and the number of shares that were
anti-dilutive were 1.1 million, 1.1 million and 1.7 million, respectively.

Pro forma information regarding net income per share has been determined as
if the Company had accounted for its employee stock options under the fair value
method. The fair value for these options was estimated at the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions for 2002, 2001 and 2000, respectively: risk free interest rate of
4.6, 6.5 and 6.5 percent; dividend yields of zero percent for all years;
expected lives of seven and one-half years for all years; and volatility factors
of the expected market price of the Company's common stock of 57.4, 62.8, and
60.6 percent. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

F-22

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting periods.

10. INCOME TAXES

The provision (benefit) for income taxes consists of the following (in
thousands):

The provision for income taxes differed from the amounts computed by
applying the U.S. federal income tax rate to income before provision for income
taxes as a result of the following (in thousands):

F-23

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A summary of the Company's deferred tax assets and liabilities, are as
follows (in thousands):

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Management regularly
evaluates the future realization of deferred tax assets and provides a valuation
allowance, if considered necessary, based on such evaluation. The Company
believes based on future anticipated results and available tax planning
strategies, it will be able to realize the deferred tax asset.

11. EMPLOYEE BENEFIT PLANS

The Company has a 401(k) salary deferral plan (the "Plan") in which all
employees of the Company meeting minimum service and age requirements are
eligible to participate. Contributions to the Plan are in the form of employee
salary deferrals, which are subject to employer matching contributions of up to
2% of the employee's annual salary. The Company's contributions are funded
semi-monthly to the Plan administrator. Matching contributions of $0.2 million
were contributed to the Plan in each of 2002, 2001 and 2000. The Company
incurred administrative expenses related to the Plan of $15,000, $14,500 and
$13,000 in 2002, 2001 and 2000, respectively.

12. RELATED PARTY TRANSACTIONS

A former officer, director and significant shareholder of the Company is
chairman of the board of a bank where the Company holds some of its operating
cash accounts.

13. CONTINGENCIES

On or about October 23, 1998, Robert Lewis filed a putative class action
complaint on behalf of certain holders of assignee interests (the "Assignee
Interests") in NHP Retirement Housing Partners I Limited Partnership ("NHP") in
the Delaware Court of Chancery, Civil Action No. 16725 (the "Delaware Action")
against NHP, the general partner of NHP ("General Partner"), the Company and
Capital Senior Living Properties 2-NHPCT, Inc. (collectively, the "Defendants").
The complaint alleges, among other things, that the Defendants breached, or
aided and abetted a breach of, the express and implied terms of the NHP
Partnership Agreement in connection with the sale of four properties by NHP to
Capital Senior Living Properties 2-NHPCT, Inc. in September 1998 (the "1998
Transaction"). The complaint sought, among other relief, rescission of the 1998
Transaction and unspecified damages. Subsequently, the plaintiff amended his
complaint adding allegations challenging the terms of the sale in December 2001
of the Amberleigh retirement facility to BRE/CSL. On December 6, 2001, Leonard
Kalmenson filed a motion to intervene in the Delaware Action on behalf of a
putative class of holders of Pension Notes of NHP in the event the Court of
Chancery determined that the claims asserted in the Delaware Action were
derivative in nature.

F-24

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

On October 18, 2002, the Delaware Court of Chancery entered a Final Order
and Judgment (i) certifying a class consisting of all record and beneficial
holders of Assignee Interests of NHP as of September 30, 1998 or any time
thereafter, (ii) approving as fair, reasonable and adequate a settlement of the
Delaware Action calling for the creation of a settlement fund in the amount of
approximately $0.8 million, (iii) dismissing the Delaware Action with prejudice
and releasing, among other things, all the claims asserted therein, and (iv)
awarding attorneys' fees and expenses in the amount of $0.3 million to be paid
from the settlement fund to counsel for the class. NHP previously contributed
$0.3 million to the creation of the settlement fund, which is the amount of the
deductible of NHP's directors and officers' liability insurance policy at the
time the Delaware Action was filed (the "D&O Policy"). Virtually all of the
balance of the settlement fund was contributed by various insurance brokers and
agents, and their insurers, in connection with the resolution of certain claims
for coverage under the D&O Policy. In accordance with the settlement,
approximately $0.6 million (the amount of the settlement fund minus the award
for attorneys' fees and expenses) was distributed to the class of Assignee
Holders on a pro rata basis after the settlement became final.

On October 9, 2002, the Company entered into a settlement agreement (the
"Agreement") with Buckner Retirement Services, Inc. ("Buckner") relating to the
Company's claim for reimbursement of health care expenses pursuant to the
Management Agreement between the parties. Pursuant to the Agreement, Buckner
waived any claims against the Company for early termination by the Company of
its Management Agreement with Buckner at the Parkway Place facility ("Parkway
Place") and additionally agreed to pay certain damages to the Company.

In the fourth quarter of 2002, the Company (and two of its management
subsidiaries), Buckner, and a related Buckner entity, and other unrelated
entities were named as defendants in a lawsuit in district court in Fort Bend
County, Texas brought by the heir of a former resident who obtained nursing home
services at Parkway Place. The Company managed Parkway Place for Buckner through
December 31, 2001. The Company's insurers have hired counsel to investigate and
defend this claim. The Company is unable at this time to estimate its liability,
if any, related to this claim.

The Company has other pending claims not mentioned above ("Other Claims")
incurred in the course of its business. Most of these Other Claims are believed
by management to be covered by insurance, subject to normal reservations of
rights by the insurance companies and possibly subject to certain exclusions in
the applicable insurance policies. Whether or not covered by insurance, these
claims, in the opinion of management, based on advice of legal counsel, should
not have a material effect on the financial statements of the Company if
determined adversely to the Company.

14. FAIR VALUE OF FINANCIAL INSTRUMENTS

The carrying amounts and fair values of financial instruments at December
31, 2002 and 2001 are as follows (in thousands):

F-25

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following methods and assumptions were used in estimating its fair
value disclosures for financial instruments:

Cash and cash equivalents and restricted cash: The carrying amounts
reported in the balance sheet for cash and cash equivalents approximate fair
value.

Notes receivable: The fair value of notes receivable is estimated by using
a discounted cash flow analysis based on current expected rates of return.

Notes payable: The fair value of notes payable is estimated using
discounted cash flow analysis, based on current incremental borrowing rates for
similar types of borrowing arrangements.

15. INVESTMENTS IN LIMITED PARTNERSHIPS

The investments in limited partnerships balance consists of the following
(in thousands):

Triad Entities: The Company has opened, in connection with its management
agreements, seventeen new Waterford and Wellington communities and two
expansions in the last four years pursuant to arrangements with the Triad
Entities. The Company has an approximate 1% limited partnership interest in each
of the Triad Entities and is accounting for these investments under the equity
method of accounting based on the provisions of the Triad Entities partnership
agreements. The Company defers 1% of its interest income, development fee income
and management fee income earned from the Triad Entities. As of December 31,
2002, the Company had deferred income of $1.1 million relating to the Triad
Entities.

The Company has loan commitments to the Triad Entities for construction and
pre-marketing expenses, in addition to requirements to fund the Triad Entities'
operating deficits through operating deficit guarantees provided for in its
management agreements with the Triad Entities and other advances, totaling $85.2
million at December 31, 2002. The Company evaluates the carrying value of these
receivables by comparing the cash flows expected from the operations of the
Triad Entities to the carrying value of the receivables. These cash flow models
consider lease-up rates, expected operating costs, debt service requirements and
various other factors. In addition, the Company entered into a support agreement
with the Triad Entities during the third quarter of 2002, whereby each of Triad
II, Triad III, Triad IV and Triad V agreed to loan excess cash flow of such
Triad to any one or more of Triad I, Triad II, Triad III, Triad IV and Triad V.
The carrying value of the notes receivable from the Triad Entities could be
adversely affected by a number of factors, including the Triad communities
experiencing slower than expected lease-up, lower than expected lease rates,
higher than expected operating costs, increases in interest rates, issues
involving debt service requirements, general adverse market conditions, other
economic factors and changes in accounting guidelines. Management believes that
the carrying value of the notes receivable are fully recoverable, based on the
support agreement, factors within

F-26

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

its control and the future achievement of the assumptions used in these cash
flow models, which are consistent with the Company's operating experience.

Deferred interest income is being amortized into income over the life of
the loan commitment that the Company has with each of the Triad Entities.
Deferred development and management fee income is being amortized into income
over the expected remaining life of the Triad partnerships.

Under equity accounting, the Company has recognized losses in the Triad
Entities of $0.2 million and $0.5 million as of December 31, 2002 and 2001,
respectively. The recognition of these losses have reduced the Company's
investments in the Triad Entities to zero, and additional losses of $0.4 million
have been recorded as a reduction to the Company's notes receivable from the
Triad Entities. The Company's share of future losses will also be recorded as a
reduction of notes receivable from the Triad Entities.

In January 2003, the Financial Accounting Standards Board issued FASB
Interpretation No. 46 "Consolidation of Variable Interest Entities" an
interpretation of ARB No. 51, effective immediately for variable interest
entities created after January 31, 2003 and effective for the first fiscal year
or interim period beginning after June 15, 2003 for variable interest entities
that existed prior to February 1, 2003. The Company will adopt the provisions of
this interpretation in the third quarter of 2003, and its adoption will result
in the Company consolidating the financial statements of the Triad Entities,
currently accounted for separately under the equity method of accounting. The
Company expects the implementation of FASB Interpretation No. 46 will have a
material effect on the Company's earnings and financial position. See Note 3 for
a description of the Company's agreements to purchase the partnership interests
in Triads II, III, IV and V owned by non-Company parties.

BRE/CSL: The Company formed BRE/CSL with an affiliate of Blackstone in
December 2001, and the joint venture seeks to acquire in excess of $200 million
of senior housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the
Company. The Company accounts for its investment in this joint venture under the
equity method of accounting. The Company recorded its investment at cost and
will adjust its investment for its share of earnings and losses of BRE/CSL. The
Company defers 10% of its management fee income earned from BRE/CSL. As of
December 31, 2002, the Company had deferred income of $50,000 relating to
BRE/CSL.

Deferred management fee income is being amortized into income over the term
of the Company's management contract.

Spring Meadows: During the fourth quarter of 2002, the Company acquired
LCOR's interests in the Spring Meadows Communities from LCOR as well as loans
made by LCOR to the ventures for $0.9 million in addition to funding $0.4
million to the venture for working capital and anticipated negative cash
requirements of the communities. The Company's interests in the four joint
ventures which own the Spring Meadows Communities include interests in certain
loans to the ventures and an approximate 19% member interest in each venture.
The Company has managed these communities since the opening of each community in
late 2000 and early 2001 and will continue to manage the communities under
long-term management contracts. In addition, the Company will receive an asset
management fee relating to each of the Spring Meadows Communities. The Company
recorded its initial advances of $1.3 million to the ventures as notes
receivable as the amount assigned for the 19% member interests was nominal. The
Company accounts for its investment in the Spring Meadows Communities under the
equity method of accounting based on the provisions of the partnership
agreements.

HCP: HCP is consolidated in the accompanying consolidated financial
statements. At December 31, 2002, 2001 and 2000, the Company owned approximately
57% of HCP's limited partner units.

NHP: The Company owned 33.1% of notes ("The NHP Notes") issued by NHP
Retirement Housing Partners I Limited Partnership ("NHP"). The Company
classified its investment in The NHP Notes as held

F-27

CAPITAL SENIOR LIVING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

to maturity. The NHP Notes bore simple interest at 13% per annum and matured on
December 31, 2001. Interest was paid quarterly at a rate of 7%, with the
remaining 6% interest deferred. During the fourth quarter of 2001, the Company
reevaluated its assumptions related to the NHP Notes, and, as a result, reduced
interest income by $0.5 million. At December 31, 2001, the Company's effective
interest rate on the NHP Notes was 16.7%. In January 2002, NHP distributed its
available cash and proceeds from the sale of its remaining community to the NHP
note holders. The Company received $5.6 million of this distribution. NHP has
been dissolved and is currently being liquidated.

HCP and NHP are subject to the reporting obligations of the Securities and
Exchange Commission.

16. ALLOWANCE FOR DOUBTFUL ACCOUNTS

The components of the allowance for doubtful accounts and notes receivable
are as follows (in thousands):

In the fourth quarter of fiscal 2000, the Company wrote off $1.6 million in
notes receivable and $1.4 million in development fees receivable relating to
certain communities that were under development for the Triad Entities. In
addition, during the fourth quarter of 2000, the Company recorded a write-down
on a house and five parcels of land of $1.0 million to record these assets at
their estimated net realizable value.

17. LEASES

The Company leases its corporate headquarters under an operating lease
expiring in 2008. Additionally, the senior living communities have entered into
various contracts for services for duration of 5 years or less and are on a fee
basis as services are rendered. Rent expense under these leases was $0.5
million, $0.5 million and $0.6 million for 2002, 2001 and 2000, respectively.
Future commitments are as follows (in thousands):

2003........................................................ $ 447
2004........................................................ 503
2005........................................................ 462
2006........................................................ 419
2007........................................................ 384
Thereafter.................................................. 61
------
$2,276
======

HCP leased two communities under non-cancelable operating leases during the
first quarter of 2002 for $37,000. These properties were sold during the first
quarter of 2002. HCP owns one additional community, which is classified as held
for sale.

18. SUBSEQUENT EVENTS

On January 16, 2003 the Company granted options to certain employees, to
purchase 22,000 shares of the Company's common stock at an exercise price of
$2.73, which was the market price on the day of grant.

F-28

INDEX TO EXHIBITS

The following documents are filed as a part of this report. Those exhibits
previously filed and incorporated herein by reference are identified below.
Exhibits not required for this report have been omitted.

- ---------------

* Incorporated by reference to exhibit of corresponding number included in
Registration Statement No. 333-33379 on Form S-1 filed by the Company with
the Securities and Exchange Commission.

(a) Incorporated by reference to exhibit of corresponding number from the
Company's Annual Report on Form 10-K for the year ended December 31, 1997,
filed by the Company with the Securities and Exchange Commission.

(b) Incorporated by reference to the exhibit of corresponding number from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1998, filed by the Company with the Securities and Exchange
Commission.

(c) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1998, filed by the Company with the Securities and Exchange
Commission.

(d) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated September 30, 1998, filed by
the Company with the Securities and Exchange Commission.

(e) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated October 29, 1998, filed by the
Company with the Securities and Exchange Commission.

(f) Incorporated by reference to the exhibit shown in parentheses from the
Company's Annual Report on Form 10-K for the year ended December 31, 1998,
filed by the Company with the Securities and Exchange Commission.

(g) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1999, filed by the Company with the Securities and Exchange
Commission.

(h) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June
30, 1999, filed by the Company with the Securities and Exchange Commission.

(i) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1999, filed by the Company with the Securities and Exchange
Commission.

(j) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated February 7, 1999, filed by the
Company with the Securities and Exchange Commission.

(k) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated February 7, 1999, filed by the
Company with the Securities and Exchange Commission.

(l) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated October 19, 1999, filed by the
Company with the Securities and Exchange Commission.

(m) Incorporated by reference to the exhibit shown in parentheses from the
Company's Current Report on Form 8-K, dated October 19, 1999, filed by the
Company with the Securities and Exchange Commission.

(n) Incorporated by reference to the exhibit shown in parentheses from the
Company's Registration Statement on Form S-8, filed on December 3, 1999, by
the Company with Securities and Exchange Commission.

(o) Incorporated by reference to the exhibit shown in parenthesis from the
Company's Annual Report on Form 10-K, dated March 30, 2000, filed by the
Company with the Securities and Exchange Commission.

(p) Incorporated by reference to the exhibit shown in parenthesis from the
Company's Current Report on Form 8-K, dated August 15, 2000, filed by the
Company with the Securities and Exchange Commission.

(q) Incorporated by reference to the exhibit shown in parenthesis from the
Company's Current Report on Form 8-K, dated November 28, 2000, filed by the
Company with the Securities and Exchange Commission.

(r) Incorporated by reference to the exhibit shown in parenthesis from the
Company's Annual Report on Form 10-K, dated March 20, 2001, filed by the
Company with the Securities and Exchange Commission.

(s) Incorporated by reference to the exhibit shown in parenthesis from the
Company's Annual Report on Form 10-K, dated March 26, 2002, filed by the
Company with the Securities and Exchange Commission.

(t) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2002, filed by the Company with the Securities and Exchange Commission.

(u) Incorporated by reference to the exhibit shown in parentheses from the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2002, filed by the Company with the Securities and Exchange
Commission.

(v) Filed herewith.