UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission file number: 1-13445

Capital Senior Living Corporation

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(972) 770-5600

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 þ          No o

      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. o

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

      The aggregate market value of the 20,296,247 shares of the Registrant’s Common Stock, par value $0.01 per share (“Common Stock”), held by nonaffiliates on December 31, 2004, based upon the closing price of the Registrant’s Common Stock as reported by the New York Stock Exchange on June 30, 2004 was approximately $97,624,948. As of March 9, 2005, the Registrant had 25,754,447 share of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

      The Registrant’s definitive proxy statement pertaining to the 2004 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.

CAPITAL SENIOR LIVING CORPORATION

TABLE OF CONTENTS

PART I

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. The Company and its predecessors have provided senior living services since 1990. As of December 31, 2004, the Company operated 54 senior living communities in 20 states with an aggregate capacity of approximately 8,700 residents, including 39 senior living communities which the Company owned or in which the Company had an ownership interest and 15 communities it managed for third parties, including one community in pre-lease. As of December 31, 2004, the Company also operated one home care agency. During 2004 approximately 95% of total revenues for the senior living communities owned and managed by the Company were derived from private pay sources. As of December 31, 2004, 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 90%.

      The Company’s operating strategy is to provide 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 senior living services to the elderly, including independent living, assisted living, 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 through independent home care agencies or the Company’s home care agency, sustains residents’ autonomy and independence based on their physical and mental abilities.

Website

      The Company’s internet website www.capitalsenior.com contains an Investor Relations section, which provides links to the Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Section 16 filings and amendments to those reports, which reports and filings are available free of charge as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission (“SEC”).

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.

      According to the American Senior Housing Association Senior Housing Construction Report for 2004, 35% of senior housing properties in the U.S. are assisted living communities, 30% are independent living communities, 25% are senior apartments and 10% are continuing care retirement communities.

      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 extensive professional training for staff and provide only limited assistance with ADLs. The Company believes that many senior living operators do not provide the 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 a number of demographic, regulatory, and other trends will contribute to the continued growth in the senior living market including the following:

      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.

      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 4.2 million in 2000. This age cohort is expected to grow to approximately 38% to 5.8 million by 2010 and by 112% to 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.

      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.

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

      Several 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.

      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 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.

      Central to the Company’s operating strategy is its focus on providing 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 2004 and 2003, the Company achieved 95% and 96%, respectively, overall approval rating from the residents’ satisfaction survey.

      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.

      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.

      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.

      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 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 hires an executive director for each of its communities and provides them with autonomy, responsibility and accountability. 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 believes its commitment to and emphasis on employee training and retention differentiates the Company from many of its competitors.

Senior Living Services

      The Company provides senior living services to the elderly, including independent living, assisted living, 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.

      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, 2004, the Company had ownership interests in 38 communities and managed 10 communities that provide independent living services, with an aggregate capacity for 7,313 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 agency or other independent home care agencies. The Company’s independent living residents pay a fee ranging from $895 to $4,330 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.

      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, 2004, the Company had ownership interests in 14 communities and managed six communities that provide assisted living services, which include communities that have independent living and other services, with an aggregate capacity for 1,185 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.

      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, 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:

      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.

      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, 2004, the Company had ownership interests in two facilities providing a continuum of care that provide nursing services with an aggregate capacity for 170 residents.

      As of December 31, 2004, the Company provided private pay, home care services to clients at one senior living community through the Company’s home care agency and made private pay, home care 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, 2004.

      The Company is party to a series of property management agreements (the “BRE/ CSL Management Agreements”) with three 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 six senior living communities. The BRE/ CSL Management Agreements extend until various dates through June 2008. 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 $0.9 million under the terms of the BRE/ CSL Management Agreements for the year ended December 31, 2004.

      Effective August 18, 2004, the Company acquired from the Covenant Group of Texas (“Covenant”) all of the outstanding stock of Covenant’s wholly owned subsidiary, CGI Management, Inc. (“CGIM”). This acquisition resulted in the Company assuming the management contracts (the “CGIM Management Agreements”) on 14 senior living communities with a combined resident capacity of approximately 1,800 residents. The CGIM Management Agreements expire on various dates through August 2019. The CGIM Management Agreements generally provide for management fees of 5% to 5.5% of gross revenues, subject to certain base management fees. The Company earned $0.6 million under the terms of the CGIM Management Agreements for the year ended December 31, 2004. In addition, the Company has the right to acquire seven of the properties owned by Covenant (which are part of the 14 communities managed by CGIM) based on sales prices specified in the stock purchase agreement.

      The Company is party to a property management agreement (the “SHPII Management Agreement”) with Senior Housing Partners II, LP (“SHPII”), a fund managed by Prudential Real Estate Investors (“Prudential”), to manage one senior living community. The SHP Management Agreement extends until June 2008 and provides for management fees of 5% of gross revenue plus reimbursement for costs and expenses related to the communities. The Company earned $0.2 million under the terms of the SHP Management Agreement for the year ended December 31, 2004.

      The Company entered into a series of property management agreements (the “SHPII/ CSL Management Agreements”), effective November 30, 2004, with four joint ventures (collectively “SHPII/ CSL”) owned 95% by SHPII and 5% by the Company, which collectively own and operate four senior living communities (collectively the “Spring Meadows Communities”). The SHPII/ CSL Management Agreements extend until various dates through November 2014. The SHPII/ 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 $0.1 million under the terms of the SHPII/ CSL Management Agreements for the year ended December 31, 2004.

      Prior to SHPII/ CSL’s acquisition of the Spring Meadows Communities on November 30, 2004, the Company was party to a series of property management agreements (the “Spring Meadows Agreements”) with affiliates of Lehman Brothers (“Lehman”) to operate the Spring Meadows Communities, which were owned by joint ventures in which Lehman and the Company were members. Three Spring Meadows 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 Spring Meadows 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 Company managed the communities under long-term management contracts, which extended until December 2010. In addition, the Company received an asset management fee of 0.75% of annual revenues relating to each of the four communities. The Company earned $1.0 million under the terms of the Spring Meadows Agreements for the year ended December 31, 2004.

      The Company was party to a series of property management agreements (the “Triad I Management Agreements”) pursuant to arrangements with Triad Senior Living I, LP (“Triad I”), a partnership affiliated with Lehman, which collectively owned and operated five senior living communities and two expansions. The Company had an approximate 1% limited partnership interest in Triad I. The Triad I Management Agreements extended until September 2022. The Triad I Management Agreements provided for a base management fee of the greater of $5,000 per month or 5% of gross revenue plus reimbursement for costs and expenses related to the communities. Under the provisions of FASB Interpretation No. 46, Triad I operations have been consolidated with the Company’s operations since January 1, 2004. Effective as of November 30, 2004, the Company acquired the partnership interests of Triad I that it did not already own and now effective with these transactions the Company wholly owns Triad I.

      During the first six months of fiscal 2003, the Company was party to a series of property management agreements (the “Triad Entities Agreements”) with four partnerships (Triad Senior Living II, L.P., Triad

Senior Living III, L.P., Triad Senior Living IV, L.P. and Triad Senior Living V, L.P., (collectively the “Triad Entities”) affiliated with Triad Senior Living, Inc., which collectively owned and operated 12 senior living communities. The Company had an approximate 1% limited partnership interest in each of the Triad Entities. The Triad Entities Management Agreements extended until September 2022. The Triad Entities Management Agreements provided for a base management fee of the greater of $5,000 per month or 5% of gross revenue plus reimbursement for costs and expenses related to the communities. Effective as of July 1, 2003, the Company acquired the partnership interests of the Triad Entities that it did not already own and now effective with these transactions the Company wholly owns each of the Triad Entities.

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

      All obligations for the Buckner Agreement for Parkway Place facility were settled in October 2002. 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 continued to provide certain consulting services and earn a consulting/licensing fee of 3.5% of the facility’s gross revenues through December 31, 2001 and 3.0% of the facility’s gross revenues beginning on January 1, 2002 and continuing through May 31, 2005. 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.

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:

      The Company intends to continue to focus on the lease-up of its non-stabilized communities and to improve its occupancy and operating margins of its stabilized communities. 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) 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 (iv) continually refurbishing and renovating its communities.

      The Company intends to continue to pursue single or portfolio acquisitions of senior living communities. Through strategic acquisitions or joint venture investments, 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 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.

      Since 1999 the Company has developed and opened 17 new senior living communities and expanded two communities for third parties. In addition, the Company has provided pre-opening marketing services for four communities owned by a third party. The Company intends to continue to pursue opportunities to provide third parties development and marketing services.

      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

      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.

      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 three to six communities clustered in a small geographic area. A regional manager will cover a larger geographic area consisting of seven 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, 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.

      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 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 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 2004 and 2003, the Company achieved a 95% and a 96%, respectively, 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.

      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, quarterly 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 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.

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”), in conjunction with the federal regulations promulgated thereunder by the Department of Health and Human Services, has established, among other requirements, standards governing the privacy of certain protected and individually identifiable health information (“PHI”) that is created, received or maintained by a range of covered entities. HIPAA has also established standards governing uniform health care transactions and the codes and identifiers to be used by the covered entities as part of these transactions. During 2005, standards governing the security of certain electronic transactions conducted by covered entities will go into effect. Penalties for violations can range from civil money penalties for errors and negligent acts to criminal fines and imprisonment for knowing and intentional misconduct. HIPAA is a complex set of regulations and many unanswered questions remain with respect to the manner in which HIPAA applies to businesses such as those operated by the Company.

      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, typically at the time of acquisition, and such audits 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, Brookdale Living Communities, Emeritus Corporation, Holiday Retirement Corporation and Sunrise Senior Living, Inc. The Company believes that the primary competitive factors in the senior living industry are: (i) location; (ii) reputation for and commitment to a high quality of service; (iii) quality of support services offered (such as food services); (iv) price of services; and (v) physical appearance and amenities associated with the communities. The Company 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.

Risk Factors

      The Company’s business involves various risks. When evaluating the Company’s business the following information should be carefully considered in conjunction with the other information contained in our periodic filings with the Securities and Exchange Commission. Additional risks and uncertainties not known to the Company currently or that currently the Company deems to be immaterial also may impair the Company’s business operations. If the Company is unable to prevent events that have a negative effect from occurring, then the Company’s business may suffer. Negative events are likely to decrease the Company’s revenue, increase its costs, make its financial results poorer and/or decrease its financial strength, and may cause its stock price to decline.

The Company has significant debt. The Company’s failure to generate cash flow sufficient to cover required interest and principal payments could result in defaults of the related debt.

      As of December 31, 2004, the Company had mortgage and other indebtedness totaling approximately $261.8 million. As of December 31, 2004, the Company had approximately $42.2 million of mortgage and other indebtedness that was payable on or prior to December 31, 2005. The Company cannot assure you that it will generate cash flow from operations or receive proceeds from refinancings, other financings or the sales of assets sufficient to cover required interest, principal and, if applicable, operating lease payments. Any payment or other default could cause the applicable lender to foreclose upon the communities securing the indebtedness or, if applicable, in the case of an operating lease, could terminate the lease, with a consequent loss of income and asset value to the Company. Further, because some of the Company’s mortgages contain cross-default and cross-collateralization provisions, a payment or other default by the Company with respect to one community could affect a significant number of the Company’s other communities.

The Company’s failure to comply with financial covenants contained in debt instruments could result in the acceleration of the related debt.

      There are various financial covenants and other restrictions in the Company’s debt instruments, including provisions which:

      If the Company fails to comply with any of these requirements, then the related indebtedness could become due and payable prior to its stated maturity date. The Company cannot assure that it could pay this debt if it became due.

The Company will require additional financing and/or refinancings in the future.

      The Company’s ability to meet its long-term capital requirements, including the repayment of certain long-term debt obligations, will depend, in part, on its ability to obtain additional financing or refinancings on acceptable terms from available financing sources, including through the use of mortgage financing, joint venture arrangements, by accessing the debt and/or equity markets and possibly through operating leases or other types of financing, such as lines of credit. There can be no assurance that the financing or refinancings will be available or that, if available, it will be on terms acceptable to the Company. Moreover, raising additional funds through the issuance of equity securities could cause existing stockholders to experience dilution and could adversely affect the market price of the Company’s common stock. The Company’s inability to obtain additional financing or refinancings on terms acceptable to the Company could delay or eliminate some or all of the Company’s growth plans, necessitate the sales of assets at unfavorable prices or both, and would have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company’s current floating rate debt, and any future floating rate debt, exposes it to rising interest rates.

      The Company currently has indebtedness with floating interest rates. Future indebtedness and, if applicable, lease obligations may be based on floating interest rates prevailing from time to time. Therefore, increases in prevailing interest rates would increase the Company’s interest or lease payment obligations and could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company cannot assure that it will be able to effectively manage its growth.

      The Company intends to expand its operations, directly or indirectly, through the acquisition of new senior living communities, the expansion of some of its existing senior living communities and through the increase in the number of communities which it manages under management agreements. The success of the Company’s growth strategy will depend, in large part, on its ability to implement these plans and to effectively operate these communities. If the Company is unable to manage its growth effectively, its business, results of operations and financial condition may be adversely affected.

The Company cannot assure that it will be able to acquire additional senior living communities or expand existing senior living communities.

      The acquisition of existing communities or other businesses involves a number of risks. Existing communities available for acquisition frequently serve or target different markets than those presently served by the Company. The Company may also determine that renovations of acquired communities and changes in staff and operating management personnel are necessary to successfully integrate those communities or businesses into its existing operations. The costs incurred to reposition or renovate newly acquired communities may not be recovered by the Company. In undertaking acquisitions, the Company also may be adversely impacted by unforeseen liabilities attributable to the prior operators of those communities or businesses, against whom it may have little or no recourse. The success of the Company’s acquisition strategy will be determined by numerous factors, including its ability to identify suitable acquisition candidates; the competition for those acquisitions; the purchase price; the requirement to make operational or structural changes and improvements; the financial performance of the communities or businesses after acquisition; its ability to finance the acquisitions; and its ability to integrate effectively any acquired communities or businesses into its management, information, and operating systems. The Company cannot assure that its acquisition of senior living communities or other businesses will be completed at the rate currently expected, if at all, or if completed, that any acquired communities or businesses will be successfully integrated into its operations.

      The Company’s ability to successfully expand existing senior living communities will depend on a number of factors, including, but not limited to, its ability to acquire suitable sites for expansion at reasonable prices; its success in obtaining necessary zoning, licensing, and other required governmental permits and authorizations; and its ability to control construction costs and accurately project completion schedules. Additionally, the Company anticipates that the expansion of existing senior living communities may involve a substantial commitment of capital for a period of time of two years or more until the expansions are operating and producing revenue, the consequence of which could be an adverse impact on its liquidity. The Company cannot assure that its expansion of existing senior living communities will be completed at the rate currently expected, if at all, or if completed, that such expansions will be profitable.

Termination of resident agreements and resident attrition could affect adversely the Company’s revenues and earnings.

      State regulations governing assisted living facilities require written resident agreements with each resident. Most of these regulations also require that each resident have the right to terminate the resident agreement for any reason on reasonable notice. Consistent with these regulations, the resident agreements signed by the Company allow residents to terminate their agreement on 30 days’ notice. Thus, the Company cannot contract with residents to stay for longer periods of time, unlike typical apartment leasing arrangements that involve lease agreements with specified leasing periods of up to a year or longer. If a large number of residents elected to terminate their resident agreements at or around the same time, then the Company’s revenues and earnings could be adversely affected. In addition, the advanced age of the Company’s average resident means that the resident turnover rate in the Company’s senior living facilities may be difficult to predict.

The Company largely relies on private pay residents. Circumstances that adversely effect the ability of the elderly to pay for the Company’s services could have a material adverse effect on the Company.

      Approximately 95% of the Company’s total revenues from communities that it owned and managed for each of the years ended December 31, 2004 and 2003 were attributable to private pay sources. For each of the same periods, approximately 5% of the Company’s revenues from these communities were attributable to reimbursements from Medicare and Medicaid. The Company expects to continue to rely primarily on the ability of residents to pay for the Company’s services from their own or familial financial resources. Inflation or other circumstances that adversely affect the ability of the elderly to pay for the Company’s services could have a material adverse effect on the Company’s business, financial condition and results of operations.

The Company is subject to some particular risks related to third-party management agreements.

      The Company currently manages 15 senior living communities for third parties and 10 senior living communities for joint ventures in which it has a minority interest pursuant to multi-year management agreements. The management agreements generally have initial terms of between five and fifteen years, subject to certain renewal rights. Under these agreements the Company provides management services to third party and joint venture owners to operate senior living communities and has provided, and may in the future provide, management and consulting services to third parties on market and site selection, pre-opening sales and marketing, start-up training and management services for facilities under development and construction. In most cases, either party to the agreements may terminate them upon the occurrence of an event of default caused by the other party. In addition, subject to the Company’s rights to cure deficiencies, community owners may terminate the Company as manager if any licenses or certificates necessary for operation are revoked, or if the Company has a change of control. Also, in some instances, a community owner may terminate the management agreement relating to a particular community if the Company is in default under other management agreements relating to other communities owned by the same community owner or its affiliates. In addition, in certain cases the community owner may terminate the agreement upon 30 days’ notice to the Company in the event of a sale of the community. In those agreements, which are terminable in the event of a sale of the community, the Company has certain rights to offer to purchase the community. The termination of a significant portion of the Company’s management agreements could have a material adverse effect on its business, financial condition and results of operations.

Performance of the Company’s obligations under its joint venture arrangements could have a material adverse effect on the Company.

      The Company holds minority interests ranging from approximately 5% to 10% in several joint ventures with affiliates of Blackstone and Prudential. The Company also manages the communities owned by these joint ventures. Under the joint venture agreements with Blackstone covering six communities, the Company is obligated to forego distributions if certain cash flow targets are not met. Also in the Blackstone joint ventures, the Company is obligated to contribute additional capital if both parties agree to make additional acquisitions. The Company is subject to various non-compete provisions under the management agreements with the Blackstone joint ventures, which may impede its ability to conduct business in desirable areas. Under the terms of the joint venture agreements with Prudential covering four properties, the Company is obligated to meet certain cash flow targets and failure to meet these cash flow targets could result in termination of the management agreements. All of the management agreements with the joint ventures contain termination and renewal provisions. The Company does not control joint venture decisions covering termination or renewal. Performance of the above obligations or termination or non-renewal of the management agreements could have a material adverse effect on the Company’s business, financial condition and results of operations.

The senior living services industry is very competitive and some competitors have substantially greater financial resources than the Company.

      The senior living services industry is highly competitive, and the Company expects that all segments of the industry will become increasingly competitive in the future. The Company competes with other companies providing independent living, assisted living, skilled nursing, home health care and other similar services and care alternatives. The Company also competes with other health care businesses with respect to attracting and retaining nurses, technicians, aides and other high quality professional and non-professional employees and managers. Although the Company believes there is a need for senior living communities in the markets where it operates residences, the Company expects that competition will increase from existing competitors and new market entrants, some of whom may have substantially greater financial resources than the Company. In addition, some of the Company’s competitors operate on a not-for-profit basis or as charitable organizations and have the ability to finance capital expenditures on a tax-exempt basis or through the receipt of charitable contributions, neither of which are available to the Company. Furthermore, if the development of new senior living communities outpaces the demand for those communities in the markets in which the Company has senior living communities, those markets may become saturated. Regulation in the independent and assisted

living industry, which represents a substantial portion of the Company’s senior living services, is not substantial. Consequently, development of new senior living communities could outpace demand. An oversupply of those communities in the Company’s markets could cause the Company to experience decreased occupancy, reduced operating margins and lower profitability.

The Company relies on the services of key executive officers and the loss of these officers or their services could have a material adverse effect on the Company.

      The Company depends on the services of its executive officers for its management. The loss of some of the Company’s executive officers and the inability to attract and retain qualified management personnel could affect its ability to manage its business and could adversely effect its business, financial condition and results of operations.

A significant increase in the Company’s labor costs could have a material adverse effect on the Company.

      The Company competes with other providers of senior living services with respect to attracting and retaining qualified management personnel responsible for the day-to-day operations of each of its communities and skilled personnel responsible for providing resident care. A shortage of nurses or trained personnel may require the Company to enhance its wage and benefits package in order to compete in the hiring and retention of these personnel or to hire more expensive temporary personnel. The Company also will be dependent on the available labor pool of semi-skilled and unskilled employees in each of the markets in which it operates. No assurance can be given that the Company’s labor costs will not increase, or that, if they do increase, they can be matched by corresponding increases in rates charged to residents. Any significant failure by the Company to control its labor costs or to pass on any increased labor costs to residents through rate increases could have a material adverse effect on its business, financial condition and results of operations.

There is an inherent risk of liability in the provision of personal and health care services, not all of which may be covered by insurance.

      The provision of personal and health care services in the long-term care industry entails an inherent risk of liability. In recent years, participants in the long-term care industry have become subject to an increasing number of lawsuits alleging negligence or related legal theories, many of which involve large claims and result in the incurrence of significant defense costs. Moreover, senior living communities offer residents a greater degree of independence in their daily living. This increased level of independence may subject the resident and, therefore, the Company to risks that would be reduced in more institutionalized settings. The Company currently maintains insurance in amounts it believes are comparable to that maintained by other senior living companies based on the nature of the risks, the Company’s historical experience and industry standards, and the Company believes that this insurance coverage is adequate. However, the Company may become subject to claims in excess of its insurance or claims not covered by its insurance, such as claims for punitive damages, terrorism and natural disasters. A claim against the Company not covered by, or in excess of, its insurance could have a material adverse effect upon the Company.

      In addition, the Company’s insurance policies must be renewed annually. Based upon poor loss experience, insurers for the long-term care industry have become increasingly wary of liability exposure. A number of insurance carriers have stopped writing coverage to this market, and those remaining have increased premiums and deductibles substantially. Therefore, the Company cannot assure that that it will be able to obtain liability insurance in the future or that, if that insurance is available, it will be available on acceptable economic terms.

The Company is subject to government regulations and compliance, some of which are burdensome and some of which may change to the Company’s detriment in the future.

      Federal and state governments regulate various aspects of the Company’s business. The development and operation of senior living communities and the provision of health care services are subject to federal, state and local licensure, certification and inspection laws that regulate, among other matters, the number of licensed

beds, the provision of services, the distribution of pharmaceuticals, billing practices and policies, equipment, staffing (including professional licensing), operating policies and procedures, fire prevention measures, environmental matters and compliance with building and safety codes. Failure to comply with these laws and regulations could result in the denial of reimbursement, the imposition of fines, temporary suspension of admission of new residents, suspension or decertification from the Medicare program, restrictions on the ability to acquire new communities or expand existing communities and, in extreme cases, the revocation of a community’s license or closure of a community. The Company believes that such regulation will increase in the future and the Company is unable to predict the content of new regulations or their effect on its business, any of which could materially adversely affect the Company.

      Various states, including several of the states in which the Company currently operates, control the supply of licensed skilled nursing beds, assisted living communities and home health care agencies through Certificate of Need (CON) or other programs. In those states, approval is required for the construction of new health care communities, the addition of licensed beds and some capital expenditures at those communities, as well as the opening of a home health care agency. To the extent that a CON or other similar approval is required for the acquisition or construction of new communities, the expansion of the number of licensed beds, services, or existing communities, or the opening of a home health care agency, the Company could be adversely affected by its failure or inability to obtain that approval, changes in the standards applicable for that approval, and possible delays and expenses associated with obtaining that approval. In addition, in most states, the reduction of the number of licensed beds or the closure of a community requires the approval of the appropriate state regulatory agency and, if the Company were to seek to reduce the number of licensed beds at, or to close, a community, the Company could be adversely affected by a failure to obtain or a delay in obtaining that approval.

      Federal and state anti-remuneration laws, such as “anti-kickback” laws, govern some financial arrangements among health care providers and others who may be in a position to refer or recommend patients to those providers. These laws prohibit, among other things, some direct and indirect payments that are intended to induce the referral of patients to, the arranging for services by, or the recommending of, a particular provider of health care items or services. Federal anti-kickback laws have been broadly interpreted to apply to some contractual relationships between health care providers and sources of patient referral. Similar state laws vary, are sometimes vague, and seldom have been interpreted by courts or regulatory agencies. Violation of these laws can result in loss of licensure, civil and criminal penalties, and exclusion of health care providers or suppliers from participation in Medicare and Medicaid programs. There can be no assurance that those laws will be interpreted in a manner consistent with the Company’s practices.

      Under the Americans with Disabilities Act of 1990, all places of public accommodation are required to meet federal requirements related to access and use by disabled persons. A number of additional federal, state and local laws exist that also may require modifications to existing and planned communities to create access to the properties by disabled persons. Although the Company believes that its communities are substantially in compliance with present requirements or are exempt therefrom, if required changes involve a greater expenditure than anticipated or must be made on a more accelerated basis than anticipated, additional costs would be incurred by the Company. Further legislation may impose additional burdens or restrictions with respect to access by disabled persons, the costs of compliance with which could be substantial.

      The Health Insurance Portability and Accountability Act of 1996, in conjunction with the federal regulations promulgated thereunder by the Department of Health and Human Services, has established, among other requirements, standards governing the privacy of certain protected and individually identifiable health information that is created, received or maintained by a range of covered entities. HIPAA has also established standards governing uniform health care transactions and the codes and identifiers to be used by the covered entities as part of these transactions. During 2005, standards governing the security of certain electronic transactions conducted by covered entities will go into effect. Penalties for violations can range from civil money penalties for errors and negligent acts to criminal fines and imprisonment for knowing and intentional misconduct. HIPAA is a complex set of regulations and many unanswered questions remain with respect to the manner in which HIPAA applies to businesses such as those operated by the Company.

The Company may be subject to liability for environmental damages.

      Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real estate may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at the property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean up costs incurred by those parties in connection with the contamination. These laws typically impose clean-up responsibility and liability without regard to whether the owner knew of or caused the presence of the contaminants, and liability under these laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. The costs of investigation, remediation or removal of the substances may be substantial, and the presence of the substances, or the failure to properly remediate the property, may adversely affect the owner’s ability to sell or lease the property or to borrow using the property as collateral. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the costs of removal or remediation of the substances at the disposal or treatment facility, whether or not the facility is owned or operated by the person. Finally, the owner of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site. If the Company becomes subject to any of these claims the costs involved could be significant and could have a material adverse effect on its business, financial condition and results of operations.

Employees

      As of December 31, 2004, the Company employed 2,795 persons, of which 1,453 were full-time employees (51 of whom are located at the Company’s corporate offices) and 1,342 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, 2004:

      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. 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 20 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 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 20 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 26 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 28 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 31 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 18 years.

      Glen H. Campbell has served as Vice President — Development of the Company since September 1997. From 1990 to 1997 Mr. Campbell served as Vice President of Development for Greenbrier Corporation, an assisted living development and management company. From 1985 to 1990 Mr. Campbell served as Director

of Facility Management for Retirement Corporation of America. Mr. Campbell has been active in the design and development of retirement communities for 30 years.

      Gloria M. Holland has served as Vice President — Finance since June 2004. From 2001 to 2004, Ms. Holland served as Assistant Treasurer and a corporate officer for Aurum Technology, Inc., a privately held company that provided technology and outsourcing to community banks. From 1996 to 2001, Ms. Holland held positions in Corporate Finance and Treasury at Brinker International, an owner and operator of casual dining restaurants. From 1989 to 1996, Ms. Holland was a Vice President in the Corporate Banking division of NationsBank and predecessor banks. Ms. Holland received a BBA in Finance from the University of Mississippi in 1989.

      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. Mr. Hollister is a member of the American Institute of Certified Public Accountants.

Subsidiaries

      Capital Senior Living Corporation is the parent company of several direct and indirect subsidiaries. Although Capital Senior Living Corporation and its subsidiaries are referred to for ease of reference in this Form 10-K as the Company, these subsidiaries are separately incorporated and maintain their legal existence separate and apart from the parent, Capital Senior Living Corporation.

New York Stock Exchange Certification

      In May 2004, as required in Section 303A.12(a), the Chief Executive Officer of the Company certified to the New York Stock Exchange that he was not aware of any violations by the Company of New York Stock Exchange corporate governance listing standards.

      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 2005 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, 2004, 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

      In the fourth quarter of 2002, the Company (and two of its management subsidiaries), Buckner Retirement Services, Inc. (“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 from September 1998 to March 2001. The Company managed Parkway Place for Buckner through December 31, 2001. The Company and its subsidiaries denied any wrongdoing. On March 16, 2004, the Court granted the Company’s Motion to Dismiss.

      In February 2004, the Company and certain subsidiaries, along with numerous other senior living companies in California, were named as defendants in a lawsuit in the superior court in Los Angeles, California. This lawsuit was brought by two public interest groups on behalf of seniors in California residing at the California facilities of the defendants. The plaintiffs alleged that pre-admission fees charged by the defendants’ facilities were actually security deposits that must be refunded in accordance with California law. On November 30, 2004, the court approved a settlement involving the Company’s independent living communities. Under the terms of the settlement, (a) all non-refundable fees collected at the independent living facilities since January 1, 2003 will be treated as a refundable security deposits and (b) the attorney for the plaintiffs received nominal attorney fees. There were no other settlement costs to the Company or its affiliates and the Company’s assisted living community in California was not named.

      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 Other 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, 2004.

PART II

Item 5.     Market for Registrant’s Common Equity and Related Stockholders Matters

(a) Market for Common Stock; Dividends; Equity Compensation Plan Information.

Market for Common Stock

      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 9, 2005 there were approximately 56 stockholders of record of the Company’s common stock.

Dividends

      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.

Equity Compensation Plan Information

      The following table presents information relating to the Company’s equity compensation plans as of December 31, 2004:

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

(c) Issuer Purchases of Equity Securities. Not Applicable.

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, 2004, 2003, 2002, 2001 and 2000 are derived from the audited consolidated financial statements of the Company.

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, 2004, 2003 and 2002. 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 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 senior living services to the elderly, including independent living, assisted living, skilled nursing and home care services.

      As of December 31, 2004, the Company operated 54 senior living communities in 20 states with an aggregate capacity of approximately 8,700 residents, including 39 senior living communities which the Company owned or in which the Company had an ownership interest and 15 communities it managed for third parties. As of December 31, 2004, the Company also operated one home care agency.

      The Company generates revenue from a variety of sources. For the year ended December 31, 2004, the Company’s revenues were derived as follows: 97.1% from the operation of 29 owned communities; 2.9% from management fees arising from management services provided for 10 affiliate-owned senior living communities and 15 third-party 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.

      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. 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.

      Effective as of July 1, 2003, the Company acquired the partnership interest of the general partners and the other third party limited partners’ interests in the Triad Entities for $1.3 million in cash, $0.4 million in notes payable and the assumption of all outstanding debt and liabilities. The total purchase price was $194.4 million and the acquisition was treated as a purchase of property. This acquisition resulted in the Company acquiring the 12 senior living communities owned by the Triad Entities with a combined resident capacity of approximately 1,670 residents. Subsequent to the end of the Company’s third quarter of 2003, the Company repaid the $0.4 million in notes payable related to this acquisition. Prior to this acquisition, the Company owned 1% of the limited partnership interests and managed the Triad Entities under a series of long-term management contracts.

      Effective as of November 30, 2004, the Company acquired Lehman’s approximate 81% limited partnership interest in Triad I for $4.0 million in cash and the issuance of a note with a net present value of $2.8 million. The Lehman note bears no interest and is deemed to be paid in full under any of the following three conditions: 1) the Company makes a payment of $3.5 million before November 29, 2008; 2) the Company makes a payment of $4.3 million before November 29, 2009; or 3) the Company makes a payment of $5.0 million before November 29, 2010. The Company expects to repay the note on or before November 29, 2008 and therefore recorded the note at $2.8 million (face amount $3.5 million discounted at 5.7%). In addition, the Company acquired the general partner’s interest in Triad I by assuming a $3.6 million note payable from the general partner to a subsidiary of the Company. The acquisition was recorded as a purchase of property. The entire purchase price of $10.4 million was recorded as a step-up in basis of the property as Triad I had been previously consolidated under FIN 46 as of December 31, 2003. These transactions resulted in the Company now wholly owning Triad I. Triad I owns five Waterford senior living communities and two expansions. The two expansions were subsequently deeded to a subsidiary of the Company in order for the two expansions to be consolidated with their primary community.

      Prior to acquiring the remaining interests of the general partner and the other third party limited partner in Triad I, the Company had an approximate 1% limited partner’s interest in Triad I and has accounted for these investments under the equity method of accounting based on the provisions of the Triad I partnership agreement until December 31, 2003.

      In 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, revised December 2003, (“FIN 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 as of December 31, 2003, for variable interest entities that existed prior to February 1, 2003. The Company adopted the provisions of this interpretation, as of December 31, 2003, which resulted in the Company consolidating Triad I’s financial position as of December 31, 2003 and resulted in the Company consolidating Triad I’s results of operations beginning January 1, 2004. The consolidation of Triad I under the provisions of FIN 46 as of December 31, 2003 resulted in an increase in property and equipment of $62.5 million.

      Effective August 18, 2004, the Company acquired from Covenant all of the outstanding stock of Covenant’s wholly owned subsidiary, CGIM. The Company paid approximately $2.3 million in cash (including closing costs of approximately $0.1 million) and issued a non-interest bearing note with a fair value of approximately $1.1 million (face amount $1.4 million discounted at 5.7%), subject to various adjustments set forth in the purchase agreement, to acquire all of the outstanding stock of CGIM. The note is due in three installments of approximately $0.3 million, $0.4 million and $0.7 million due on the first, third and fifth anniversaries of the closing, respectively, subject to reduction if the management fees earned from the third party owned communities with various terms are terminated and not replaced by substitute agreements during the period, and certain other adjustments. This acquisition resulted in the Company assuming the management contracts on 14 senior living communities with a combined resident capacity of approximately 1,800 residents. The acquisition was accounted for as a purchase and the entire purchase price of 3.5 million was allocated to management contract rights. In addition, the Company has the right to acquire seven of the properties owned by Covenant (which are part of the 14 communities managed by CGIM) based on sales prices specified in the stock purchase agreement.

      The Company formed BRE/CSL with Blackstone in December 2001, and the joint ventures seek to acquire senior housing properties. BRE/CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms of the joint ventures, 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.

      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.

      In addition, on June 30, 2003, the Company contributed to BRE/CSL one of its senior living communities with a capacity of 182 residents. As a result of the contribution the Company repaid $7.4 million of long-term debt, received $3.1 million in cash from BRE/CSL, and has a 10% equity interest in BRE/CSL of $0.4 million resulting in the recognition of a gain of $3.4 million.

      The Company manages the six 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 $0.1 million of management services revenue as a result of its 10% interest in the BRE/CSL joint venture.

      Effective as of November 30, 2004, the Company acquired Lehman’s approximate 81% interest in the Spring Meadows Communities and simultaneously sold the Spring Meadows Communities to SHPII/CSL, which is owned 95% by SHPII and 5% by the Company. As a result these transactions, the Company paid

$1.1 million for Lehman’s interest in the joint ventures, received net current assets of $0.9 million and wrote-off the remainder totaling $0.2 million. In addition, the Company contributed $1.3 million to SHPII/CSL for its 5% interest. The Company will manage the communities for SHPII/CSL under long-term management contracts.

      Prior to SHPII/CSL’s acquisition of the Spring Meadows Communities, the Company, in December 2002, acquired LCOR’s approximate 19% member interests in the four joint ventures that owned 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 owned the Spring Meadows Communities included interests in certain loans to the ventures and an approximate 19% member interest in each venture. 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 accounted for its investment in the Spring Meadows Communities under the equity method of accounting based on the provisions of the partnership agreements. The Company managed the Spring Meadows Communities since the opening of each community in late 2000 and early 2001 and continued to manage the communities under long-term management contracts until November 2004 when the joint ventures were sold. In addition, the Company received an asset management fee relating to each of the four communities. The Company had the obligation to fund certain future operating deficits of the Spring Meadows Communities to the extent of its 19% member interest. No amounts were funded by the Company during 2004 under this obligation.

      In September 2003, the Company sold its Carmichael community to a subsidiary of SHPII, a fund managed by Prudential, for $11.7 million before closing costs of $0.6 million. Carmichael is an independent living community located in Sacramento, California with a resident capacity of 156. As a result of the sale the Company retired $7.4 million in debt and received $3.6 million in cash and recognized a gain of $3.1 million. The Company manages the Carmichael community for SHPII under a long-term management contract.

      The Company owned 57% of the HCP partnership and the assets, liabilities, minority interest, and the results of operations of HCP have been consolidated in the Company’s financial statements. During 2003, HCP sold its remaining community and subsequently has been dissolved with its remaining assets transferred to a liquidating trust. In connection therewith, the Company recognized deferred revenue of $3.4 million in the fourth quarter of 2003 due to the liquidation.

      The Company owned 33.1% of the NHP Pension Notes (“NHP Notes”) and 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. 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 with its remaining assets transferred to a liquidating trust.

      Effective December 29, 2004, the Company refinanced the debt of 14 senior housing communities with GMAC Commercial Mortgage (“GMAC”). The total loan facility of $128.4 million refinanced eight properties previously financed by GMAC and six properties previously financed under three separate loan agreements with Key Corporate Capital, Compass Bank and Bank of America, which have been repaid. The new loans with GMAC have a term of three years with two one-year extension options. The loans have an initial interest rate of LIBOR plus 350 basis point and the loan agreements provide for reduced rates once certain debt service coverage ratios are achieved. The Company incurred $1.1 million in deferred financing costs related to these loans, which are being amortized over three years.

Recent Events

      Effective January 31, 2005, the Company entered into interest rate cap agreements with two commercial banks to reduce the impact of increases in interest rates on the Company’s variable rate loans. One interest cap agreement effectively limits the interest rate exposure on a $50 million notional amount to a maximum LIBOR rate of 5% and expires on January 31, 2006. The second interest rate cap agreement effectively limits the interest rate exposure on $100 million notional amount to a maximum LIBOR rate of 5%, as long as one-month LIBOR is less than 7%. If one-month LIBOR is greater than 7%, the agreement effectively limits the

interest rate on the same $100 million notional amount to a maximum LIBOR rate of 7%. This second agreement matures on January 31, 2008.

      On February 10, 2005, the Company’s Compensation Committee of the Board of Directors accelerated the vesting on 151,976 unvested stock options, with an option price of $6.30, awarded to officers and employees. These options were originally scheduled to vest in December 2005. The market price of the Company’s common stock at the close of business on February 10, 2005 was $5.61. The Compensation Committee’s decision to accelerate the vesting of these options was in response to the FASB’s issuance of Statement 123(R). By accelerating the vesting of these options, the Company believes it will potentially result in the Company not being required to recognize any compensation expense related to these options.

      In addition, on February 10, 2005, the Company’s Compensation Committee of the Board of Directors approved the form of Restricted Stock Award under the 1997 Omnibus Stock and Incentive Plan for Capital Senior Living Corporation. The Company has not made any grants of restricted stock under this plan.

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 notes. 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 management’s 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 approximately 8%, 9% and 8% of the Company’s net revenues in fiscal 2004, 2003 and 2002, respectively. 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

      BRE/CSL: The Company has formed BRE/CSL with Blackstone, and the joint ventures seek to acquire 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. Deferred management fee income is being amortized into income over the term of the Company’s management contract. As of December 31, 2004, the Company had deferred income of $0.1 million relating to BRE/CSL.

      Spring Meadow Communities: The Company has formed SHPII/CSL with SHPII, in November 2004, and the joint ventures are owned 95% by SHPII and 5% by the Company. The Company accounts for its investment in SHPII/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 SHPII/CSL. The Company defers 5% of its management fee income earned from SHPII/CSL. Deferred management fee income is being amortized into income over the term of the Company’s management contracts. As of December 31, 2004, the Company had deferred income of approximately $4,000 relating to SHPII/CSL.

      Prior to SHPII/CSL’s acquisition of the Spring Meadows Communities, the Company, in December 2002, acquired LCOR’s approximate 19% member interests in the four joint ventures that owned 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 owned the Spring Meadows Communities included interests in certain loans to the ventures and an approximate 19% member interest in each venture. 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 accounted for its investment in the Spring Meadows Communities under the equity method of accounting based on the provisions of the partnership agreements. The Company managed the Spring Meadows Communities since the opening of each community in late 2000 and early 2001 and continued to manage the communities under long-term management contracts until November 2004 when the joint ventures were sold. In addition, the Company received an asset management fee relating to each of the four communities. The Company had the obligation to fund certain future operating deficits of the Spring Meadows Communities to the extent of its 19% member interest. No amounts were funded by the Company during 2004 under this obligation.

      Triad Entities: Effective as of July 1, 2003, the Company acquired the partnership interest of the general partners and the other third party limited partners’ interests in the Triad Entities for $1.3 million in cash, $0.4 million in notes payable and the assumption of all outstanding debt and liabilities. The total purchase price was $194.4 million and the acquisition was treated as a purchase of property. This acquisition resulted in the Company acquiring 12 senior living communities owned by the Triad Entities with a combined resident capacity of approximately 1,670 residents. Subsequent to the end of the Company’s third quarter of 2003, the Company repaid the $0.4 million in notes payable related to this acquisition. Prior to this acquisition, the Company owned 1% of the limited partnership interests and managed the Triad Entities under a series of long-term management contracts.

      Triad I: Effective as of November 30, 2004, the Company acquired Lehman’s approximate 81% limited partnership interest in Triad I for $4.0 million in cash and the issuance of a note with a net present value of $2.8 million. In addition, the Company acquired the general partner’s interest in Triad I by assuming a $3.6 million note payable from the general partner to a subsidiary of the Company. The acquisition was recorded as a purchase of property. The entire purchase price of $10.4 million was recorded as a step-up in basis of the property as Triad I had been previously consolidated under FIN 46 as of December 31, 2003. These transactions resulted in the Company now wholly owning Triad I. Triad I owns five Waterford senior living communities and two expansions. The two expansions were subsequently deeded to a subsidiary of the Company in order for the two expansions to be consolidated with their primary community.

      Prior to acquiring the remaining interests of the general partner and the other third party limited partner the Company had an approximate 1% limited partner’s interests in Triad I and has accounted for these

investments under the equity method of accounting based on the provisions of the Triad I partnership agreement until December 31, 2003.

      In 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, revised December 2003, (“FIN 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 as of December 31, 2003, for variable interest entities that existed prior to February 1, 2003. The Company adopted the provisions of this interpretation, as of December 31, 2003, which resulted in the Company consolidating Triad I’s financial position as of December 31, 2003 and resulted in the Company consolidating Triad I’s results of operations beginning January 1, 2004. The consolidation of Triad I under the provisions of FIN 46 as of December 31, 2003 resulted in an increase in property and equipment of $62.5 million.

     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 four parcels of land held for sale, two of which are under contract and expected to be sold during fiscal 2005. 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.

     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 10 to 40 years for buildings and building improvements, 5 to 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 analyzed certain long-lived assets with operating losses, under the undiscounted cash flow method, for impairment. The Company does not believe there are any indicators that would require and the cash flow analysis did not require an adjustment to the carrying value of the property and equipment or their remaining useful lives as of December 31, 2004 and 2003.

New Accounting Standards

      On December 16, 2004, the Financial Accounting Standards Board issued FASB Statement No. 123, revised 2004 (“Statement 123(R)”), Share-Based Payment, which is a revision of FASB Statement 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Statement 123(R) is effective for public entities in the first interim or annual reporting period beginning after June 15, 2005.

      Statement 123(R) permits public companies to adopt its requirements using one of two methods:

      The Company plans to adopt Statement 123(R) using the modified-retrospective method, restating only the prior interim periods of the current year.

      As permitted by Statement 123, the Company currently accounts for share-based payments to employees using Opinion 25’s intrinsic value method and, as such, generally recognizes no compensation cost for employee stock options. Accordingly, the adoption of Statement 123(R)(R)’s fair value method will have a significant impact on the Company’s result of operations, although it will have no impact on the Company’s financial position. The impact of the adoption of Statement 123(R) cannot be predicted at this time because it will depend on the levels of share-based payments granted in the future. However, had the Company adopted Statement 123(R) in prior periods, the impact of the standard would have approximated the impact of Statement 123 as described below in the disclosure of pro forma net income and earnings per share. Statement 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in the periods after adoption. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions were $0.2 million, $0.1 million, and $6,000 in fiscal 2004, 2003 and 2002, respectively.

      The Company currently 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.

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.

      Revenues. Total revenues increased $27.0 million or 40.6% to $93.3 million in 2004 compared to $66.3 million in 2003. Resident and health care revenue increased $27.9 million or 44.7% to $90.5 million in 2004 compared to $62.6 million in the prior year. The increase in resident and healthcare revenue reflects an increase of $14.8 million from the acquisition of the Triad Entities (12 communities), an increase of

$15.0 million from the consolidation of Triad I (five communities and two expansions), and an increase at the Company’s other communities of $2.3 million offset by a decrease in resident and healthcare revenue of $4.2 million relating to two communities that were sold at the end of the second and third quarters of fiscal 2003. Unaffiliated management services revenue in fiscal 2004 was derived from the management of 15 third party communities, 14 of which were assumed during the third quarter of 2004 as a result of the Company’s acquisition of CGIM. Unaffiliated management services revenue in fiscal 2003 resulted primarily from the management of one third-party community in the fourth quarter of 2003 and the settlement of a management contract with Buckner. Affiliated management services revenue decreased $1.2 million primarily as a result of the Company’s acquisition/consolidation of the Triad Entities and Triad I. Affiliated development fees in fiscal 2003 represent the recognition of deferred development fees related to the Triad Entities and Triad I.

      Expenses. Total expenses increased $26.0 million or 43.0% to $86.5 million in 2004 compared to $60.5 million in 2003. This increase in expense primarily results from a $17.6 million increase in operating expenses, a $4.2 million increase in general and administrative expenses and a $4.2 million increase in depreciation and amortization expense. Operating expenses increased to $57.8 million compared to $40.2 million in the prior year. This 43.8% increase in operating expenses primarily results from $8.3 million related to the Company’s acquisition of the Triad Entities, $10.3 million due to the acquisition/consolidation of Triad I and an increase of $1.0 million at the Company’s other communities offset by a decrease of $2.0 million relating to the two communities that were sold during fiscal 2003. General and administrative expenses increased to $16.5 million in 2004 compared to $12.3 million in the prior year. This 33.9% increase in general and administrative expenses primarily results from $2.1 million related to the Company’s acquisition of the Triad Entities, $2.2 million due to the acquisition/consolidation of Triad I, $0.7 million in costs related to compliance with the Sarbanes-Oxley Act offset by a decrease of $0.3 million relating to the two communities that were sold during fiscal 2003 and a decrease of $0.5 million relating to the Company’s other communities and corporate overhead. Bad debt expense in both fiscal 2004 and 2003 was $0.2 million. Depreciation and amortization expense increased to $12.0 million in 2004 compared to $7.8 million in 2003. This 54.1% increase primarily results from $2.5 million related to the Company’s acquisition of the Triad Entities, $2.0 million due to the acquisition/consolidation of Triad I offset by a decrease of $0.3 million relating to the two communities that were sold during 2003.

      Other income and expenses. Interest income decreased $3.7 million to $0.6 million in fiscal 2004 compared to $4.3 million in fiscal 2003. This 86.6% decrease in interest income primarily results from the acquisition/consolidation of the Triad Entities and Triad I. Interest expense increased $3.3 million to $15.8 million in 2004 compared to $12.5 million in 2003. This 26.3% increase in interest expense is primarily the result of higher debt outstanding in 2004 compared to the same period of fiscal 2003 due to the assumption of $109.6 million of debt related to the acquisition of the Triad Entities in July 2003 and due to $47.6 million of debt consolidated in December 2003 related to Triad I offset by $14.9 million of debt repaid related to the two communities sold during 2003 and $19.0 million of debt retired during the fiscal 2004. Gain (loss) on sale of assets decreased by $6.8 million to a net loss of $37,000 in fiscal 2004 compared to a net gain of $6.8 million in fiscal 2003. In 2004, the Company sold one parcel of land, which resulted in the recognition of a gain of $0.2 million and net proceeds of $0.5 million. In addition, in 2004 the Company acquired the four joint ventures that owned the Spring Meadows Communities and simultaneously sold the Spring Meadows Communities to SHPII/ CSL resulting in a net loss of $0.2 million and net proceeds to the Company of $0.8 million. In 2003, the Company sold two communities and two parcels of land, which resulted in the recognition of a gain of $3.4 million and net proceeds to the Company of $5.6 million. In addition, in 2003 the Company contributed a community to BRE/ CSL, and as a result, the Company repaid $7.4 million of long-term debt, received $3.1 million in cash and has a 10% equity interest in the venture, resulting in the recognition of a gain of $3.4 million. Other income decreased to $0.2 million in fiscal 2004 compared to $3.6 million in the prior fiscal year. Other income in 2004 results from the Company’s net equity in the earnings of affiliates of $0.2 million. In December 2004, the Company refinanced 14 senior housing communities with GMAC Commercial Mortgage (“GMAC”). The total loan facility of $128.4 million refinanced eight properties previously financed by GMAC and six properties previously financed under three separate loan agreements with Key Corporate Capital, Compass Bank and Bank of America, which have been repaid. The new loans with GMAC have a term of three years with two one-year extension options. The loans

have an initial interest rate of LIBOR plus 350 basis point and the loan agreements provide for reduced rates once certain debt service coverage ratios are achieved. The Company incurred $1.1 million in deferred financing costs related to these loans, which is being amortized over three years. During fiscal 2004 the Company wrote-off $0.8 million in deferred financing costs related to the loans that were repaid. As a result of refinancing certain debt related to the Company’s treasury lock agreements with Key Bank and settling the Company’s swap agreements with Key Bank the Company recognized a loss on the interest rate treasury lock agreements of $1.4 million and a gain on the interest rate swap agreements of $1.4 million. Other income in fiscal 2003 results from the Company’s equity in the earnings of affiliates of $0.2 million along with the recognition of deferred income of $3.4 million related to the liquidation of the HCP partnership.

      Provision for income taxes. Benefit for income taxes in 2004 was $2.3 million or 25.1% effective tax rate compared to a provision for income taxes in 2003 of $3.1 million or 38.3% effective tax rate. The effective tax rates for 2004 and 2003 differ from the statutory tax rates because of state income taxes and permanent tax differences. The permanent tax differences in the fiscal 2004 include $2.7 million in net losses incurred by Triad I, which was consolidated under the provisions of FIN 46 for the first eleven months of fiscal 2004 prior to the Company’s acquisition of Triad I on November 30, 2004.

      Minority interest. Minority interest for both 2004 and 2003 represents the minority holders’ share of the losses incurred by HCP. During 2003, HCP sold its remaining community and transferred its remaining assets to a liquidating trust.

      Net income. As a result of the foregoing factors, net income decreased $11.8 million to a net loss of $6.8 million for 2004, as compared to a net income of $5.0 million for 2003.

      Revenues. Total revenues increased $4.8 million or 7.9% to $66.3 million in 2003 compared to $61.5 million in 2002. Resident and health care revenue increased $5.0 million or 8.7% to $62.6 million in 2003 compared to $57.6 million in the prior year. This increase in resident and healthcare revenue reflects revenue of $11.3 million relating to the acquisition of the Triad Entities on July 1, 2003, an increase at the Company’s other communities of $0.8 million offset by a loss of revenue from the five communities contributed to BRE/ CSL of $6.4 million and the loss of revenue from the sale of the Carmichael community to SHPII in September 2003 of $0.7 million. Unaffiliated management services revenue decreased $0.7 million or 68.6%, primarily due to the Company acquiring an interest in the four Spring Meadows communities. Affiliated management services revenue increased $1.2 million or 56.9% primarily due to increased management services revenue earned on the management of Triad I, BRE/ CSL and the Spring Meadows Communities offset by a reduction in management services revenue as a result of the Company’s acquisition of the Triad Entities. Affiliated development fee income decreased as a result of the completion of the Company’s development projects during fiscal 2002.

      Expenses. Total expenses increased $10.0 million or 19.8% to $60.5 million in 2003 compared to $50.5 million in 2002. Operating expenses increased $7.3 million in 2003 to $40.2 million compared to $32.9 million in the prior year. This 22.4% increase primarily reflects an increase in operating expenses of $8.6 million from the acquisition of the Triad Entities and an increase in operating expenses of $2.2 million from the Company’s other communities offset by the a reduction in operating expenses of $3.2 million from the contribution of the five communities to BRE/ CSL, and a reduction in operating expenses of $0.3 million from the sale of the Company’s Carmichael community. General and administrative expenses increased 6.8% or $0.7 million to $12.3 million in 2003 compared to $11.6 million in the prior year. This increase primarily reflects an increase in general and administrative expenses of $2.3 million from the acquisition of the Triad Entities offset by a $0.9 million reduction from the five communities contributed to BRE/ CSL and a reduction of $0.7 million from the Company’s other communities. Provision for bad debts of $0.2 million and $0.3 million in fiscal 2003 and 2002, respectively, primarily relate to normal write-offs of resident receivables. Depreciation and amortization expenses increased to $7.8 million in 2003 compared to $5.8 million in 2002 and this 33.3% increase in depreciation expense reflects an increase of $2.6 million from the acquisition of the Triad communities and an increase from the Company’s other communities of $0.1 million offset by a

reduction in depreciation and amortization of $0.7 million from the contribution of the five communities to BRE/ CSL and by $0.1 million from the sale of the Carmichael community.

      Other income and expenses. Interest income decreased $1.7 million to $4.3 million in fiscal 2003 compared to $6.0 million in fiscal 2002. This 28.3% decrease in interest income primarily reflects the loss of interest income from the Triad Entities, which were acquired by the Company on July 1, 2003. Interest expense increased $1.7 million to $12.5 million in 2003 compared to $10.7 million in 2002. This 16.1% increase in interest expense is primarily the result of the assumption of debt related the acquisition of the Triad Entities of $109.6 million offset by the repayment of $7.4 million of debt related to the community contributed to BRE/ CSL and the repayment of $7.4 million of debt related to the sale of the Carmichael community. Gain on sale of assets increased by $4.9 million to $6.8 million in fiscal 2003 compared to $1.9 million in the prior year. In 2003, the Company sold two communities and two parcels of land, which resulted in the recognition of a gain of $3.4 million and net proceeds to the Company of $5.6 million. In addition, in 2003 the Company contributed a community to BRE/ CSL, and as a result, the Company repaid $7.4 million of long-term debt, received $3.1 million in cash and has a 10% equity interest in the venture, resulting in the recognition of a gain of $3.4 million. 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, 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. Other income increased to $3.6 million in fiscal 2003 compared to $0.1 million in the prior fiscal year. Other income in fiscal 2003 results from the Company’s equity in the earnings of affiliates of $0.2 million along with the recognition of deferred income of $3.4 million related to the liquidation of the HCP partnership. Other income of $0.1 million in fiscal 2002 represents the Company’s equity in the earnings of affiliates.

      Provision for income taxes. Provision for income taxes in 2003 was $3.1 million or 38.3% effective tax rate compared to $3.0 million or 39.2% effective tax rate in 2002. The effective tax rates for 2003 and 2002 differ from the statutory tax rates because of state income taxes and permanent tax differences.

      Minority interest. Minority interest decreased $0.5 million to a benefit of $0.1 million in 2003 compared to minority interest of $0.4 million in 2002 due to losses incurred by HCP in fiscal 2003 compared to earnings in fiscal 2002. During 2003, HCP sold its remaining community and transferred its remaining assets to a liquidating trust.

      Net income. As a result of the foregoing factors, net income increased $0.3 million to $5.0 million for 2003, as compared to $4.7 million for 2002.

Quarterly Results

      The following table presents certain unaudited quarterly financial information for the four quarters ended December 31, 2004 and 2003. This information has been prepared on the same basis as the audited 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 $19.5 million of cash balances on hand as of December 31, 2004, the Company’s principal sources of liquidity are expected to be cash flows from operations, proceeds from the sale of noncore assets and cash flows from BRE/ CSL and SHPII/ CSL. Of the $19.5 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 and SHPII/ CSL to be sufficient to fund its short-term working capital requirements. The Company’s ability to meet its long-term capital requirements, including the repayment of certain long-term debt obligations, will depend, in part, on its ability to obtain additional financing or refinancings on acceptable terms from available financing sources, including mortgage financing, joint venture arrangements, by accessing the debt and/or equity markets and possibly through operating leases or other types of financing, such as lines of credit. There can be no assurance that the financing or refinancings will be available or that, if available, it will be on terms acceptable to the Company.

      The Company has $34.6 million in debt outstanding with GMAC that matures in September 2005. The Company is currently working with GMAC to refinance the debt and the Company expects to complete this refinancing during the third quarter of fiscal 2005. However, there can be no assurance that the refinancing will occur or that it will be on terms acceptable to the Company. This debt is classified as a current liability in the Company’s consolidated balance sheet.

      The Company had net cash provided by operating activities of $4.2 million in fiscal 2004 compared to $2.5 million and $13.9 million in fiscal 2003 and 2002, respectively. In fiscal 2004, net cash provided by operating activities was primarily derived from net non-cash charges of $13.6 million, a decrease in prepaid and other expenses of $0.3 million, a decrease in other assets of $0.5 million, a increase in accounts payable and accrued expenses of $0.3 million and a decrease in customer deposit of $0.1 million offset by a net loss of $6.8 million, an increase in accounts receivable of $1.5 million, an increase in property tax and insurance deposits of $0.9 million and an increase in income taxes receivable of $1.4 million. In fiscal 2003, net cash provided by operating activities was primarily derived from net income of $5.0 million, a decrease in other assets of $1.1 million, and a decrease in income taxes payable of $0.2 million offset by net non-cash benefit of

$0.1 million, an increase in account receivable of $0.3 million, an increase in prepaid expenses and other assets of $0.8 million, a decrease in accounts payable of $0.9 million, a decrease in accrued liabilities of $1.2 million, and a increase in deposits of $0.5 million. In fiscal 2002, net cash provided by 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.

      The Company had net cash used in investing activities of $7.6 million and $4.8 million in fiscal 2004 and 2002, respectively, compared to net cash provided by investing activities of $0.7 million in fiscal 2003. In fiscal 2004, the Company’s net cash used in financing activities was primarily the result of capital expenditures of $2.4 million, net cash paid for the acquisition of Triad I of $4.0 million, net cash paid for the acquisition of CGIM of $2.3 million and advances to affiliates of $0.4 million offset by net cash acquired from the acquisition of the four Spring Meadows joint ventures of $0.8 million, proceeds from the sale of one parcel of land of $0.5 million, net of selling costs, and distributions from limited partnerships of $0.2 million. In fiscal 2003, the Company’s net cash provided by investing activities was primarily the result of proceeds from the sale of two communities and two parcels of land for $5.5 million net of selling costs, proceeds from the contribution of one community to BRE/ CSL of $3.1 million, net cash acquired from the acquisition of the Triad Entities of $0.1 million, net cash from the consolidation of Triad I of $0.8 million and distributions from limited partnerships of $0.2 million offset by advances to Triad I and the Triad Entities of $7.4 million and capital expenditures of $1.6 million. In fiscal 2002, the Company’s 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.

      The Company had net cash provided by financing activities of $16.3 million in fiscal 2004 compared to net cash used in financing activities of $8.4 million and $7.2 million in fiscal 2003 and 2002, respectively. In fiscal 2004, net cash provided by financing activities was primarily derived from proceeds from the Company’s common stock offering of $32.2 million, proceeds from the exercise of stock options of $0.3 million, the release of restricted cash of $7.2 million offset by net note repayments of $21.8 million, cash paid to settle interest rate swap agreements of $0.5 million and cash used in financing activities of $1.1 million. For fiscal 2003 the net cash used in financing activities primarily results from repayments of notes payable of $18.5 million, distributions to minority partners of $0.3 million, deferred loan charges paid of $0.2 million offset by proceeds from the issuance of notes payable of $5.1 million, proceeds from the release of restricted cash of $5.2 million and proceeds from the exercise of common stock options of $0.3 million. 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.

      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 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 ventures seek to acquire senior housing properties. BRE/ CSL is owned 90% by Blackstone and 10% by the Company. Pursuant to the terms of the joint ventures, 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.

      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.

      In addition, on June 30, 2003, the Company contributed to BRE/ CSL one of its senior living communities with a capacity of 182 residents. As a result of the contribution the Company repaid $7.4 million of long-term debt, received $3.1 million in cash from BRE/ CSL, and has a 10% equity interest in BRE/ CSL of $0.4 million resulting in the recognition of a gain of $3.4 million. As part of the contribution to BRE/ CSL, the Company guaranteed 25%, or $1.9 million, of BRE/ CSL’s debt with Bank One. The Company made this guarantee to induce Bank One to allow the debt to be assumed by BRE/ CSL. The Company estimates the carrying value of its obligation under this guarantee as nominal.

      The Company manages the six 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 $0.1 million of management services revenue as a result of its 10% interest in the BRE/ CSL joint venture.

      Effective as of November 30, 2004, the Company acquired Lehman’s approximate 81% interest in the Spring Meadows Communities and simultaneously sold the Spring Meadows Communities to SHPII/ CSL, which is owned 95% by SHPII and 5% by the Company. As a result these transactions, the Company paid $1.1 million for Lehman’s interests in the joint ventures, received net assets of $0.9 million and wrote-off the remainder totaling $0.2 million. In addition, the Company contributed $1.3 million to SHPII/ CSL for its 5% interest. The Company will manage the communities for SHPII/ CSL under long-term management contracts.

      Prior to SHPII/ CSL’s acquisition of the Spring Meadows Communities, the Company, in December 2002, acquired LCOR’s approximate 19% member interests in the four joint ventures that owned 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 owned the Spring Meadows Communities included interests in certain loans to the ventures and an approximate 19% member interest in each venture. 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 accounted for its investment in the Spring Meadows Communities under the equity method of accounting based on the provisions of the partnership agreements. The Company managed the Spring Meadows Communities since the opening of each community in late 2000 and early 2001 and continued to manage the communities under long-term management contracts until November 2004 when the joint ventures were sold. In addition, the Company received an asset management fee relating to each of the four communities. The Company had the obligation to fund certain future operating deficits of the Spring Meadows Communities to the extent of its 19% member interest. No amounts were funded by the Company during 2004 under this obligation.

      In September 2003, the Company sold its Carmichael community to SHPII, for $11.7 million before closing costs of $0.6 million. Carmichael is an independent living community located in Sacramento, California with a resident capacity of 156. As a result of the sale the Company retired $7.4 million in debt and received $3.6 million in cash and recognized a gain of $3.1 million. The Company manages the Carmichael community for SHPII under a long-term management contract.

      Effective as of July 1, 2003, the Company acquired the partnership interest of the general partners and the other third party limited partners’ interests in the Triad Entities for $1.3 million in cash, $0.4 million in notes payable and the assumption of all outstanding debt and liabilities ($109.6 million bank debts,

$73.2 million debt due to the Company, and $9.9 million net working capital liabilities). The total purchase price was $194.4 million and the acquisition was treated as a purchase of property. The Company now wholly owns each of the Triad Entities. This acquisition resulted in the Company acquiring ownership of 12 senior living communities with a combined resident capacity of approximately 1,670 residents. Prior to the acquisition the Company had developed the properties owned by and managed the Triad Entities. Subsequent to the end of the Company’s third quarter of 2003, the Company repaid the $0.4 million in notes payable related to this acquisition.

      The purchase price was allocated as follows (in thousands):

      Set forth below is information relating to the construction/permanent loan facilities the Company assumed as a result of the acquisition of the Triad Entities at July 1, 2003 (dollars in thousands):

      The following unaudited pro forma financial information combines the results of the Company and the Triad Entities as if the transaction had taken place at the beginning of fiscal 2003. The pro forma financial information is presented for informational purposes only and does not reflect the results of operations of the Company, which would have actually resulted if the purchase occurred as of the dates indicated, or future results of operations of the Company (in thousands).

      Effective as of November 30, 2004, the Company acquired Lehman’s approximate 81% limited partner’s interest in Triad I for $4.0 million in cash and the issuance of a note with a net present value of $2.8 million. In addition, the Company acquired the general partner’s interest in Triad I by assuming a $3.6 million note payable from the general partner to a subsidiary of the Company. The acquisition was recorded as a purchase of property. The entire purchase price of $10.4 million was recorded as a step-up in basis of the property as Triad I had been previously consolidated under FIN 46 as of December 31, 2003. These transactions resulted in the Company now wholly owning Triad I. Triad I owns five Waterford senior living communities and two expansions. The two expansions were subsequently deeded to a subsidiary of the Company in order for the two expansions to be consolidated with their primary community.

      Prior to acquiring the remaining interests of the general partner and the other third party limited partner in Triad I the Company had an approximate 1% limited partner’s interests in Triad I and has accounted for these investments under the equity method of accounting based on the provisions of the Triad I partnership agreement until December 31, 2003.

      In 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (Revised December 2003) “Consolidation of Variable Interest Entities” an interpretation of ARB No. 51, effective immediately for variable interest entities created after January 31, 2003 and effective as of December 31, 2003 for variable interest entities that existed prior to February 1, 2003. The Company adopted the provisions of this interpretation at December 31, 2003, and its adoption resulted in the Company consolidating the financial position of Triad I at December 31, 2003 and resulted in the Company consolidating the operations of Triad I beginning in the Company first quarter of 2004. The consolidation of Triad I under the provisions of FIN 46 as of December 31, 2003 resulted in an increase in property and equipment of $62.5 million.

      Prior to consolidation the Company accounted for Triad I and the Triad Entities under the equity method of accounting. The Company recognized losses in Triad I and the Triad Entities of $0.1 million and $0.2 million as of December 31, 2003 and 2002, respectively. The recognition of these losses have reduced the Company’s investments in Triad I and the Triad Entities to zero and additional losses of $0.5 million were recorded as a reduction to the Company’s notes receivable from the Triad Entities.

      Deferred interest income was being amortized into income over the life of the loan commitment that the Company has with Triad I and the Triad Entities. Deferred development and management fee income was being amortized into income over the expected remaining life of Triad I and Triad Entities’ partnership. All deferred items were eliminated upon consolidation/acquisition.

      The following unaudited pro forma financial information combines the results of the Company and Triad I as if the provisions of FASB Interpretation No. 46 had been applied at the beginning of fiscal 2003. The pro forma financial information is presented for informational purposes only and does not reflect the results of operations of the Company, which would have actually resulted if Triad I had been consolidated as of the dates indicated, or future results of operations of the Company (in thousands):

      Effective August 18, 2004, the Company acquired from Covenant all of the outstanding stock of Covenant’s wholly owned subsidiary, CGIM. The Company paid approximately $2.3 million in cash (including closing cost of approximately $0.1 million) and issued a note with a fair value of approximately $1.1 million, subject to various adjustments set forth in the purchase agreement, to acquire all of the outstanding stock of CGIM. The note is due in three installments of approximately $0.3 million, $0.4 million and $0.7 million due on the first, third and fifth anniversaries of the closing, respectively, subject to reduction if the management fees earned from the third party owned communities with various terms are terminated and not replaced by substitute agreements during the period, and certain other adjustments. The total purchase price was $3.5 million and the acquisition was treated as a purchase of property. This acquisition resulted in the Company assuming the management contracts on 14 senior living communities with a combined resident capacity of approximately 1,800 residents. In addition, the Company has the right to acquire seven of the properties owned by Covenant (which are part of the 14 communities managed by CGIM) based on sales prices specified in the stock purchase agreement. The purchase price of $3.5 million was allocated to management contracts. The Company has not completed its analysis of this purchase and as such the purchase accounting information disclosed should be considered preliminary.

      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 was classified as held for sale. In 2003, the Company sold the remaining HCP community for $1.1 million, which resulted in the recognition of a gain of $48,000 and net proceeds of $1.0 million. Subsequent to the sale of this community, HCP has been dissolved

with its remaining assets transferred to a liquidating trust. In connection therewith, the Company recognized deferred revenue of $3.4 million in the fourth quarter of 2003 due to the liquidation.

Disclosures About Contractual Obligations

      The following table provides the amounts due under specified contractual obligations (including interest expense) for the periods indicated as of December 31, 2004 (in thousands):

      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.

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.

      The Company’s primary market risk is exposure to changes in interest rates on debt instruments. As of December 31, 2004, the Company had $261.8 million in outstanding debt comprised of various fixed and variable rate debt instruments of $48.6 million and $213.2 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, which 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. Each percentage point change in interest rates would increase the Company’s annual interest expense by approximately $2.1 million based on the Company’s outstanding variable debt as of December 31, 2004.

      The following table summarizes information on the Company’s debt instruments outstanding as of December 31, 2004. The table presents the principal due and weighted average interest rates by expected maturity date 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, 2004.

      Principal Amount and Average Interest Rate by Expected Maturity Date at December 31, 2004 ($ in thousands):