**UNITED
STATES**


**SECURITIES
AND EXCHANGE COMMISSION**


**Washington,
D.C. 20549**







**FORM
10-K**


**(Mark
      One)**x
    **ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
      1934**




**For
the fiscal year ended December 31, 2004.**





**OR**


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







**Commission
file number 1-14012**










**EMERITUS
CORPORATION**


**(Exact
name of registrant as specified in its charter)**





**FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2004**





**Washington**
    **91-1605464****(State
      or other jurisdiction**
    **(I.R.S.
      Employer****of
      incorporation or organization)**
    **Identification
      No.)**





**3131
Elliott Avenue, Suite 500, Seattle, WA 98121**


**(Address
of principal executive offices)**





**(206)
298-2909**


**(Registrant’s
telephone number, including area code)**





**Securities
registered pursuant to Section 12(b) of the Act:**








**Title
      of each class**
    **Name
      of each exchange on which registered**Common
      Stock, $.0001 par value
    American
      Stock Exchange, Inc.





**Securities
registered pursuant to Section 12(g) of the Act: None**




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), (2) and has been subject to such filing requirements for
the past 90 days. Yes **x** No  o





Indicate
by check mark that there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of Registrant’s knowledge, in definitive proxy or
information 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 o       No  **x**


Aggregate
market value of common voting stock held by non-affiliates of the registrant as
of June 30, 2004, was $44,687,618 .


Aggregate
market value of common voting stock held by non-affiliates of the registrant as
of February 28, 2005, was $ 83,294,273 .


As of
February 28, 2005, 10,819,996 shares of the Registrant’s Common Stock were
outstanding.




**DOCUMENTS
INCORPORATED BY REFERENCE:**




The
information required by Part III of Form 10-K (items 10-14) is incorporated
herein by reference to the Registrant’s definitive Proxy Statement to be filed
on or before April 29, 2005.


















**EMERITUS
CORPORATION**





**TABLE OF CONTENTS**


****
    
    **Page
      No.****PART I**ITEM 1.
    BUSINESS
    1ITEM 2.
    PROPERTIES
    8ITEM 3.
    LEGAL
      PROCEEDINGS
    15ITEM 4.
    SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
    16EXECUTIVE
      OFFICERS OF EMERITUS
    16**PART II**ITEM 5.
    MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATEDSTOCKHOLDER
      MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
    18ITEM 6.
    SELECTED
      FINANCIAL DATA
    19ITEM 7.
    MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND
      RESULTS OF OPERATIONS
    21ITEM 7A.
    QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    56ITEM 8.
    FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
    57ITEM 9.
    CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING
      AND FINANCIAL DISCLOSURE
    57ITEM 9A.
    CONTROLS AND PROCEDURES
    57ITEM 9B.
    OTHER
      INFORMATION
    58**PART III**ITEM 10.
    DIRECTORS
      AND EXECUTIVE OFFICERS OF THE REGISTRANT
    59ITEM 11.
    EXECUTIVE
      COMPENSATION
    59ITEM 12.
    SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT
      AND RELATED STOCKHOLDER MATTERS
    59ITEM 13.
    CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS
    60ITEM 14.
    PRINCIPAL
      ACCOUNTANT FEES AND SERVICES
    60**PART IV**ITEM 15.
    EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES
    61













Table of Contents










**Definitions**





Throughout
this filing certain terms are used repeatedly. In the interest of brevity, the
full reference has been abbreviated to a single name or acronym. The following
defines these abbreviated terms:





1.
    "FASB"
      refers to the Financial Accounting Standards
Board.


2.
    "VIE"
      refers to variable interest entity.


3.
    "REIT"
      refers to real estate investment trust.


4.
    "Mr.
      Baty" refers to Daniel R. Baty, the Company's chairman of the board of
      directors and chief executive officer.


5.
    "Triple-net
      lease" means a lease under which the lessee pays all operating expenses of
      the property, including taxes, licenses, utilities, maintenance, and
      insurance. The lessor receives a net rent.








**PART I**





**ITEM 1. BUSINESS**





*Overview*





Emeritus
is one of the largest and most experienced national operators of assisted living
residential communities. Assisted living communities provide a residential
housing alternative for senior citizens who need help with the activities of
daily living, with an emphasis on assisted living and personal care
services.





At
December 31, 2004, we operated, or had an interest in, 181 assisted living
communities, consisting of approximately 14,851 units with a capacity for 18,351
residents, located in 34 states. These include 6 communities that we own, 158
communities that we lease, and 17 communities that we manage, including one in
which we hold a joint venture interest.





We strive
to provide a wide variety of assisted living services in a professionally
managed environment that allows our residents to maintain dignity and
independence. Our residents are typically unable to live independently, but do
not require the intensive care provided in skilled nursing facilities. Under our
approach, seniors reside in a private or semi-private residential unit for a
monthly fee based on each resident’s individual service needs. We believe our
residential assisted living communities allow seniors to maintain a more
independent lifestyle than is possible in the institutional environment of
skilled nursing facilities, while also providing peace of mind knowing that
staff is available should the need arise. In addition, we believe that our
services, including assisting residents with activities of daily living, such as
medication management, bathing, dressing, personal hygiene, and grooming are
attractive to seniors who are inadequately served by independent living
facilities.





Emeritus's
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and amendments thereto, filed with the Securities and Exchange
Commission (SEC) pursuant to Section 13(a) of the Securities Exchange Act of
1934, as amended, and the rules and regulations thereunder are made available
free of charge on Emeritus's web site (www.emeritus.com) as soon as reasonably
practicable after Emeritus electronically files such material with, or furnishes
it to, the SEC.  The information contained on Emeritus's web site is not
being incorporated herein.








*The
Assisted Living Industry*





We
believe that the assisted living industry is the preferred residential
alternative for seniors who cannot live independently due to physical or
cognitive frailties but who do not require the more intensive medical attention
provided by a skilled nursing facility.





**1**


Table of Contents


Generally,
assisted living provides housing and 24-hour personal support services designed
to assist seniors with the activities of daily living, which include bathing,
eating, personal hygiene, grooming, medication reminders, ambulating, and
dressing. Certain assisted living facilities may offer higher levels of personal
assistance for residents with Alzheimer’s disease or other forms of dementia,
based in part on local regulations.





We
believe that a number of factors will allow assisted living companies to
continue as one of the fastest growing choices for senior care:





***  *Consumer
Preference.* We
believe that assisted living is preferred by prospective residents as well as
their families, who are often the decision makers for seniors. Assisted living
is a cost-effective alternative to other types of care, offering seniors greater
independence while enabling them to reside longer in a more residential
environment.




***  *Cost-Effectiveness.* The
average annual cost to care for a Medicare or Medicaid patient in a skilled
nursing home can exceed $40,000. The average cost to care for a private pay
patient in a skilled nursing home is about $80,000 per year in the top ten most
costly markets. In contrast, assisted living services generally cost 30% to 50%
less than skilled nursing facilities located in the same region. We also believe
that the cost of assisted living services compares favorably with home
healthcare, particularly when costs associated with housing, meals, and personal
care assistance are taken into account. According to the GE Long Term Care
Insurance Nursing Home Survey in 2002, the national annual average cost of a
year in a nursing home was $54,900. The survey evaluated the cost of assistance
in a nursing home with the activities of daily living for a person suffering
from a debilitation such as Parkinson's disease. It did not include costs for
therapy, rehabilitation, or medications.




***  *Demographics.* The
target market for our services is generally persons 75 years and older who
represent the fastest growing segments of the U.S. population. According to the
U.S. Census Bureau, the portion of the U.S. population age 75 and older is
expected to increase by 5.5% from approximately 17.6 million in 2003 to
approximately 18.6 million by the year 2010. The number of persons age 85 and
older, as a segment of the U.S. population, is expected to increase by 18.5%
from approximately 4.9 million in 2003 to 5.8 million by the year 2010.
Furthermore, the number of persons afflicted with Alzheimer’s disease is also
expected to grow in the coming years. According to data published in the August
2003 issue of the Archives of Neurology, an AMA publication, this population
will increase 13.3% from the current 4.5 million to 5.1 million people by the
year 2013. Because Alzheimer’s disease and other forms of dementia are more
likely to occur as a person ages, we expect the increasing life expectancy of
seniors to result in a greater number of persons afflicted with Alzheimer’s
disease and other forms of dementia in future years, absent breakthroughs in
medical research.




*  *Changing
Family Dynamics* .
According to the U.S. Census Bureau, the median income of the elderly population
is increasing. According to the 2000 census data, more than 54% of the
population over the age of 75 have incomes over $20,000 per year and slightly
more than 44% have annual incomes of at least $25,000. Accordingly, we believe
that the number of seniors and their families who are able to afford
high-quality senior residential services, such as those we offer, has also
increased. In addition, the number of two-income households increased during the
1990's and the geographical separation of senior family members from their adult
children correlates with the geographic mobility of the U.S. population. As a
result, many families that traditionally would have provided the type of care
and services we offer to senior family members are less able to do so. The
number of two-income households stopped growing during the recession starting in
March 2001, but was expected to start increasing again in 2004, although at a
slower pace than during the 1990's. However, we have no data at this time that
tells us this did in fact occur.







**2**


Table of Contents


*  *Supply/Demand
Imbalance* . While
the senior population is growing significantly, the supply of skilled nursing
beds per thousand is declining. We attribute this imbalance to a number of
factors in addition to the aging of the population. Many states, in an effort to
maintain control of Medicaid expenditures on long-term care, have implemented
more restrictive Certificate of Need regulations or similar legislation that
restricts the supply of licensed skilled nursing facility beds. Additionally,
acuity-based reimbursement systems have encouraged skilled nursing facilities to
focus on higher acuity patients. We also believe that high construction costs
and limits on government reimbursement for construction and start-up expenses
have constrained the growth and supply of traditional skilled nursing beds. We
believe that these factors, taken in combination, result in relatively fewer
skilled nursing beds available for the increasing number of seniors who require
assistance with the activities of daily living but do not require 24-hour
medical attention.







*Competitive
Strengths*





We
compete with other assisted living communities located in the areas where we
operate. These communities are operated by individuals, local and regional
businesses, and larger operators of regional and national groups of communities,
including public companies similar to us. We believe that we have the following
competitive strengths:





*  *State-of-the-Art
Communities.* Of our
181 communities, 57 communities have been built and opened since January 1,
1996. In addition, we have significantly upgraded 48 of our older communities to
improve their appearance and operating efficiency. These upgrades include the
finished appearance of the communities, as well as various improvements to
kitchens, nurse call systems, and electronic systems, including those for data
transmission, data sharing, and e-mail.




*  *Large
Operating Scale.* We
believe that our size gives us significant advantages over smaller operators.
Given the scale of our operations, we have the opportunity to select the best
operating systems and service alternatives and to develop a set of best
practices for implementation on a national scale. We also believe that, because
of our size, we are able to purchase such items as food, equipment, insurance,
and employee benefits at lower costs, and to negotiate more favorable financing
arrangements.




*  *Lower
Cost of Communities.* As of
December 31, 2004, the average cost per unit of our owned and leased communities
was approximately $74,300. We believe that these costs are less than the current
average replacement costs of these communities and below the average costs
incurred by many other public companies operating in the industry. We also
believe that these lower capital costs give us opportunities to enhance margins
and greater flexibility in designing our rate structure and responding to
varying regional economic and regulatory changes.




*  *Geographic
Diversification and Regional Focus.* We
operate our communities in 34 states across the United States. We believe that
because of this geographic diversification we are less vulnerable to adverse
economic developments and industry factors, such as overbuilding and regulatory
changes, that are limited to a particular region. We believe that this also
moderates the effects of regional employment and competitive conditions. Within
each region, we have focused on establishing a critical mass of communities in
secondary markets, which enables us to maximize operating
efficiencies.




*  *Experienced
Management with Industry Relationships.* We
believe that we have strong senior leadership, with proven management skills in
the assisted living industry. Mr. Baty, Chairman of the Board and Chief
Executive Officer, Mr. Brandstrom, Vice President of Finance, Secretary and
Chief Financial Officer, and Mr. Becker Senior Vice President of Operations each
have more than 30 years of experience in the long-term care industry, ranging
from independent living to skilled nursing care. We believe that their combined
experience and the relationships that Mr. Baty has developed with owners,
operators, and sources of capital have helped us and will continue to help us
develop operating efficiencies, investment and joint venture relationships, as
well as obtain sources of debt and equity capital. Mr. Baty also has a
significant financial and management interest in Holiday Retirement Corporation,
an operator of independent living facilities, and





**3**


Table of
Contents





Columbia-Pacific
Group, Inc., an operator of independent living facilities and assisted living
communities. In addition, our operating vice presidents have an average of 18
years of experience with major companies in the long-term care industry. We
believe that this strong senior leadership, with proven management skills, will
allow us to take advantage of the opportunities present in the assisted living
industry.


*Business
Strategy*





We
believe that there is a significant demand for alternative long-term care
services that are well-positioned between the limited services offered by
independent living facilities and the higher-level medical and institutional
care offered by skilled nursing facilities. Our goal is to become the national
leader in the assisted living segment of the long-term care industry through the
following strategy:





***
    *Focus
      on Operations and Occupancy.*Through
      1998, we focused on rapidly expanding our operations in order to assemble
      a portfolio of assisted living communities with a critical mass of
      capacity. We pursued an aggressive acquisition and development strategy
      during that time. Having achieved our initial growth objective, in 1999
      and continuing through 2001, we substantially reduced our pace of
      acquisition and development activities to concentrate on improving
      community performance through both increased occupancy and revenue per
      occupied unit. Initially, we focused most of our efforts on increasing
      occupancy across our portfolio. Having achieved a portion of our total
      goal by late 1999, we then shifted our efforts toward enhancing our rates,
      particularly in facilities that were substantially below market or
      industry averages. This rate strategy has led to increased rates across
      most of our portfolio. In 2004, we embarked on a campaign to further
      increase our occupancy, particularly in communities we acquired during
      2002 and 2003. We believe that this continued focus on both rates and
      occupancy as opportunities arise to enhance our performance will continue
      to generate the incremental growth in margins we are striving to
      achieve..




***
    *Supplement
      Business through Management Agreements*.
      From 1999 through 2002, we managed a significant number of communities,
      ranging from 68 in 1999 to 96 in 2002. With changes in the capital markets
      and opportunities to own or lease communities, the number of managed
      communities has declined to 17 in 2004 (most of those making up the
      decline became leased communities in our consolidated portfolio).
      Nevertheless, we will continue to review management opportunities that fit
      into our existing operational strategy as a supplement to our core
      business. We generally manage these new communities for a fee based on a
      percentage of their gross revenue.


*
    *Acquire
      Communities Selectively.*In
      1998, we reduced our acquisition activity in part to concentrate on the
      need to improve operations through occupancy and rate enhancement. As we
      achieve these objectives, we expect to be more receptive to purchase or
      lease acquisition opportunities that meet designated criteria. In general,
      we tend to favor acquisition opportunities that enhance our current market
      coverage, require minimal upfront capital, are neutral or favorable to the
      Company’s cash flow, and present operational or financing efficiency
      opportunities not otherwise realized by the existing owner or operator..
      In 2002, 2003, and 2004, as the opportunities arose, we acquired
      additional communities that satisfy our criteria. We intend to continue to
      pursue acquisitions that meet these
criteria..




***
    *Appeal
      to the Middle Market.*The market segment most attractive to us is middle to upper-middle income
      seniors in smaller cities and suburbs with populations of 50,000 to
      150,000 persons. We believe that this “value-sensitive” segment of the
      senior community is the largest, broadest, and most stable.





**4**


Table of Contents


Resident
Services







Our
assisted living communities offer residents a full range of services based on
individual resident needs in a supportive “home-like” environment. By offering a
full range of services, we can accommodate residents' needs. The services that
we provide to our residents are designed to respond to their individual needs
and to improve their quality of life.













**Service
      Level**
    **Type
      of Resident**
    **Description
      of Care Provided**Basic
      services
    All
      residents--independent, assisted living and those with Alzheimer’s and
      related dementia
    We
      offer these basic services to our residents:
      
      *
      three nutritious meals per day,
      
      *
      social and recreational activities,
      
      *
      weekly housekeeping and linen service,
      
      *
      building maintenance, individual apartment maintenance, and
      grounds
      keeping,
      
      *
      24-hour emergency response and security,
      
      *
      licensed nurses available to monitor and coordinate care
needs
      and
      organize wellness activities, and
      
      *
      transportation to appointments, excursions, etc.Assisted
      living
      Services
    Assisted
      living residents
    Our
      assisted living services provided for each resident depend on the
      recommended level of care or assistance required by the individual. A
      thorough assessment of the individual's needs along with consultation with
      the resident, the resident's physician and the resident's family,
      determine the recommended level of care. The level of care is based on the
      degree of assistance he/she requires in several categories. Our categories
      of care include, but are not limited to:
      
      *
      medication management and supervision,
      
      *
      reminders for dining and recreational activities,
      
      *
      assistance with bathing, dressing, and grooming,
      
      *
      incontinence care and assistance,
      
      *
      psycho-social support,
      
      *
      dining assistance, and
      
      *
      miscellaneous services (including diabetic management,
      prescription
      medication reviews, transfers, and simple
      treatments).Special
      Care Program
      (Alzheimer’s
      & related dementia)
    Residents
      with Alzheimer’s and related dementias
    We
      have designed our Special Care program to meet the health, psychological,
      and social needs of our residents diagnosed with Alzheimer's or related
      dementia. In a manner consistent with our assisted living services, we
      help structure a service plan for each resident based on his/her
      individual needs. Some of the key service areas that we focus on to
      provide the best care for our residents with Alzheimer's or related
      dementias center around:
      
      *
      personalized environment,
      
      *
      activities planned to support meaningful interactions,
      
      *
      specialized dining and hydration programs,
      
      *
      partnerships with families and significant others through
      support
      groups,
      one-on-one meetings, and educational forums,
      behavior
      as communication.







**5**




Table of Contents


*Service
Revenue Sources*





We rely
primarily on our residents’ ability to pay our charges for services from their
own or familial resources and expect that we will do so for the foreseeable
future. Although care in an assisted living community is typically less
expensive than in a skilled nursing facility, we believe that generally only
seniors with income or assets meeting or exceeding the regional median can
afford to reside in our communities. Inflation or other circumstances that
adversely affect seniors’ ability to pay for assisted living services could
therefore have an adverse effect on our business.





As third
party reimbursement programs and other forms of payment continue to grow, we
intend to pursue these alternative forms of payment, depending on the level of
reimbursement provided in relation to the level of care provided. We also
believe that private long-term care insurance will increasingly become a revenue
source in the future, although it is currently small. All
sources of revenue other than residents’ private resources constitute less than
13.4% of our total revenues.





*Management
Activities*





At
December 31, 2004, we managed and provided administrative services to 17
assisted living communities under management agreements that typically provide
for management fees ranging from 5% to 7% of gross
revenues. Our management agreements generally have terms ranging from two to
five years, and may be renewed or renegotiated at the expiration of the term.
Management fees were approximately $4.7 million for 2004. We have various
categories of management agreements, including:





*
    a
      management agreement covering 5 communities that is a continuing component
      of the Emeritrust I transaction referred to in "Item 7. Management's
      Discussion and Analysis, Significant Transactions, Emeritrust
      Transactions, Emeritrust I Communities Management". This management
      agreement, which may be terminated by either party on 90 days notice,
      provided for a base fee of 3% of gross revenues and an additional fee of
      4% of gross revenues to the extent of 50% of cash flow from the
      communities. In March 2004, this management agreement was amended to
      provide for a management fee of 5% of gross revenues, regardless of
      financial performance. If either party exercises its option to terminate
      this management agreement, or if the management agreement expires on
      September 30, 2005, and is not renewed, our revenue from management fees
      will diminish substantially.





*  management
agreements covering 7 communities owned by entities controlled by Mr. Baty. We
generally receive fees ranging from 5% to 6% of the gross revenues generated by
the communities. We previously announced that we had agreed to lease up to two
of these communities and will operate them pursuant to the lease. One community
was leased on March 1, 2005, and the other is scheduled to be leased by the end
of the second quarter 2005.





*
    a
      management agreement covering one community owned by a joint venture in
      which we have a financial interest. We receive management fees of 6% of
      gross revenues.





*
    management
      agreements covering three communities owned by independent third parties.
      We receive management fees based on
occupancy.





*
    a
      management agreement covering one community owned by an independent third
      party. We receive management fees of the greater of $7,000 per month or 6%
      of gross revenue with opportunities to earn additional fees based on
      operating cash flow.








**6**


Table of Contents


*Marketing
and Referral Relationships*





Our
operating strategy is designed to integrate our assisted living communities into
the continuum of healthcare providers in the geographic markets in which we
operate. One objective of this strategy is to enable residents who require
additional healthcare services to benefit from our relationships with local
hospitals, physicians, home healthcare agencies, and skilled nursing facilities
in order to obtain the most appropriate level of care. Thus, we seek to
establish relationships with local hospitals, through joint marketing efforts
where appropriate, and home healthcare agencies, alliances with visiting nurses
associations and, on a more limited basis, priority transfer agreements with
local, high-quality skilled nursing facilities. In addition to benefiting
residents, the implementation of this operating strategy has strengthened and
expanded our network of referral sources.





*Administration*





We employ
an integrated structure of management, financial systems, and controls to
maximize operating efficiency and contain costs. In addition, we have developed
the internal procedures, policies, and standards we believe are necessary for
effective operation and management of our assisted living communities. We have
recruited experienced key employees from several established operators in the
long-term care services field and believe we have assembled the administrative,
operational, and financial personnel who will enable us to continue to manage
our operating strategies effectively.





We have
established Central, Eastern, Great Lakes, and Western Operations. An
operational vice president heads each group. Each group may consist of one or
more divisions. Each division consists of several operating regions headed by a
regional director of operations who provides management support services for
each of the communities in his/her respective region. An on-site executive
director supervises day-to-day community operations, and in certain
jurisdictions, must satisfy various licensing requirements. We provide
management support services to each of our residential communities, including
establishing operating standards, recruiting, training, and financial and
accounting services.





We have
centralized finance and other operational functions at our headquarters in
Seattle, Washington, in order to allow community-based personnel to focus on
resident care. The Seattle office establishes policies and procedures applicable
to the entire company, oversees our financial and marketing functions, manages
our acquisition and development activities, and provides our overall strategic
direction.





We use a
blend of centralized and decentralized accounting and computer systems that link
each community with our headquarters. Through these systems, we are able to
monitor operating costs and distribute financial and operating information to
appropriate levels of management in a cost efficient manner. We believe that our
current data systems are adequate for current operating needs and provide the
flexibility to meet the requirements of our operations without disruption or
significant modification to existing systems beyond 2005. We use high quality
hardware and operating systems from current and proven technologies to support
our technology infrastructure.





*Competition*





The
number of assisted living communities continues to grow in the United States. We
believe that market saturation has had, and could continue to have, an adverse
effect on our communities and their ability to reach and maintain stabilized
occupancy levels. Moreover, the senior housing services industry has been
subject to pressures that have resulted in the consolidation of many small,
local operations into larger regional and national multi-facility operations. We
anticipate that our source of competition will come from local, regional, and
national assisted living companies that operate, manage, and develop residences
within the geographic area in which we operate, as well as retirement facilities
and communities, home healthcare agencies, not-for-profit or charitable
operators and, to a lesser extent, skilled nursing facilities and convalescent
centers. We believe that quality of service, reputation, community location,
physical








**7**


Table of
Contents


appearance,
and price will be significant competitive factors. Some of our competitors may
have significantly greater resources, experience, and name recognition within
the healthcare community than we do.





*Employees*





At
December 31, 2004, we had 8,541 employees, including 6,137 full-time employees,
of which 206 were employed at our headquarters and regional offices. Of this
total, 913 were employed in our managed communities, including 684 full-time
employees. Although none of our employees are currently represented by a union,
there was an election held in one of our facilities in Florida during
October 2003.  The union is challenging the results of the election and the
election results are currently under review by the National Labor Relations
Board. If the
union were successful in its challenge, the Board would certify a
bargaining unit of approximately 35 employees. We
believe that our relationship with our employees is satisfactory.





Although
we believe that we are able to employ sufficiently skilled personnel to staff
the communities we operate or manage, a shortage of skilled personnel,
particularly in nursing, in any of the geographic areas in which we operate
could adversely affect our ability to recruit and retain qualified employees and
to control our operating expenses.







**ITEM
2. PROPERT****IES**





*Communities*





Our
assisted living communities generally consist of one-story to three-story
buildings and include common dining and social areas . 33 of our
operating communities offer some independent living services and three are
operated as skilled nursing facilities . The
table below summarizes information regarding our current operating communities
as of December 31, 2004.








**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**
 **Alabama**Galleria
      Oaks *
    Birmingham
    Oct-2002
    71
    
    107
    
    Lease**Arizona**Arbor
      at Olive Grove *
    Phoenix
    Jun-1994
    98
    
    111
    
    LeaseLa
      Villita *
    Phoenix
    Jun-1994
    92
    
    92
    
    Option/ManageLoyalton
      of Flagstaff
    Flagstaff
    Jun-1999
    61
    
    67
    
    Lease
      (4)Loyalton
      of Phoenix
    Phoenix
    Jan-1999
    101
    
    111
    
    Lease
      (4)Village
      Oaks at Chandler *
    Chandler
    Oct-2002
    66
    
    105
    
    LeaseVillage
      Oaks at Glendale *
    Glendale
    Oct-2002
    66
    
    105
    
    LeaseVillage
      Oaks at Mesa *
    Mesa
    Oct-2002
    66
    
    105
    
    Lease**California**Arbor
      Gardens at Corona *
    Corona
    Oct-04
    45
    
    55
    
    Lease
      (4)Austin
      Gardens
    Lodi
    Apr-04
    30
    
    56
    
    Lease
      (4)Creston
      Village *
    Paso
      Robles
    Feb-1998
    100
    
    110
    
    Lease
      (4)Emerald
      Hills*
    Auburn
    Jun-1998
    89
    
    98
    
    LeaseFulton
      Villa*
    Stockton
    Mar-1995
    80
    
    80
    
    Lease
      (2)Loyalton
      of Folsom *
    Folsom
    Jan-2002
    98
    
    113
    
    Lease
      (4)Loyalton
      of Rancho Solano *
    Fairfield
    Mar-1998
    172
    
    189
    
    Lease
      (4)





**8**


Table of Contents


****


**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**


The
      Palms at Loma Linda
    Loma
      Linda
    Dec-2003
    140
    
    220
    
    Own
      (3)The
      Springs at Oceanside *
    Oceanside
    Dec-2003
    113
    
    236
    
    Own
      (3)The
      Terrace *
    Grand
      Terrace
    Mar-1996
    87
    
    87
    
    Lease
      (4)Villa
      Del Rey
    Escondido
    Mar-1997
    84
    
    84
    
    Lease
      (2)**Colorado**Loyalton
      of Broadmoor ~
    Colorado
      Springs
    Dec-2003
    37
    
    45
    
    Own
      (3)**Connecticut**Cold
      Spring Commons *
    Rocky
      Hill
    Apr-1997
    80
    
    88
    
    Lease**Delaware**Gardens
      at Whitechapel
    Newark
    Oct-1995
    100
    
    110
    
    Lease
      (4)Green
      Meadows at Dover *
    Dover
    Jul-1998
    52
    
    63
    
    Lease**Florida**Barrington
      Place *
    Lecanto
    May-1996
    79
    
    120
    
    Lease
      (4)Beneva
      Park Club
    Sarasota
    Jul-1995
    96
    
    102
    
    Option/ManageCollege
      Park Club *
    Bradenton
    Jul-1995
    85
    
    93
    
    Option/ManageLa
      Casa Grande *
    New
      Port Richey
    May-1997
    200
    
    235
    
    Lease
      (2)Park
      Club of Brandon
    Brandon
    Jul-1995
    88
    
    88
    
    Lease
      (4)Park
      Club of Fort Myers *
    Ft.
      Myers
    Jul-1995
    77
    
    82
    
    Lease
      (4)Park
      Club of Oakbridge *
    Lakeland
    Jul-1995
    88
    
    88
    
    Lease
      (4)River
      Oaks *
    Englewood
    May-1997
    155
    
    200
    
    Lease
      (2)Springtree
      *
    Sunrise
    May-1996
    179
    
    246
    
    Lease
      (4)Stanford
      Centre *
    Altamonte
      Springs
    May-1997
    118
    
    180
    
    Lease
      (2)The
      Colonial Park Club *
    Sarasota
    Aug-1996
    88
    
    90
    
    Lease
      (4)The
      Lakes *
    Ft.
      Myers
    Jun-2000
    154
    
    190
    
    Lease
      (4)The
      Lodge at Mainlands *
    Pinellas
      Park
    Aug-1996
    154
    
    162
    
    Option/ManageThe
      Pavillion at Crossing Pointe ~ *
    Orlando
    Jul-1995
    174
    
    190
    
    Lease
      (4)Village
      Oaks at Conway *
    Orlando
    Oct-2002
    66
    
    103
    
    LeaseVillage
      Oaks at Melbourne
    Melbourne
    Oct-2002
    66
    
    103
    
    LeaseVillage
      Oaks at Orange Park
    Orange
      Park
    Oct-2002
    66
    
    103
    
    LeaseVillage
      Oaks at Southpoint *
    Jacksonville
    Oct-2002
    66
    
    103
    
    LeaseVillage
      Oaks at Tuskawilla
    Winter
      Springs
    Oct-2002
    66
    
    105
    
    Lease**Georgia**Heritage
      Hills ~
    Columbia
    Apr-04
    30
    
    56
    
    Lease
      (4)**Idaho**Highland
      Hills
    Pocatello
    Oct-1996
    49
    
    55
    
    Lease
      (4)Juniper
      Meadows ~
    Lewiston
    Nov-1997
    82
    
    90
    
    Lease
      (2)Loyalton
      of Coeur d'Alene ~
    Coeur
      d' Alene
    Mar-1996
    108
    
    114
    
    Lease
      (4)Ridge
      Wind ~
    Chubbuck
    Aug-1996
    80
    
    106
    
    Lease
      (4)Summer
      Wind ~
    Boise
    Sep-1995
    49
    
    53
    
    Lease





**9**


Table of Contents





**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**


**Illinois**Canterbury
      Ridge *
    Urbana
    Nov-1998
    101
    
    111
    
    Lease
      (4)Loyalton
      of Rockford *
    Rockford
    Jun-2000
    100
    
    110
    
    Lease
      (4)Manor
      at Essington ~
    Joliet
    Oct-04
    100
    
    120
    
    Lease
      (4)**Indiana**Meridian
      Oaks *
    Indianapolis
    Oct-2002
    77
    
    111
    
    LeaseVillage
      Oaks at Fort Wayne *
    Fort
      Wayne
    Oct-2002
    66
    
    105
    
    LeaseVillage
      Oaks at Greenwood *
    Indianapolis
    Oct-2002
    66
    
    105
    
    Lease**Iowa**Silver
      Pines *
    Cedar
      Rapids
    Jan-1995
    80
    
    80
    
    Lease
      (2)**Kansas**Elm
      Grove Estates ~ *
    Hutchinson
    Apr-1997
    121
    
    133
    
    Lease
      (4)Liberal
      Springs
    Liberal
    Dec-2003
    44
    
    56
    
    Own
      (3)The
      Fairways of Augusta
    Augusta
    Dec-2003
    21
    
    27
    
    Own
      (3)**Kentucky**Stonecreek
      Lodge
    Louisville
    Apr-1997
    80
    
    88
    
    Lease**Louisiana**Kingsley
      Place at Alexandria *
    Alexandria
    May-2002
    80
    
    96
    
    LeaseKingsley
      Place at Lafayette *
    Lafayette
    May-2002
    80
    
    96
    
    LeaseKingsley
      Place at Lake Charles *
    Lake
      Charles
    May-2002
    80
    
    96
    
    LeaseKingsley
      Place at Shreveport *
    Shreveport
    May-2002
    79
    
    79
    
    Lease
      (4)**Maryland**Emerald
      Estates *
    Baltimore
    Oct-1999
    120
    
    134
    
    ManageLoyalton
      of Hagerstown
    Hagerstown
    Jul-1999
    100
    
    110
    
    Lease
      (4)**Massachusetts**Canterbury
      Woods *
    Attleboro
    Jun-2000
    130
    
    130
    
    Lease
      (4)Meadow
      Lodge at Drum Hill
    Chelmsford
    Aug-1997
    80
    
    88
    
    Lease
      (2)The
      Lodge at Eddy Pond *
    Auburn
    Jan-2000
    108
    
    110
    
    Lease
      (2)The
      Pines at Tewksbury *
    Tewksbury
    Jan-1996
    49
    
    65
    
    Lease
      (4)Woods
      at Eddy Pond *
    Auburn
    Mar-1997
    80
    
    88
    
    Lease**Mississippi**Loyalton
      of Biloxi *
    Biloxi
    Jan-1999
    83
    
    91
    
    LeaseLoyalton
      of Hattiesburg ~
    Hattiesburg
    Jul-1999
    79
    
    83
    
    Lease
      (4)Pine
      Meadows
    Hattiesburg
    Apr-04
    30
    
    56
    
    Lease
      (4)Ridgeland
      Pointe *
    Ridgeland
    Aug-1997
    79
    
    87
    
    Lease
      (2)Silverleaf
      Manor ~
    Meridian
    Jul-1998
    101
    
    111
    
    Lease
      (4)Trace
      Point ~ *
    Clinton
    Oct-1999
    100
    
    110
    
    Manage





**10**


Table of Contents


****


**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**


**Missouri**Autumn
      Ridge ~
    Herculaneum
    Jun-1997
    94
    
    94
    
    Lease
      (4)**Montana**Springmeadows
      Residence ~
    Bozeman
    Apr-1997
    74
    
    81
    
    Lease
      (2)**Nevada**Concorde
      ~
    Las
      Vegas
    Nov-1996
    116
    
    128
    
    Lease
      (2)Village
      Oaks at Las Vegas *
    Las
      Vegas
    Oct-2002
    66
    
    105
    
    LeaseThe
      Seasons ~ *
    Reno
    Feb-2002
    94
    
    109
    
    Lease
      (4)**New
      Jersey**Laurel
      Lake Estates *
    Voorhees
    Jul-1995
    117
    
    119
    
    LeaseLoyalton
      of Cape May
    Cape
      May
    May-2001
    100
    
    110
    
    Lease
      (4)**New
      York**Bassett
      Manor * (1)
    Williamsville
    Nov-1996
    103
    
    105
    
    LeaseBassett
      Park Manor (1)
    Williamsville
    Nov-1996
    78
    
    80
    
    LeaseBellevue
      Manor * (1)
    Syracuse
    Nov-1996
    90
    
    90
    
    LeaseColonie
      Manor (1)
    Latham
    Nov-1996
    94
    
    94
    
    LeaseEast
      Side Manor (1)
    Fayetteville
    Nov-1996
    80
    
    88
    
    LeaseGreen
      Meadows at Painted Post (1)
    Painted
      Post
    Oct-1995
    73
    
    96
    
    LeaseLoyalton
      of Lakewood
    Lakewood
    Jul-1999
    83
    
    91
    
    Lease
      (4)Perinton
      Park Manor (1)
    Fairport
    Nov-1996
    78
    
    86
    
    LeaseThe
      Landing at Brockport *
    Brockport
    Jul-1999
    84
    
    92
    
    ManageThe
      Landing at Queensbury *
    Queensbury
    Nov-1999
    84
    
    92
    
    ManageWest
      Side Manor - Liverpool (1)
    Liverpool
    Nov-1996
    72
    
    72
    
    LeaseWest
      Side Manor - Rochester (1)
    Rochester
    Nov-1996
    78
    
    80
    
    LeaseWoodland
      Manor (1)
    Vestal
    Nov-1996
    60
    
    116
    
    Lease**North
      Carolina**Heritage
      Hills Retirement
    Hendersonville
    Feb-1996
    99
    
    99
    
    OwnHeritage
      Lodge Assisted Living
    Hendersonville
    Feb-1996
    20
    
    24
    
    LeaseLoyalton
      of Greensboro
    Greensboro
    May-2003
    50
    
    70
    
    LeasePine
      Park Retirement ~
    Hendersonville
    Feb-1996
    110
    
    110
    
    LeaseThe
      Pines of Goldsboro
    Goldsboro
    Sep-1998
    101
    
    111
    
    Lease
      (4)**Ohio**Brookside
      Estates *
    Middleberg
      Heights
    Sep-1998
    99
    
    101
    
    Lease
      (4)Loyalton
      of Ravenna
    Ravenna
    May-2003
    55
    
    60
    
    LeasePark
      Lane ~
    Toledo
    Jan-1998
    92
    
    101
    
    ManageThe
      Landing at Canton *
    Canton
    Aug-2000
    84
    
    92
    
    Manage**Oregon**Meadowbrook
      ~
    Ontario
    Jun-1995
    53
    
    55
    
    Lease
      (4)





**11**


Table of Contents





**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**


**Pennsylvania**Green
      Meadows at Allentown *
    Allentown
    Oct-1995
    76
    
    97
    
    LeaseGreen
      Meadows at Latrobe *
    Latrobe
    Oct-1995
    84
    
    125
    
    LeaseLoyalton
      of Bloomsburg
    Bloomsburg
    May-2003
    46
    
    67
    
    LeaseLoyalton
      of Creekview *
    Mechanicsburg
    May-2003
    101
    
    120
    
    LeaseLoyalton
      of Harrisburg
    Harrisburg
    May-2003
    47
    
    65
    
    Lease**South
      Carolina**Anderson
      Place - Cottages
    Anderson
    Oct-1996
    75
    
    75
    
    Lease
      (4)Anderson
      Place - Nursing Home #
    Anderson
    Oct-1996
    22
    
    44
    
    Lease
      (4)Anderson
      Place - Summer House ~
    Anderson
    Oct-1996
    30
    
    40
    
    Lease
      (4)Bellaire
      Place
    Greenville
    May-1997
    81
    
    89
    
    Lease
      (4)Countryside
      Park
    Easley
    Feb-1996
    48
    
    66
    
    LeaseCountryside
      Village Assisted Living *
    Easley
    Feb-1996
    48
    
    78
    
    LeaseCountryside
      Village Health Center # *
    Easley
    Feb-1996
    24
    
    44
    
    LeaseCountryside
      Village Retirement ~
    Easley
    Feb-1996
    72
    
    75
    
    LeaseSkylyn
      Health Center # *
    Spartanburg
    Feb-1996
    26
    
    48
    
    LeaseSkylyn
      Personal Care
    Spartanburg
    Feb-1996
    115
    
    131
    
    LeaseSkylyn
      Retirement ~
    Spartanburg
    Feb-1996
    120
    
    120
    
    Lease**Tennessee**Walking
      Horse Meadows *
    Clarkesville
    Jun-1997
    50
    
    55
    
    Option/Manage**Texas**Amber
      Oaks ~ *
    San
      Antonio
    Apr-1997
    163
    
    275
    
    LeaseBeckett
      Meadows *
    Austin
    Oct-2002
    72
    
    72
    
    Lease
      (4)Cambria
      Lodge *
    El
      Paso
    Sep-1996
    79
    
    87
    
    LeaseChampion
      Oaks
    Houston
    Oct-2002
    48
    
    84
    
    LeaseCollin
      Oaks *
    Plano
    Oct-2002
    78
    
    112
    
    LeaseCreekside
    Plano
    Apr-04
    30
    
    56
    
    Lease
      (4)Desert
      Springs
    El
      Paso
    Apr-04
    30
    
    56
    
    Lease
      (4)Dowlen
      Oaks
    Beaumont
    Dec-1996
    79
    
    87
    
    Lease
      (4)Eastman
      Estates
    Longview
    Jun-1997
    70
    
    77
    
    Lease
      (4)Elmbrook
      Estates
    Lubbock
    Dec-1996
    79
    
    87
    
    Lease
      (4)Hamilton
      House ~ *
    San
      Antonio
    Sep-2002
    111
    
    123
    
    LeaseKingsley
      Place at Henderson *
    Henderson
    May-2002
    57
    
    101
    
    Lease
      (4)Kingsley
      Place at Oakwell Farms *
    San
      Antonio
    May-2002
    80
    
    160
    
    Lease
      (4)Kingsley
      Place at Stonebridge Ranch *
    McKinney
    May-2002
    80
    
    166
    
    Lease
      (4)Kingsley
      Place at the Medical Center *
    San
      Antonio
    May-2002
    80
    
    160
    
    Lease
      (4)Lakeridge
      Place *
    Wichita
      Falls
    Jun-1997
    79
    
    87
    
    Lease
      (4)Loyalton
      of Austin *
    Austin
    Oct-2002
    76
    
    111
    
    LeaseLoyalton
      of Lake Highlands *
    Dallas
    Oct-2002
    78
    
    112
    
    LeaseMeadowlands
      Terrace
    Waco
    Jun-1997
    71
    
    78
    
    Lease
      (4)Memorial
      Oaks *
    Houston
    Oct-2002
    68
    
    105
    
    LeaseMyrtlewood
      Estates *
    San
      Angelo
    May-1997
    79
    
    87
    
    Lease
      (4)Oak
      Hollow
    Bedford
    Apr-04
    30
    
    56
    
    Lease
      (4)





**12**


Table of Contents


****


**Emeritus****Operations**
    **Units**
    
    **Beds****Community**
    **Location**
    **Commenced**
    **(a)**
    
    **(b)**
    
    **Interest**


Pinehurst
    Tyler
    Apr-04
    30
    
    56
    
    Lease
      (4)Redwood
      Springs
    San
      Marcos
    Apr-1997
    90
    
    90
    
    LeaseSaddleridge
      Lodge
    Midland
    Dec-1996
    79
    
    87
    
    Lease
      (4)Seville
      Estates *
    Amarillo
    Mar-1997
    50
    
    55
    
    Lease
      (4)Sherwood
      Place
    Odessa
    Sep-1996
    79
    
    87
    
    LeaseStonebridge
    Dallas
    Apr-04
    30
    
    56
    
    Lease
      (4)Sugar
      Land Oaks *
    Sugar
      Land
    Oct-2002
    75
    
    110
    
    LeaseTanglewood
      Oaks *
    Fort
      Worth
    Oct-2002
    78
    
    112
    
    LeaseThe
      Palisades ~ *
    El
      Paso
    Apr-1997
    158
    
    215
    
    LeaseVickery
      Towers at Belmont ~
    Dallas
    Apr-1995
    301
    
    331
    
    ManageVillage
      Oaks at Cielo Vista
    El
      Paso
    Oct-2002
    66
    
    105
    
    LeaseVillage
      Oaks at Farmers Branch *
    Farmers
      Branch
    Oct-2002
    66
    
    105
    
    LeaseVillage
      Oaks at Hollywood Park *
    San
      Antonio
    Oct-2002
    66
    
    105
    
    LeaseWoodbridge
      Estates *
    San
      Antonio
    Oct-2002
    78
    
    112
    
    Lease**Utah**Emeritus
      Estates ~ *
    Ogden
    Feb-1998
    83
    
    91
    
    Lease
      (4)**Virginia**Cobblestones
      at Fairmont
    Manassas
    Sep-1996
    75
    
    82
    
    Lease
      (2)Loyalton
      of Danville *
    Danville
    May-2003
    68
    
    120
    
    LeaseLoyalton
      of Harrisonburg
    Harrisonburg
    May-2003
    57
    
    114
    
    LeaseLoyalton
      of Roanoke
    Roanoke
    May-2003
    65
    
    118
    
    LeaseLoyalton
      of Staunton *
    Staunton
    Jul-1999
    101
    
    111
    
    Lease
      (4)Wilburn
      Gardens *
    Fredericksburg
    Jan-1999
    101
    
    111
    
    Manage**Washington**Arbor
      Place at Silverlake
    Everett
    Jun-1999
    101
    
    111
    
    ManageCooper
      George ~
    Spokane
    Jun-1996
    140
    
    158
    
    PartnershipEmeritus
      Oaks of Silverdale *
    Silverdale
    Nov-2003
    46
    
    52
    
    LeaseEvergreen
      Lodge
    Federal
      Way
    Apr-1996
    98
    
    124
    
    Lease
      (4)Fairhaven
      Estates ~
    Bellingham
    Oct-1996
    50
    
    55
    
    Lease
      (4)Garrison
      Creek Lodge ~
    Walla
      Walla
    Jun-1996
    80
    
    88
    
    LeaseHarbour
      Pointe Shores ~
    Ocean
      Shores
    Feb-1997
    50
    
    55
    
    Lease
      (4)Kirkland
      Lodge at Lakeside
    Kirkland
    Mar-1996
    74
    
    84
    
    Lease
      (2)Regent
      Court at Kent *
    Kent
    Jan-2002
    24
    
    48
    
    ManageRenton
      Villa ~
    Renton
    Sep-1993
    79
    
    97
    
    LeaseRichland
      Gardens
    Richland
    May-1998
    100
    
    110
    
    ManageSeabrook
    Everett
    Jun-1994
    60
    
    62
    
    LeaseThe
      Courtyard at the Willows
    Puyallup
    Sep-1997
    101
    
    111
    
    Lease
      (2)The
      Hearthstone ~
    Moses
      Lake
    Nov-1996
    84
    
    92
    
    Lease
      (4)**West
      Virginia**Charleston
      Gardens *
    Charleston
    Aug-2001
    100
    
    132
    
    Lease
      (4)Total
      Operating Communities
    181
    
    14,851
    
    18,351








**13**


Table of Contents











~
    Currently
      offers independent living services.




#
    Currently
      operates as a skilled nursing facility.




*
    Currently
      offers memory loss (Alzheimer's or related dementia)
  care.




(a)
    A
      unit is a single- or double-occupancy residential living space, typically
      an apartment or studio.




(b)
    “Beds”
      reflects the actual number of beds, which in no event is greater than the
      maximum number of licensed beds allowed under the community’s
      license.




1)
    We
      provide administrative services to the community that is operated by
      Painted Post Partners through a lease agreement with an independent
      party.




2)
    These
      leased communities are reflected in our consolidated financial statements
      as owned communities because of accounting requirements related to
      sale-leaseback accounting, notwithstanding the legal sale of the
      communities and their subsequent leasing by us.




3)
    Due
      to financing requirements, assets of these communities are held by one of
      our wholly owned subsidiaries. It is management's intention that the
      assets and liabilities of the subsidiary are not available to pay other
      debts or obligations of the consolidated Company and the consolidated
      Company is not liable for the liabilities of the subsidiaryexcept
      as otherwise provided in connection with these financing
      requirements.




4)
    Leases
      for these communities are accounted for as capital leases. For communities
      under capital lease arrangements, a liability is established on the
      balance sheet based on the present value of the rent payments not to
      exceed the fair value of the underlying leased property, including base
      rent, fixed annual increases and any other payment obligations over the
      lease term and a corresponding long-term asset is recorded. Lease payments
      are allocated between principal and interest on the lease obligation and
      the capital lease asset is depreciated over the term of the lease.










*Executive
Offices*





Our
executive offices are located in Seattle, Washington, where we lease
approximately 26,500 square feet of space. Our lease agreement runs for a term
of 10 years, expiring July 2006, and includes two five-year renewal
options.





**14**




Table of Contents





**ITEM 3. LEGAL PROCEEDINGS**









From time
to time, we are subject to lawsuits and other matters in the normal course of
business, including claims related to general and professional liability.
Reserves for these claims have been accrued based upon actuarial and/or
estimated exposure, taking into account self-insured retention or deductibles,
as applicable. While we cannot predict the results with certainty, except as
noted below, we do not believe that any liability from any such lawsuits or
other matters will have a material effect on our financial position, results of
operations, or liquidity.





In
February 2005, a San Antonio, Texas, jury found one of our assisted living
communities negligent in the care of a resident. The jury awarded a verdict
against us in the amount of $1.5 million in compensatory damages and $18 million
in punitive damages. The verdict was in connection with an action that alleged
negligence brought by the relatives of a resident at one of our assisted living
facilities. We believe that this verdict is unjust, that there are substantial
grounds for an appeal and that the damage award was not justified by the facts
or the law in the case presented by the plaintiff. We are immediately appealing
the verdict based on significant legal errors we believed occurred at the trial.
We have posted funds in the amount of $1.7 million in order to stay the
proceedings while the appellate process runs its course, which could be anywhere
from 18 months to three years. We will not be required to pay additional amounts
until the appeal and further litigation is completed or the case is settled. We
have recorded a reserve on our consolidated balance sheet for the judgment
against us with a corresponding charge on our consolidated statements of
operations in 2004.





In
February 2004, the California Public Interest Research Group brought an action
against owners and operators of assisted living communities and senior housing
facilities including us. The action seeks, on behalf of residents of these
facilities located in California, to recover move-in or preadmission fees that
have been paid over the past three years as well as certain penalties. We are
defending this action vigorously and have entered into a joint defense agreement
with other operators in California. We believe recent court rulings in the case
have significantly eroded the viability of the plaintiff’s action








**15**


Table of Contents







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







Emeritus
did not submit any matter to a vote of its security holders during the fourth
quarter of its fiscal year ended December 31, 2004.








**Executive Officers of Emeritus**





The
following table presents certain information about our executive officers.








Name
    
    Age
    
    PositionDaniel
      R. Baty
    
    61
    
    Chairman
      of the Board and Chief Executive OfficerRaymond
      R. Brandstrom
    
    52
    
    Vice
      President of Finance, Secretary, and Chief Financial
    OfficerGary
      S. Becker
    
    57
    
    Senior
      Vice President of OperationsMartin
      D. Roffe
    
    57
    
    Vice
      President, Financial PlanningFrank
      Ruffo Jr.
    
    62
    
    Vice
      President, AdministrationSuzette
      McCanless
    
    56
    
    Vice
      President, Operations -- Eastern DivisionRussell
      G. Kubik
    
    51
    
    Vice
      President, Operations -- Central DivisionP.
      Kacy Kang
    
    37
    
    Vice
      President, Operations -- Western DivisionChristopher
      M. Belford
    
    43
    
    Vice
      President, Operations -- Great Lakes DivisionSusan
      A. Scherr
    
    56
    
    Vice
      President of Signature Services








*Daniel
R. Baty* , one of
Emeritus’s founders, has served as its Chief Executive Officer and as a director
since its inception in 1993 and became Chairman of the Board in April 1995. Mr.
Baty also has served as the Chairman of the Board of Holiday Retirement
Corporation since 1987 and served as its Chief Executive Officer from 1991
through September 1997. Since 1984, Mr. Baty has also served as Chairman of the
Board of Columbia Pacific Group, Inc. and, since 1986, as Chairman of the Board
of Columbia Management, Inc. Both of these companies are wholly owned by Mr.
Baty and are engaged in developing independent living facilities and providing
consulting services for that market.  Mr. Baty is the father of Stanley L.
Baty, a director.





*Raymond
R. Brandstrom,* one of
Emeritus’s founders, has served as a director since its inception in 1993 and as
Vice Chairman of the Board from March 1999 until March 2000. From 1993 to March
1999, Mr. Brandstrom also served as Emeritus’s President and Chief Operating
Officer. In March 2000, Mr. Brandstrom was elected Vice President of Finance,
Chief Financial Officer, and Secretary of Emeritus. From May 1992 to May 1997,
Mr. Brandstrom served as Vice President and Treasurer of Columbia Winery, a
company affiliated with Mr. Baty that is engaged in the production and sale of
table wines.





*Gary
S. Becker* joined
Emeritus as Western Division Director in January 1997, was promoted to Vice
President, Operations-Western Division in September 1999, and then promoted to
Senior Vice President of Operations in March 2000. Mr. Becker has 30 years of
health care management experience. From October 1993 to December 1996 he was
Vice President of Operations for the Western Division of SunBridge Healthcare
Corporation, the nursing home division of Sun Healthcare Group, Inc. Sun
Healthcare Group, Inc. is one of the largest providers of long-term,
subacute, and related specialty health care services in the United
States.





**16**


Table of Contents


*Martin
D. Roffe* joined
Emeritus as Director of Financial Planning in March 1998, and was promoted to
Vice President of Financial Planning in October 1999. Mr. Roffe has 31 years
experience in the acute care, long-term care, and senior housing industries.
Prior to joining Emeritus, from May 1987 until February 1996, Mr. Roffe served
as Vice President of Financial Planning for the Hillhaven Corporation, where he
also held the previous positions of Sr. Application Analyst and Director of
Financial Planning. Hillhaven Corporation operated nursing centers, pharmacies,
and retirement housing communities.





*Frank
A. Ruffo Jr* ., one of
the Company’s founders, has served as Vice President, Administration, since
2004, and served as a senior consultant to the Company from 1999 to 2003. From
1993 to 1999, Mr. Ruffo served as the Company’s Executive Vice President. From
1991 to 1993 Mr. Ruffo served as a Vice President of Columbia Pacific
Management, a company affiliated with Mr. Baty that develops senior housing
facilities. From 1976 to 1989, Mr. Ruffo was Vice President/Senior Vice
President of Hillhaven Corporation, then the second largest skilled care
provider in the United States.





*Suzette
McCanless* joined
Emeritus as Eastern Division Director of Operations in March 1997 and was
promoted to Vice President of Operations - Eastern Division, in September 1999.
Mrs. McCanless has 23 years of health care management experience. Prior to
joining Emeritus, from July 1996 to February 1997, she was Group Vice President
for Beverly Enterprises, Inc., where she also held the previous positions of
Administrator and Regional Director of Operations. The business of Beverly
Enterprises, Inc. consists principally of providing healthcare services,
including the operation of nursing facilities, assisted living centers, hospice
and home care centers, outpatient therapy clinics and rehabilitation therapy
services.





*Russell
G. Kubik* joined
Emeritus as Central Division Director of Operations in April 1997 and was
promoted to Vice President, Operations - Central Division, in September 1999.
Mr. Kubik has 19 years of health care management experience. Prior to joining
Emeritus, from 1994 to 1997, Mr. Kubik served as Regional Director of Operations
for Sun Healthcare Group, Inc. in the Seattle/Puget Sound area. Mr. Kubik also
worked as Regional Director of Operations for Beverly Enterprises, Inc. in
Washington and Idaho.





*P.
Kacy Kang* joined
Emeritus as Regional Director of Operations in June 1997 and was promoted to
Senior Director of Operations - Western Division, in February 2001. Mr. Kang was
then promoted to Vice President of Operations - Western Division in August 2001.
Prior to joining Emeritus, Mr. Kang operated nursing and rehabilitation
facilities for Beverly Enterprises, Inc. from 1991 to 1994 and for Sun
Healthcare Group, Inc. from 1994 through 1997.





*Christopher
M. Belford* joined
Emeritus as Regional Director of Operations for California in January 2001
and was promoted to Divisional Director of Operations for the Southwest
Division in May 2001.  Mr. Belford was then promoted to Vice President of
Operations - Great Lakes Division in October 2003.  Prior to joining
Emeritus, Mr. Belford served as Vice President of Operations for Regent Assisted
Living, Inc. from 1996 to 2000 in the Southwest Division. 
Mr. Belford operated nursing, assisted, and independent living
facilities for ERA Care in the Seattle/Puget Sound area from 1991 to
1996.





*Susan
A. Scherr* joined
Emeritus as a Regional Support Specialist in October 1997 and was promoted to
Director of Signature Services and a member of the Emeritus Senior Management
team in December 1999. In April 2001, she became Vice President of Signature
Services, providing leadership and direction to Emeritus through Sales and
Marketing, Education and Training, Dining Services, and Wellness and Activities
Programming. Ms. Scherr brings to Emeritus more than 19 years’ experience in the
assisted living, acute and skilled care, and hospice/home health care
industries. Prior to her association with Emeritus, she worked with SunBridge
Healthcare Corporation, the nursing home division of Sun Healthcare
Group, Inc. and Jerry Erwin & Associates, an assisted living company.








**17**


Table of Contents


**PART II**





**ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS**





Our
common stock has been traded on the American Stock Exchange under the symbol
“ESC” since November 21, 1995, the date of our initial public offering. The
following table sets forth for the periods indicated the high and low closing
prices for our common stock as reported on AMEX.








****
    
    **High**
    
    **Low****2004**First
      Quarter
    
    $
    9.60
    
    $
    6.65Second
      Quarter
    
    $
    7.50
    
    $
    5.70Third
      Quarter
    
    $
    8.52
    
    $
    6.01Fourth
      Quarter
    
    $
    12.90
    
    $
    8.43**2003**First
      Quarter
    
    $
    5.78
    
    $
    3.60Second
      Quarter
    
    $
    4.49
    
    $
    3.44Third
      Quarter
    
    $
    8.09
    
    $
    3.85Fourth
      Quarter
    
    $
    8.50
    
    $
    5.90**2002**First
      Quarter
    
    $
    5.22
    
    $
    2.05Second
      Quarter
    
    $
    5.00
    
    $
    3.80Third
      Quarter
    
    $
    4.50
    
    $
    1.70Fourth
      Quarter
    
    $
    5.68
    
    $
    1.70





As of
February 28, 2005, we had 118 holders of record of our Common
Stock.





We have
never declared or paid any dividends on our Common Stock, and expect to retain
any future earnings to finance the operation and expansion of our business.
Future dividend payments will depend on our results of operations, financial
condition, capital expenditure plans, and other obligations and will be at the
sole discretion of our Board of Directors. Certain of our existing leases and
lending arrangements contain provisions that restrict our ability to pay
dividends, and it is anticipated that the terms of future leases and debt
financing arrangements may contain similar restrictions. In addition, any
dividends in arrears on the Series B preferred stock have to be distributed
prior to any common stock dividends being declared or paid. Therefore, we do not
anticipate paying any cash dividends on our Common Stock in the foreseeable
future.










**18**


Table of
Contents


****


**ITEM 6. SELECTED CONSOLIDATED FINANCIAL
DATA**





The
selected data presented below under the captions "Consolidated Statements of
Operations Data" and "Consolidated Balance Sheet Data" for, and as of the end
of, each of the years in the five-year period ended December 31, 2004, are
derived from the consolidated financial statements of Emeritus Corporation. The
consolidated balance sheets as of December 31, 2004 and 2003, and consolidated
statements of operations for each of the years in the three-year period ended
December 31, 2004, are included elsewhere in this document.







**Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands, except per share data)****Consolidated
      Statements of Operations Data:**Total
      operating revenues
    
    $
    317,935
    
    $
    202,949
    
    $
    150,923
    
    $
    136,594
    
    $
    121,689Total
      operating expenses
    
    
    318,015
    
    
    193,627
    
    
    148,521
    
    
    130,464
    
    
    123,491Income
      (loss) from continuing operations
    
    
    (80
    )
    
    9,322
    
    
    2,402
    
    
    6,130
    
    
    (1,802
    )Net
      other expense
    
    
    (40,263
    )
    
    (16,089
    )
    
    (9,104
    )
    
    (10,953
    )
    
    (20,360
    )Loss
      from continuing operations before income taxes
    
    
    (40,343
    )
    
    (6,767
    )
    
    (6,702
    )
    
    (4,823
    )
    
    (22,162
    )Provision
      for income taxes
    
    
    (1,188
    )
    
    (418
    )
    
    -
    
    
    -
    
    
    -Net
      loss from continuing operations
    
    
    (41,531
    )
    
    (7,185
    )
    
    (6,702
    )
    
    (4,823
    )
    
    (22,162
    )Income
      (loss) from discontinued operations
    
    
    991
    
    
    (896
    )
    
    247
    
    
    (199
    )
    
    (798
    )Net
      loss
    
    
    (40,540
    )
    
    (8,081
    )
    
    (6,455
    )
    
    (5,022
    )
    
    (22,960
    )Preferred
      stock dividends
    
    
    (3,737
    )
    
    (6,238
    )
    
    (7,343
    )
    
    (6,368
    )
    
    (5,327
    )Gain
      on repurchase of Series A preferred stock
    
    
    -
    
    
    14,523
    
    
    -
    
    
    -
    
    
    -Net
      income (loss) to common shareholders
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )
    $
    (11,390
    )
    $
    (28,287
    )Basic
      income (loss) per common share:Continuing
      operations
    
    $
    (4.26
    )
    $
    0.11
    
    $
    (1.37
    )
    $
    (1.10
    )
    $
    (2.72
    )Discontinued
      operations
    
    
    0.09
    
    
    (0.09
    )
    
    0.02
    
    
    (0.02
    )
    
    (0.08
    )$
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )
    $
    (1.12
    )
    $
    (2.80
    )Diluted
      income (loss) per common share:Continuing
      operations
    
    $
    (4.26
    )
    $
    0.10
    
    $
    (1.37
    )
    $
    (1.10
    )
    $
    (2.72
    )Discontinued
      operations
    
    
    0.09
    
    
    (0.08
    )
    
    0.02
    
    
    (0.02
    )
    
    (0.08
    )$
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )
    $
    (1.12
    )
    $
    (2.80
    )Weighted
      average number of common shares outstanding:Basic
    
    
    10,623
    
    
    10,255
    
    
    10,207
    
    
    10,162
    
    
    10,117Diluted
    
    
    10,623
    
    
    11,521
    
    
    10,207
    
    
    10,162
    
    
    10,117**Consolidated
      Operating Data:**Communities
      in which we have an interest
    
    
    181
    
    
    175
    
    
    180
    
    
    133
    
    
    135Number
      of units
    
    
    14,851
    
    
    14,845
    
    
    15,762
    
    
    12,248
    
    
    12,412





**19**


Table of Contents


**December
      31,****2004**
    
    **2003**
    
    **2002**
    
    **2001**
    
    **2000****(In
      thousands)****Consolidated
      Balance Sheet Data:**Cash
      and cash equivalents
    
    $
    10,748
    
    $
    6,368
    
    $
    7,301
    
    $
    10,194
    
    $
    7,496Working
      capital (deficit)
    
    $
    (71,876
    )
    $
    (38,285
    )
    $
    (27,618
    )
    $
    (13,627
    )
    $
    (82,389
    )Total
      assets
    
    $
    716,522
    
    $
    389,794
    
    $
    203,820
    
    $
    168,811
    
    $
    178,079Long-term
      debt, less current portion
    
    $
    50,528
    
    $
    136,388
    
    $
    119,887
    
    $
    131,070
    
    $
    60,499Capital
      lease and financing obligations, less current portion
    
    $
    614,046
    
    $
    215,324
    
    $
    40,949
    
    $
    -
    
    $
    -Convertible
      debentures
    
    $
    32,000
    
    $
    32,000
    
    $
    32,000
    
    $
    32,000
    
    $
    32,000Redeemable
      preferred stock
    
    $
    -
    
    $
    -
    
    $
    25,000
    
    $
    25,000
    
    $
    25,000Shareholders'
      deficit
    
    $
    (128,319
    )
    $
    (86,927
    )
    $
    (89,834
    )
    $
    (78,677
    )
    $
    (69,551
    )









**20**


Table of Contents







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








**Overview**





Emeritus
is a Washington corporation organized by Daniel R. Baty and two other founders
in 1993. In November 1995, we completed our initial public
offering.





From 1995
through 1999, we expanded rapidly through acquisition and internal development
and by December 31, 1999, operated 129 assisted living communities with
11,726 units. We believe, however, that during this expansion, the assisted
living industry became significantly over-built, creating an environment
characterized by sluggish or falling occupancy and market resistance to rate
increases. As a result of these difficult operating circumstances, we limited
further growth and in 2000 began an increasing focus first on raising our
occupancy and later on rate development, operating efficiencies and cost
controls.





We
believe that the health of the assisted living industry is improving and that
there are developing opportunities to improve occupancy and adjust rates, as
well as greater access to capital. In light of these perceptions, we have
completed several leases and acquisitions in the last three years and have
converted most of our managed communities to owned or leased communities. In
2000 and 2001, we operated approximately 130 communities, but in 2003 and 2004,
we increased that to 175 and 181 communities, respectively, primarily through
the lease of 24 communities formerly operated by Marriott and through other
selected leases and acquisitions. From the end of 2002 to the end of 2004, the
communities we manage decreased from 96 to 17 and the owned and leased
communities increased from 84 to 164, reflecting both our increasing confidence
in the assisted living industry and the availability of capital.





In 2005
we expect to continue reviewing acquisition opportunities.





The
following table sets forth a summary of our property interests.





**As
      of December 31,**
    
    **As
      of December 31,**
    
    **As
      of December 31,****2004**
    
    **2003**
    
    **2002****Buildings**
    
    **Units**
    
    **Buildings**
    
    **Units**
    
    **Buildings**
    
    **Units**Owned
      (1)
    6
    
    454
    
    19
    
    1,813
    
    17
    
    1,687Leased
      (1 ) (2)
    158
    
    12,589
    
    109
    
    8,303
    
    67
    
    5,279Managed/Admin
      Services (3) (4) (5)
    16
    
    1,668
    
    46
    
    4,589
    
    94
    
    8,577Joint
      Venture/Partnership
    1
    
    140
    
    1
    
    140
    
    2
    
    219Operated
      Portfolio
    181
    
    14,851
    
    175
    
    14,845
    
    180
    
    15,762Percentage
      increase (decrease)
    3.4%
    
    0.0%
    
    (2.8%)
    
    (5.8%)
    
    35.3%
    
    28.7%








(1) Included in our consolidated portfolio of communities.


(2) Of
the leased communities at the end of 2004, 75 are accounted for as operating
leases, in which the assets and liabilities of the communities are not included
in our consolidated balance sheet and 68 are accounted for as capital leases, in
which a long-term asset and corresponding liability is established on our
balance sheet. The remaining 15 leased communities are reflected in our
consolidated financial statements as owned communities because of accounting
requirements related to sale-leaseback accounting, notwithstanding the legal
sale of the communities and their
subsequent leasing by us. There were 76 operating, 29 capital leases and four
leased communities reflected in our consolidated financial statements as owned
because of accounting requirements related to sale-leaseback accounting at the
end of 2003. There were 63 operating and four capital leases at the end of 2002.


(3)
Buildings managed decreased in 2004 primarily due to the conversion of
communities from managed to leased. The decrease in 2003 was primarily due to
the termination of 13 Regent management contracts, the conversion of the
21





**21**


Table of
Contents


Emeritrust
II communities from managed to leased as of September 30, 2003, and the
conversion of 8 Horizon Bay communities from managed to leased as of December
31, 2003.


(4) One
managed building has been shut down and was sold March 12, 2004.


(5) One
management contract was terminated October 1, 2004.





Two of
the important factors affecting our financial results are the rates we charge
our residents and the occupancy levels we achieve in our communities. We rely
primarily on our residents' ability to pay our charges for services from their
own or familial resources and expect that we will do so for the foreseeable
future. Although care in an assisted living community is typically less
expensive than in a skilled nursing facility, we believe that generally only
seniors with income or assets meeting or exceeding the regional median can
afford to reside in our communities. In this context, we must be sensitive to
our residents' financial circumstances and remain aware that rates and occupancy
are interrelated.





In
evaluating the rate component, we generally rely on the average monthly revenue
per unit, computed by dividing the total revenue for a particular period by the
average number of occupied units determined on a monthly basis for the same
period. In evaluating the occupancy component, we generally rely on the average
occupancy rate, computed by dividing the average units occupied, during a
particular period by the average number of units available, during the period.
This average is computed on a monthly basis. We evaluate these and other
operating components for our consolidated portfolio, which included the
communities we own and lease, and our operating portfolio, which also includes
the communities we manage as if we were the owner or lessor.





In our
consolidated portfolio, our average monthly revenue per unit increased from
$2,577 in 2002 to $2,767 in 2003 and to $2,861 in 2004. These changes
represented increases of 7.4% and 3.4% for 2003 and 2004, respectively. We
believe that these improvements were a consequence of a carefully designed rate
enhancement program that we began implementing in 2000 in conjunction with
acquisition of communities with higher rates per unit than our existing
portfolio during that period.





In our
consolidated portfolio, our average occupancy rate was 80.9% in 2002, decreasing
to 77.4% in 2003 and increasing to 82.2% in 2004. We believe that the decrease
in occupancy rates from 2002 to 2003 was primarily the result of the acquisition
of 24 communities at the end of 2002 with substantially less occupancy than our
existing portfolio. We also believe that our rate enhancement program affected
occupancy growth and we continue to evaluate the factors of rate and occupancy
to find the optimum balance in each community, as witnessed by the increase in
occupancy rates from 2003 to 2004, which was a result of a major marketing
campaign begun in early 2004 and included re-pricing of units as needed to
ensure market competitiveness.





Since our
inception in 1993, we have incurred operating losses and as of December 31,
2004, we had an accumulated deficit of approximately $204.1 million. We believe
that these losses have resulted from our early emphasis on expansion, financing
costs arising from multiple financing and refinancing transactions related to
this expansion, administrative and corporate expenses that we incurred in
anticipation of further expansion that did not materialize and occupancy rates
that have declined and remained lower for longer periods than we anticipated.








**Significant
Transactions**





In 2004
we increased the number of communities we lease, reduced the number of
communities we manage, and, in connection with these changes, increased and
restructured portions of our long-term financing obligations. The transactions
associated with these developments are summarized below.





**22**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
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*Emeritrust
Transactions*





Beginning
in 1999, we managed 46 communities under arrangements with several related
investor groups (Emeritrust) that involved (i) payment of management fees to us
(ii) options for us to purchase the communities at a price determined by a
formula, and (iii) obligations to fund operating losses of certain
communities.





*Emeritrust I
Communities Management.* During 2004, 2003, and 2002, we managed the Emeritrust I communities, which
included 25 of the 46 communities. Through March 31, 2004, the management
agreement provided for a base fee of 3% of gross revenues generated by the
communities and an additional management fee of 4% of gross revenues, payable to
the extent of 50% of cash flow from the communities. The management agreement
also required us to fund cash operating losses of the communities. In each of
April and August 2003, the Emeritrust I owners disposed of a community, reducing
the number of managed communities to 23. In March 2004, the Emeritrust I owners
disposed of a community, reducing the number of communities that we managed to
22. In June 2004, the Emeritrust I owners sold a community located in Grand
Terrace, California, to an entity controlled by Mr. Baty. This entity, in turn,
leased the community to us, reducing the number of communities that we managed
to 21. On September 30, 2004, 16 of the original 21 Emeritrust I
Communities were acquired by a third party REIT and leased to us and their
operating results are included in our consolidated financial statements
beginning October 1, 2004. The five remaining communities continue to be managed
by us. Under this arrangement, we received management fees (net of our funding
obligations) of approximately $1.9 million, $2.7 million, and $1.8 million in
2004, 2003, and 2002, respectively. This management agreement, as extended
several times, expired at the end of 2003. On January 2, 2004, the Emeritrust I
investors entered into a new management agreement with us providing for
management fees computed on the same basis and (i) terminating all options to
purchase the communities, (ii) terminating any further funding obligation, and
(iii) providing for a term expiring September 30, 2005, provided that either
party may terminate the agreement on 90 days notice. Effective April 1, 2004,
the Emeritrust I owners extended the underlying financing on the Emeritrust I
communities. In connection with the financing extension, the management
agreement was amended to provide for a flat management fee of 5% of gross
revenues and amended the term to March 31, 2005, with a one-year extension to
March 31, 2006, available under certain circumstances, subject to termination by
either party on short notice.








*Emeritrust
I Communities Lease.* In
connection with these communities and others, the following transaction took
place that eliminated the majority of the Emeritrust I communities as managed
communities, converting them to leased communities. As of September 30,
2004, 16 of the remaining 21 Emeritrust I Communities were acquired by a
third party REIT and leased to us and their operating results are included in
our consolidated financial statements beginning October 1, 2004. We still manage
5 communities on behalf of the Emeritrust I group; the Emeritrust I group had
previously disposed of 4 communities, including 1 which continues to be leased
by us.





On
September 30, 2004, we completed the first phase of a transaction to lease
(Baty/REIT Lease) up to 20 assisted living communities in 12 states, with 1,824
units. These communities, which were owned by entities in which Mr. Baty has
financial interests, were acquired by an independent REIT for an approximate
$170.8 million investment and are being leased to us. We completed the lease on
the first 18 communities on September 30, 2004, and anticipate the remaining two
communities will close during the first or second quarter 2005. Sixteen of the
communities included in this lease were part of the group of 21 owned by AL
Investors and have been referred to in past filings with the Securities and
Exchange Commission as the “Emeritrust I communities.” We managed these
communities under a master management agreement entered into in 1999, which has
been amended from time to time since then. We will continue to manage the five
remaining Emeritrust I communities under the amended master management agreement
for a fee based on a fixed percentage of revenue as described above under
Emeritrust I Communities Management. Of the other four communities included in
the lease, we previously managed two, leased one, and one is new to our
portfolio.





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The 18
communities are leased by us from the REIT pursuant to a new master lease with a
15-year term, with one 15-year renewal option. Due to certain subjective default
provisions and default remedies, the leases are accounted for as capital leases.
For the leases completed on September 30, 2004 this resulted in additions to
property and equipment and capital lease and financing obligations totaling
approximately $156 million. Approximately an additional $35.3 million in
property and equipment and financing obligations will be recorded pursuant to
the future closing of the two remaining facilities. The initial lease payment
for the facilities that have closed is approximately $12.2 million per year,
with inflators to the extent the change in the consumer price index exceeds 0%,
not to exceed 40 basis points during years two through four and 30 basis points
thereafter as calculated with respect to the REIT's investment basis in the
properties. The initial lease payment is expected to increase by $2.5 million
when the remaining two facilities close. We are responsible for all operating
costs, including repairs, property taxes, and insurance. The new master lease is
cross-defaulted and cross-collateralized with all of our other leases and loans
relating to other communities owned by the REIT and contains certain financial
and other covenants. We have the right of first refusal to purchase these leased
communities and Mr. Baty is personally guaranteeing our obligations under the
lease. Mr. Baty will receive 50% of the positive cash flow of the 20 communities
and will be responsible for 50% of any negative cash flow. In 2004, Mr. Baty
received $200,000 as consideration.  We have the right to purchase Mr.
Baty’s 50% interest in the cash flow of the 20 communities for 50% of the lesser
of 6 times cash flow or the fair market value of that cash flow. For purposes of
this transaction, cash flow is defined as actual cash flow after management fees
of 5% of revenues payable to us, actual capital expenditures, and certain other
agreed adjustments.





All 20
communities provide assisted and/or memory loss related services to seniors. The
facilities are located in California, Delaware, Florida, Kansas, Montana,
Nevada, South Carolina, Ohio, Utah, Texas, Virginia, and Washington.





*Emeritrust II
Communities Management.* Through
September 30, 2003, we managed the Emeritrust II communities, which
included 21 of the 46 Emeritrust communities, under management agreements
providing for a base management fee of 5% of gross revenue generated by the
communities and an additional management fee of 2%, payable if we met certain
cash flow standards. The management agreement for five of the communities also
required us to fund cash operating losses of those communities. Under this
arrangement, we received management fees (net of our funding obligations) of
approximately $2.0 million for the year ended December 31, 2003 and
approximately $2.6 million for the year ended December 31, 2002.





*Emeritrust II
Communities Lease.* On
September 30, 2003, an independent REIT acquired the 21 Emeritrust II
communities for a cash purchase price of $118.6 million and leased them to us. A
master lease covers the Emeritrust II communities and four other
communities originally leased under a capital lease arrangement from the REIT in
March 2002. Due to certain subjective default provisions and default remedies
which allow for acceleration of all unpaid lease payments, the leases are
accounted for as capital leases, which resulted in additions to property and
equipment and capital lease and financing obligations totaling approximately
$164.1 million. The lease is for an initial 15-year period, with one 15-year
renewal, and grants us a right of first opportunity to purchase any of the
Emeritrust II communities if the REIT decides to sell. The lease is a
triple-net lease, with annual base rent of $14.7 million (of which
$10.5 million is attributable to the Emeritrust II communities), and
periodic escalators of the lesser of three times the change in the consumer
price index or 28.67 basis points as calculated with respect to the REIT's
investment basis in the properties. The REIT also provided $11.5 million of debt
financing secured by our leasehold interests in the Emeritrust II
communities. This debt was consolidated with other debt held by the REIT. As
part of the transaction, we also agreed to issue to the Emeritrust II
investors warrants to purchase 500,000 shares of our common stock, of which
400,000 shares have been issued. The warrants expire September 30, 2008, and
have an exercise price of $7.60 (subject to certain adjustments). The holders
have limited registration rights. We included the fair value of these warrants,
totaling approximately $2.5 million, as lease acquisition costs that we will
amortize over the life of the lease.





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*Repurchase
of Series A Preferred Stock*





In a
two-part transaction that was completed August 28, 2003, we repurchased all the
outstanding shares of our Series A Preferred Stock for an aggregate
purchase price of $20.5 million. The Series A Preferred Stock had been issued
originally in October 1997 for $25.0 million. As a part of the repurchase, the
holder of the Series A Preferred Stock waived approximately $10.1 million in
accrued and unpaid dividends. As a result of the transaction, we recognized a
gain of approximately $14.5 million. Just prior to the repurchase, the
Series A Preferred Stock was accruing compounded, cumulative dividends of
approximately $3.7 million annually, with mandatory redemption in October 2004
at a price of $25 million plus accrued and unpaid dividends. In completing
the repurchase, we avoided these future obligations. We obtained the funds to
complete the repurchase through three related transactions.





The first
transaction involved three communities that we leased. Prior to this
transaction, we also held notes receivable in the aggregate amount of
$4.4 million that were secured by the same three communities and under
which we received interest of approximately $144,000 annually. In the
transaction, the communities were transferred to a REIT, which became the new
owner and lessor, and we received net proceeds of $10.2 million in
repayment of the notes we held and in exchange for our related security and
other property interests in the communities. The transfer of the communities was
subject to our leases, the terms of which did not change. Because we disposed of
our notes, we will no longer receive the interest we formerly did. We recognized
a deferred gain of approximately $8.5 million, which is being amortized over the
remaining life of the leases.





The
second transaction, with the same REIT, involved the sale-leaseback of four
communities, three of which we owned and one of which we held through a 50%
joint venture interest, resulting in net proceeds of $6.6 million. The
lease is for a 15-year term with a 15-year extension, is a triple-net lease
requiring us to pay all expenses associated with the communities, and provides
for a base annual rent of approximately $3.5 million, with periodic
escalators of the lesser of three times the change in the consumer price index
or 25 basis points as calculated with respect to the REIT's investment basis in
the properties. Prior to this transaction, the communities secured mortgage
financing of $24.6 million, with annual interest payments of approximately
$2.4 million, which was assumed by the REIT in the sale. As a part of the
assumption, we provided a letter of credit against the default of the underlying
debt and continued a security interest in community receivables and limited
guarantees in favor of the debt holder. These features of the transaction
constitute continuing involvement for accounting purposes, preclude
sale-leaseback accounting, and require us to use finance accounting. As a
result, although the transaction resulted in the legal sale of the communities
to the REIT and their subsequent leasing by us, our consolidated financial
statements continue to reflect the communities as owned and we have established
a financing obligation equal to the purchase price of approximately $34.6
million.





The third
transaction, again with the same REIT, was a mortgage loan for $7.5 million
secured by our leasehold interest in the seven communities involved in the first
two transactions. The debt matures in August 2006 and required monthly
interest-only payments at an initial rate of 12% per annum, with periodic
increases. This mortgage debt was subsequently consolidated with other debt held
by the REIT.





*Lease
of Eight Communities in May 2003*





In May
2003, we entered into an operating lease with a REIT covering eight assisted
living communities in four states containing an aggregate of 489 units. The
lease is for an initial 10-year period with three 5-year extensions and includes
an option to acquire the communities during the second year for a price of $42.2
million and during the third year at the same price plus a 3% premium. We
believe this option exercise price is currently well above fair value based on
current operations. Under the lease we have a right of first opportunity to
purchase any of the properties if the owner decides to sell. The lease is a
triple-net operating lease, with annual base rental of $3.5 million, and rent
adjustments at the end of the first and second lease years based on a percentage
of any increase in operating revenues, with an aggregate annual limit of





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$275,000,
and adjustments each year thereafter based on increases in the consumer price
index. The REIT has agreed to fund up to $500,000 for capital expenditures, with
amounts added to the lease base and option price, and has provided us a 10-year
working capital loan for $600,000, with interest at 10% per annum payable
monthly.





*Lease
of Eight Communities from Baty*





In April
2002, we entered into agreements to acquire the ownership interest of one
community and the leasehold interest of seven communities through the assumption
of their respective mortgage debt and lease obligations. The eight communities,
comprising 617 units in Louisiana and Texas, had been previously operated by
Horizon Bay Management L.L.C. In May 2002, we assigned our rights under these
agreements to entities wholly owned by Mr. Baty and entered into five-year
management agreements with the Baty entities expiring April 30, 2007, and
providing for a management fee of 5% of gross revenue. As a part of these
agreements, we had the right to reacquire the one community and seven leased
communities at any time prior to April 30, 2007, by assuming the mortgage
debt and lease obligations and paying the Baty entities the amount of any cash
investment in the communities, plus 9% per annum. In the original agreements of
acquisition with the Baty entities, Horizon Bay agreed to fund operating losses
of the communities to the extent of $2.3 million in the first twelve months and
$1.1 million in the second twelve months following the closing. Under the
management agreements with the Baty entities, we agreed to fund any operating
losses in excess of these limits over the five-year management term. In late
2002, the Baty entities and Horizon Bay altered their agreement relating to
operating losses whereby (i) Horizon Bay paid the Baty entities $2 million
and (ii) the Baty entities waived any further funding by Horizon of operating
losses of the communities.





On
September 30, 2003, we entered into an agreement to lease the eight Horizon
Bay communities. ** Under the
agreement, the Baty entities assigned, and we assumed, the existing leases
relating to seven of the facilities, which were leased from two different
lessors. In lieu of acquiring the remaining community, which was owned by a Baty
entity subject to mortgage financing, we leased the community for a term of 10
years, with rent equal to the debt service on the mortgage indebtedness
(including interest and principal) plus 25% of cash flow (after accounting for
assumed management fees and capital expenditures). As of April 1, 2004, this
Horizon Bay community became a capital lease under the CPM-JEA transactions
described below. The debt that is secured by this community may be
cross-collateralized by Mr. Baty with an Emeritrust I community that he may
acquire and lease to us, as described below. Annual rent relating to the eight
communities is estimated at $4.6 million, with annual adjustments based upon
changes in the consumer price index. We paid the Baty Entities approximately
$70,000, which represents their cash investment plus 9% per annum, as provided
in the original agreement related to the management of these communities between
the Baty Entities and us. Although this transaction closed December 31,
2003, the economic and financial terms were effective June 30, 2003. Four
of these facilities are capital leases resulting in additions to property and
equipment and capital lease and financing obligations on our consolidated
balance sheets totaling approximately $23.6 million





*Fretus
Lease*





On
October 1, 2002, we entered into a lease agreement with Fretus Investors LLC
("Fretus"), for 24 assisted living communities (the "Properties") in six states
containing an aggregate of approximately 1,650 units. Fretus acquired the
Properties from Marriott Senior Living Services, a subsidiary of Marriott
International. Fretus is a private investment joint venture between Fremont
Realty Capital ("Fremont"), which holds a 65% stake, with the remaining 35%
minority stake held by an entity controlled by Mr. Baty and in which he holds an
indirect 36% interest. Mr. Baty is also guarantor
of a portion of the debt and the Baty-related entity is the administrative
member of Fretus . Fretus,
in turn, leased the Properties to us. We have no obligation with respect to the
properties other than our responsibilities under the lease, which includes the
option to purchase solely at our discretion.





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The
Fretus lease is for an initial 10-year period with two 5-year extensions and
includes an opportunity for us to purchase the Properties during the third,
fourth, or fifth year and the right under certain circumstances for the lease to
be cancelled as to one or more properties upon the payment of a termination fee
to us. The lease is a triple-net operating lease, with base rental equal to (i)
the debt service on the outstanding senior mortgage granted
by Fretus , and
(ii) an amount necessary to provide a 12% annual return on equity to Fretus. The
initial senior mortgage debt is for $45.0 million and interest is accrued at
LIBOR plus 3.5%, subject to a floor of 6.25%. The Fretus equity is approximately
$25.0 million but may increase as a result of additional capital contributions
for specified purposes and will decrease as a result of cash distributions to
investors. Based on the initial senior mortgage terms and Fretus equity, current
rental is approximately $500,000 per month. In addition to the base rental, the
lease also provides for percentage rental equal to a percentage (ranging from 7%
to 8.5%) of gross revenues in excess of a specified threshold, commencing with
the thirteenth month of the lease. The Properties in this lease transaction are
all purpose-built assisted living communities in which we offer both assisted
and memory loss services in selected communities. Rent expense under the Fretus
lease was $5.9 million, $5.8 million, and $1.5 million for the years
ended December 31, 2004, 2003, and 2002, respectively.





*March
2002 Lease of Four Communities*





In March
2002, we entered into a 15-year master lease arrangement with HC REIT, Inc. for
four communities, two of which we previously held an ownership interest in and
two of which we previously leased from another lessor. A Baty-related entity
held a 50% economic interest in one of the communities in which we had an
interest. Preceding the HC REIT transaction, we purchased the Baty-related
entity's economic interest for Baty’s investment basis of $2.1 million plus a 9%
return, a $2.95 million total payment. The other community in which we had an
interest was 50% owned by an outside investor. Also preceding the HC REIT
transaction, we purchased the remaining 50% interest in this community for $2.65
million. Subsequent to the two purchase transactions, we entered into a master
lease arrangement with the REIT for all four communities and recognized a net
loss of approximately $530,000, which is recorded in “Other, net” in the
consolidated statements of operations. The loss is primarily comprised of
write-offs of existing loan fees and lease acquisition costs for the four
buildings. Additionally, we have a deferred gain on sale associated with the
transaction that approximates $1.8 million and new lease acquisition costs of
$1.0 million, that are being amortized over the lease period of 15 years. These
leases were accounted for as capital leases in which we established on our
balance sheet a capital lease obligation of $42.8 million and corresponding
long-term assets under property and equipment of the same amount. The statement
of operations includes charges for depreciation and interest based on this asset
and liability.





*Debt
Consolidation*





In March
2005, we closed a debt restructuring transaction that reduces the effective
interest rate by approximately 2.75% on $21.4 million of debt, extends the
maturity to February 2008, and improves annual cash flows and earnings by
approximately $1.6 million and $550,000, respectively, exclusive of transaction
charges, as further described below.





The REIT
that financed the Emeritrust II transaction already held $6.8 million of
our leasehold mortgage debt that matured in March 2005 and bore interest at 12%
per annum, commencing March 2002 with periodic increases up to 13% per annum.
This REIT also provided $7.5 million in leasehold mortgage financing incurred to
support the Series A Preferred Stock repurchase in August 2003. On
September 30, 2003, these two financings, together with the $11.5 million
leasehold mortgage financing related to the Emeritrust II communities, were
consolidated into a single $25.8 million leasehold mortgage financing, secured
by the 32 communities and maturing on June 30, 2007. The debt bears interest at
an initial rate of 12.13% per annum with periodic increases up to 13%. The
consolidated loan requires monthly payments of interest the first year and
monthly payments of principal and interest, based on a 10-year amortization,
thereafter. Additional principal reductions may occur, at our option, through
the increase in the amount of the lease financing based on the portfolio
achieving certain coverage ratios. We made a principal reduction





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of $6.0
million on August 2, 2004. The balance on the note as of March 2, 2005, was
approximately $19.5 million.





We
modified the existing note in full substitution with Healthcare Realty Trust,
Incorporated ("HRT"), an unrelated third party lender. Health Care REIT, Inc.
(“HCN”) sold the loan to HRT, and assigned substantially all of the leasehold
mortgages and all additional collateral securing the loan pursuant to a certain
Loan Purchase Agreement between HCN, HRT, and us. We and HRT agreed to modify,
amend, and restate the loan. The restated loan has a maturity date of February
28, 2008. Interest accrues on the principal amount outstanding at the fixed rate
of 10% per annum. Commencing on the first day of the first month after the
commencement date and on the first day of each month thereafter, we will make
monthly interest only payments sufficient to pay all interest accrued. On the
maturity date, the Company will make a balloon payment equal to the outstanding
balance of this note including the outstanding principal balance, all accrued
and unpaid interest and all charges, expenses, and other amounts payable by us
to HRT. We will not have the privilege of prepaying on the note in whole or in
part at any time without the prior written consent of HRT, at HRT's sole
discretion. In addition, the note contains certain subjective default clauses,
which, as a remedy, HRT may declare the loan to be immediately due and
payable.





In
connection with the loan modification, HRT also extended an additional $1.8
million to us on the same terms as the restated loan from HRT to pay off certain
transaction cost advances that matured in March 2006 and had an interest rate of
12.0% (increasing to 12.5% in April 2005).





*Alterra
Transactions*





In
December 2003, we invested $7.7 million in a limited liability company
(LLC) that acquired Alterra Healthcare Corporation, a national assisted living
company headquartered in Milwaukee, Wisconsin, that was the subject of a
voluntary Chapter 11 bankruptcy. The investment represents an 11% interest in
the total invested capital of the LLC and includes an excess of approximately
$3.6 million over the underlying net book value. Alterra operates approximately
300 assisted living communities in 22 states. The purchase price for Alterra was
$76 million and the transaction closed on December 4, 2003, following
approval by the Bankruptcy Court. The members of the LLC consist of an affiliate
of Fortress Investment Group LLC (Fortress), a New York based private equity
fund, which is the managing member, an entity controlled by Mr. Baty, and us.
Under the LLC agreement, distributions are first allocated to Fortress until it
receives payment on a $15.0 million loan to the LLC at 15% interest and its
original investment of $49 million together with a 15% preferred return, and
then are allocated to the three investors in proportion to percentage interests,
as defined in the agreement, which are a 50% interest for Fortress and a 25%
interest each for the entity controlled by Mr. Baty and us.





On
December 31, 2003, independent of the LLC, we acquired five assisted living
communities, containing an aggregate of 355 units, from Alterra for the
assumption of $22.6 million of mortgage debt, which bears interest at 6.98% per
annum, provides for monthly payments of $178,000, including principal and
interest, and matures August 2008.





Through
January 31, 2004, the investment was structured as an ownership interest in an
LLC, which is a pass-through entity for tax purposes, similar to a limited
partnership. Under generally accepted accounting principles, the Company was
required to use the equity method of accounting for its LLC membership interest
and record a portion of Alterra's results of operations in its financial
statements. As a consequence, equity losses of approximately $794,000 are
included in the consolidated statement of operations for the year ended December
31, 2004, under the caption “Other, net,” which represents the Company's portion
of Alterra's net loss for December 2003 and January 2004.





The LLC
made an election to be treated as a corporation for tax purposes effective
January 31, 2004, and is no longer a pass-through entity. As a result of this
election, on February 1, 2004, the Company began accounting for Alterra on
a cost basis under APB 18 “The Equity Method of Accounting for Investments in





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Common
Stock” until Fortress's investment falls below a certain level and/or there is a
change in structure such that the Company would have significant influence over
the operations of Alterra. If and when such an event occurs, Emeritus will
resume using the equity method of accounting for its investment in
Alterra.





*CPM-JEA
Transactions*





On April
1, 2004, we completed the first stage of a lease of up to 24 assisted living
facilities in 13 states, including up to 10 stand-alone dementia care
facilities. The facilities were acquired by an independent REIT for an
approximate $190.7 million investment, inclusive of transaction fees and leased
to us. On October 1, 2004, we completed the lease of another facility located in
Joliet, Illinois, and on October 22, 2004, we entered into a lease for one
community located in Cape May, New Jersey. Due to certain subjective default
clauses in the lease and remedies which allow for acceleration of all unpaid
rents in the event of default, these leases have been accounted for as capital
leases, which resulted in additions to property and equipment and capital lease
and financing obligations totaling approximately $174.1 million. We have leased
20 of the 24 senior housing and long-term care properties, which the REIT
acquired for a total investment of about $168.3 million, inclusive of
transaction fees. Ten of the communities, all of which we managed in 2003, were
owned by entities that Mr. Baty controls and in which he has financial interests
(CPM stands for Columbia Pacific Management and the entities are collectively
referred to as the “Baty Entities”). The remainder of the communities were owned
by entities in which Mr. Baty had an indirect ownership interest (the “JEA
Entities”). With respect to the communities formerly owned by the JEA Entities,
we entered into a management agreement with JEA Senior Living (“JEA”), a partner
in the JEA Entities that is not affiliated with Mr. Baty, to provide certain
management services to the communities for a period of three years. Under the
terms of this management agreement, JEA is entitled to a monthly management fee
of 5% of the gross revenues of the communities and to a termination payment of
$100,000 per year for a period of ten years after the termination of the
management agreement. We also agreed to an earn-out payment to the JEA Entities
of up to $2.0 million based on the improvement in the net operating income of
the communities during the three-year period after the closing. Lease
acquisition costs include $2.7 million in cash and $1.0 million by the execution
and delivery by us of our promissory notes to two of the Baty Entities, which
provide for interest at the rate of 8% and a maturity date of April 1, 2007. In
connection with the transaction, we received payment on a $2.7 million note
receivable from a separate CPM entity. The communities are leased under four
master leases with the independent REIT, each with a maturity date of March 31,
2019, with three 5-year renewal options. The lease rate is 9% with fixed
inflators of the lesser of four times the change in the consumer price index or
3%. The base rent as of December 31, 2004, is approximately $1.2 million per
month. Of the balance of $22.4 million of the REIT’s investment, $14.8 million
representing two communities, closed in the first quarter of 2005, and the
remaining amount of $7.6 million representing one community that will not be
acquired.





On
October 1, 2004, we entered into a lease for one community located in Corona,
California.  The Corona community, which had been owned by Alterra
Healthcare Corporation, was not a lease that was anticipated at the time of the
original transaction.  The facility was acquired by the REIT for an
approximate $3.2 million investment, inclusive of transaction fees and leased to
us, which resulted in additions to property and equipment and capital lease and
financing obligations totaling approximately $3.7 million.





In March
2005, we entered into agreements covering the final two communities of lease
transactions announced in March, 2004. One community had been previously managed
by us and is located in Richland, Washington. This community offers assisted
living services and was part of the CPM group. The second Community located in
Lubbock, Texas, offers memory loss services and is a part of the JEA managed
group of communities. It is new to our portfolio.








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*HCP
Transaction*





On July
30, 2004, we completed a sale-leaseback of 11 communities. The communities were
sold to Health Care Property Investors, Inc. (HCP), an independent third party,
and leased back to us for a 15-year initial lease period with two 10-year
renewal options. These properties are included in an existing master lease
covering 25 communities. As part of this agreement, maturities for leases and
debt that HCP holds on 9 existing communities will also be extended 5 years. The
lease basis is set at $83.5 million with an initial rate of 9.25 percent. Annual
lease escalators are based on the Consumer Price Index and capped at 3 percent.
Certain features of the transaction, including a guarantee of the lease payments
by Mr. Baty and a potential put option under certain defaults, constitute
continuing involvement for accounting purposes and preclude sale-leaseback
accounting, requiring us to use finance accounting. As a result, although the
transaction resulted in the legal sale of the communities to HCP and their
subsequent leasing by us, our consolidated financial statements continue to
reflect the communities as owned and establish a financing obligation equal to
the purchase price of $83.5 million. The communities provide assisted and
dementia related services to seniors, containing 1,150 units located in 8
states.







*Sale
of Community and Land*





On August
9, 2004, we sold a single community located in Scottsdale, Arizona, for
$1,775,000. The buyer paid approximately $444,000 in cash and we are carrying a
note receivable for the remaining $1.3 million. The note has a 5-year term with
interest at 5.5 percent and includes principal payments based on a 30-year
amortization, with the first principal payment due December 1, 2004. We recorded
a gain related to this sale in discontinued operations of $700,000 in the third
quarter 2004 financial statements as we have no continuing involvement in the
community. The community provided independent living services to seniors. The
operations and related gain on the sale are reflected as discontinued operations
in our consolidated statements of operations.





On August
12, 2004, we sold undeveloped land located in Grand Terrace, California, for a
cash price of $517,880.  We previously carried the land on our books at a
basis of $235,000. We recorded a gain, net of closing costs, of $265,000 in
Other, net in the condensed consolidated statements of operations for the year
ended December 31, 2004.





On
November 1, 2004, we sold a single community located in Issaquah, Washington,
for cash of $9.6 million. Since we had a continuing involvement in the community
until such time as the buyer was granted a license on January 7, 2005, to
operate the community, we deferred the proceeds and associated gain of $1.3
million until that point and recorded the related assets at December 31, 2004,
as held for sale.






**30**
 
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 **AND
RESULTS OF OPERATIONS - CONTINUED**
 Table of Contents
 The
following table summarizes the transactions described above:


**Month**
    
    **Owned**
    
    **Leased**
    
    
    
    **Consolidated**
    
    **Managed**
    
    **Total****December
      31, 2002**
    
    
    
    
    
    18
    
    
    67
    
    **1**
    
    
    85
    
    
    95
    
    
    180-
    
    
    -
    
    
    
    
    -
    
    
    -
    
    
    -**March
      31, 2003**
    
    
    
    
    
    **18**
    
    
    **67**
    
    
    
    
    **85**
    
    
    **95**
    
    
    **180**Sterling
      Park - disposition
    
    
    Apr-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Laurel
      Place - disposition
    
    
    Apr-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Northshore
      House - disposition
    
    
    Apr-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Lease
      of Eight Communities in May
    
    
    May-03
    
    
    -
    
    
    8
    
    
    
    
    8
    
    
    -
    
    
    8**June
      30, 2003**
    
    
    
    
    
    **18**
    
    
    **75**
    
    
    
    
    **93**
    
    
    **92**
    
    
    **185**Loss
      of Regent Management Contract
    
    
    Jul-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (11
    )
    
    (11
    )Carriage
      Hill
    
    
    Jul-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Park
      Place - disposition ALI
    
    
    Aug-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Sale-leaseback
      in connection withrepurchase
      of the Series A Preferred Stock
    
    
    Aug-03
    
    
    (4
    )
    
    4
    
    **2**
    
    
    -
    
    
    -
    
    
    -Emeritrust
      II Communities Lease
    
    
    Sep-03
    
    
    -
    
    
    21
    
    **3**
    
    
    21
    
    
    (21
    )
    
    -Loyalton
      Court of Scottsdale - disposition
    
    
    Sep-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Bestland
      Retirement (Camlu) - disposition
    
    
    Sep-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Charlton
      Place - disposition
    
    
    Sep-03
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )**September
      30, 2003**
    
    
    
    
    
    **14**
    
    
    **100**
    
    
    
    
    **114**
    
    
    **55**
    
    
    **169**Emeritus
      Oaks at Silverdale
    
    
    Nov-03
    
    
    -
    
    
    1
    
    
    
    
    1
    
    
    -
    
    
    1Lease
      of Eight Communities from Baty
    
    
    Dec-03
    
    
    -
    
    
    8
    
    **4**
    
    
    8
    
    
    (8
    )
    
    -Five
      Community Mortgage Assumption
    
    
    Dec-03
    
    
    5
    
    
    -
    
    
    
    
    5
    
    
    -
    
    
    5**December
      31, 2003**
    
    
    
    
    
    **19**
    
    
    **109**
    
    
    
    
    **128**
    
    
    **47**
    
    
    **175**Madison
      Glen - disposition
    
    
    Mar-04
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )**March
      31, 2004**
    
    
    
    
    
    **19**
    
    
    **109**
    
    
    
    
    **128**
    
    
    **46**
    
    
    **174**CPM-JEA
      transactions
    
    
    Apr-04
    
    
    -
    
    
    16
    
    **3**
    
    
    16
    
    
    (8
    )
    
    8Autumn
      Ridge
    
    
    Jun-04
    
    
    -
    
    
    1
    
    **3**
    
    
    1
    
    
    (1
    )
    
    -The
      Terrace
    
    
    Jun-04
    
    
    -
    
    
    1
    
    **3**
    
    
    1
    
    
    (1
    )
    
    -**June
      30, 2004**
    
    
    
    
    
    **19**
    
    
    **127**
    
    
    
    
    **146**
    
    
    **36**
    
    
    **182**HCP
      Transaction - sale-leaseback
    
    
    Jul-04
    
    
    (11
    )
    
    11
    
    **2**
    
    
    -
    
    
    -
    
    
    -Scottsdale
      Royale - sold
    
    
    Aug-04
    
    
    (1
    )
    
    -
    
    
    
    
    (1
    )
    
    -
    
    
    (1
    )Baty/REIT
      Lease
    
    
    Sep-04
    
    
    -
    
    
    17
    
    **3**
    
    
    17
    
    
    (17
    )
    
    -**September
      30, 2004**
    
    
    
    
    
    **7**
    
    
    **155**
    
    
    
    
    **162**
    
    
    **19**
    
    
    **181**
 
 **31**
 **MANAGEMENT'S
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 **AND
RESULTS OF OPERATIONS - CONTINUED**
  Table of Contents
 
 **Month**
    
    **Owned**
    
    **Leased**
    
    
    
    **Consolidated**
    
    **Managed**
    
    **Total**Manor
      at Essington
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **3**
    
    
    1
    
    
    -
    
    
    1Arbor
      Gardens at Corona
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **3**
    
    
    1
    
    
    -
    
    
    1Willows
      at York - disposition
    
    
    Oct-04
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Loyalton
      of Cape May
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **3**
    
    
    1
    
    
    (1
    )
    
    -Hearthside
      of Issaquah - disposition
    
    
    Nov-04
    
    
    (1
    )
    
    -
    
    
    
    
    (1
    )
    
    -
    
    
    (1
    )**December
      31, 2004**
    
    
    
    
    
    **6**
    
    
    **158**
    
    
    
    
    **164**
    
    
    **17**
    
    
    **181**
 
 
 1Four
      of these leases are capital leases2These
      15 leased communities are reflected in our consolidated financial
      statements as owned communities because ofaccounting requirements related to sale-leaseback accounting,
      notwithstanding the legal sale of the communities and
  theirsubsequent leasing by us.3These
      leases are accounted for as capital leases in our consolidated financial
      statements.4Five
      of these eight communities are reflected in our consolidated financial
      statements as capital leases.
 
 
 
 
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remainder of this page is intentionally left blank]




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Contents




**Discontinued
Operations**





On August
9, 2004, we sold an owned facility (“Scottsdale Royale”) to an unrelated third
party. Due to certain legal requirements of resident notification, we leased the
property back from the third party through August 31, 2004. In addition, on
September 30, 2004, we committed to sell another owned facility (“Hearthside of
Issaquah”), which under FASB Statement No. 144 “Accounting for the Impairment or
Disposal of Long-Lived Assets”, qualifies as an asset held for sale. A current
asset of $7.9 million was recorded on our financial statements and we
discontinued depreciating the asset as of September 30, 2004. Hearthside of
Issaquah was sold on November 1, 2004. Since we had a continuing involvement in
the community until such time as the buyer was granted a license on January 7,
2005, to operate the community, we deferred the gain of $1.3 million until that
point. Both transactions qualify for discontinued operations treatment under
FASB Statement No. 144 and the results of discontinued operations is reported as
a separate line item in the condensed consolidated statement of operations.





The
following table shows the revenues and net income (loss) for the discontinued
operations (in thousands):





**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002****Total
      revenue:**Hearthside
      of Issaquah
    
    $
    2,936
    
    $
    3,302
    
    $
    3,188Scottsdale
      Royale
    
    
    305
    
    
    406
    
    
    545Total
    
    $
    3,241
    
    $
    3,708
    
    $
    3,733**Income
      (loss):**Hearthside
      of Issaquah
    
    $
    313
    
    $
    196
    
    $
    324Scottsdale
      Royale
    
    
    678
    
    
    (1,092
    )
    
    (76
    )Total
    
    $
    991
    
    $
    (896
    )
    $
    248







**Subsequent
Event**





In
February 2005, a San Antonio, Texas, jury found one of our assisted living
communities negligent in the care of a resident. The jury awarded a verdict
against us in the amount of $1.5 million in compensatory damages and $18 million
in punitive damages. The verdict was in connection with an action that alleged
negligence brought by the relatives of a resident at one of our assisted living
facilities. We are immediately appealing the verdict based on significant legal
errors we believe occurred at the trial. We have posted funds in the amount of
$1.7 million in order to stay the proceedings while the appellate process runs
its course, which could be anywhere from 18 months to three years. We will not
be required to pay additional amounts until the appeal and further litigation is
completed or the case is settled. We have recorded a reserve on our consolidated
balance sheet for the judgment against us with a corresponding charge on our
consolidated statements of operations in 2004.











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Table of Contents







**Results
of Operations**





*Summary
of Significant Accounting Policies and Use of Estimates*





Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenues, and
expenses, and related disclosure of contingent assets and liabilities. On an
ongoing basis, we evaluate our estimates, including those related to resident
programs and incentives such as move-in fees, bad debts, investments, intangible
assets, impairment of long-lived assets, income taxes, restructuring, long-term
service contracts, contingencies, self-insured retention, health insurance, and
litigation. We base our estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates.





We
believe the following accounting policies are most significant to the judgments
and estimates used in the preparation of our consolidated financial statements.
Revisions in such estimates are charged to income in the period in which the
facts that give rise to the revision become known.





*
    For
      commercial general liability and professional liability insurance for
      2004, we formed a wholly owned captive insurance company domiciled in the
      U.S. The insurance policy issued by the captive is claims-made and insures
      liabilities associated with general and professional liability. The policy
      insures on a per occurrence and aggregate-limit basis in excess of a
      self-insured retention. We accrue losses based upon actuarial estimates of
      the total aggregate liability for claims occurring within the year, plus
      captive related expenses. Losses, whether within the self-insured
      retention, the policy limits, or exceeding policy limits are covered
      through a self-insurance pool agreement with all managed communities on a
      per unit of capacity basis. Should losses exceed actuarial estimates,
      additional expense may be accrued at the time of determination. The
      captive was capitalized and the premium structure established pursuant to
      regulatory requirements. Emeritus pays premiums based in part on a fixed
      schedule and in part as losses are actually paid. The captive is subject
      to regulatory agency oversight and is reviewed for compliance with
      applicable law. Results from these reviews may change the timing or amount
      of subsequent funding.





*
    For
      health insurance, we self-insure each covered member up to a certain level
      above which, for certain covered members, a catastrophic insurance policy
      covers any additional costs. Health insurance expense is accrued based
      upon historical experience of the aggregate liability for claims incurred.
      If these estimates are insufficient, additional charges may be required.





*
    Workers'
      compensation insurance coverage applies for specific insurable states
      (excluding Texas, New York, and the compulsory State Funds States) through
      a high deductible, fully collateralized insurance policy. The policy
      premium is based upon standard rates applied to estimated annual payroll.
      The posted collateral is greater than expected annual losses. We contract
      with an independent third-party administrator to administer the claims;
      and paid claim expenses are drawn from a collateral account. The sum of
      the premium and related costs, estimated administration costs, and
      actuarial based estimated losses is accrued on a monthly basis based on
      actual payroll. The difference between the posted collateral and estimated
      actual losses is carried as an asset on the balance sheet. At policy
      expiration, an insurer audit is conducted to adjust premiums based on
      actual, rather than estimated, annual payroll. Any premium adjustment for
      the differences between





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 **AND
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estimated
and actual payroll will first be applied to the accrued asset and then, if
needed, as an adjustment to workers' compensation expense at the time such
adjustment is determined. The insurer also audits the total incurred claim
amount at least annually and may adjust the applicable policy year collateral
requirement. There is a reasonable expectation that the total incurred losses
will be less than the posted collateral and the benefit of any
over-collateralization will inure to the Company. We insure occupational
injuries and illness in New York through participation in a self-insured group
pool on a guaranteed cost insurance policy basis, with the premium payable
monthly. The insurer group contracts with an independent third-party
administrator on behalf of its members to manage the claims, and claim expenses
are paid by the insurer. For work-related injuries in Texas, we provide work
related injury benefits through a qualified “Non-Subscriber Employee Retirement
Income Security Act Occupational Injury and Illness Benefit Plan.” Claim
expenses are paid as incurred and estimated losses are accrued on a monthly
basis based on actual payroll. An insurance policy is in place to cover
liability losses in excess of a deductible amount. We contract with an
independent third-party administrator to manage the claims.





*
    We
      account for stock option awards to employees under the intrinsic
      value-based method of accounting prescribed by APB No. 25,
      “Accounting for Stock Issued to Employees”. Under this method, no
      compensation expense is recorded provided the exercise price is equal to
      or greater than the quoted market price of the stock at the grant date. We
      make pro forma disclosures of net income and earnings per share as if the
      fair value-based method of accounting (the alternative method of
      accounting for stock-based compensation) had been applied as required by
      FAS No. 123, “Accounting for Stock-Based Compensation”. The fair
      value-based method requires us to make assumptions to determine expected
      risk-free interest rates, stock price volatility, dividend yield and
      weighted-average option life. To the extent such things as actual
      volatility or life of the options is different from estimated, amounts
      expensed will be more or less than would have been recorded
      otherwise.





*
    We
      maintain allowances for doubtful accounts for estimated losses resulting
      from the inability of our residents to make required payments. If the
      financial condition of our residents were to deteriorate, resulting in an
      impairment of their ability to make payments, additional allowances may be
      required.





*
    We
      record a valuation allowance to reduce our deferred tax assets to the
      amount that is more likely than not to be realized which at this time
      shows a net asset valuation of zero. We have considered future taxable
      income and ongoing prudent and feasible tax planning strategies in
      assessing the need for the valuation allowance. However, in the event we
      were to determine that we would be able to realize our deferred tax assets
      in the future in excess of our net recorded amount, an adjustment to the
      deferred tax asset would increase net income in the period such
      determination was made.





*
    We
      account for impairment of long-lived assets, which include property and
      equipment, investments, and amortizable intangible assets, in accordance
      with the provisions of SFAS No. 144 Accounting for the Impairment or
      Disposal of Long-Lived Assets or SFAS No. 142 Goodwill and Other
      Intangible Assets, as applicable. An impairment review is performed
      whenever a change in condition occurs, which indicates that the carrying
      amounts of assets may not be recoverable. Such changes include changes in
      our business strategies and plans, changes in the quality or structure of
      our relationships with our partners and deteriorating operating
      performance of individual communities. We use a variety of factors to
      assess the realizable value of assets depending on their nature and use.
      Such assessments are primarily based upon the sum of expected future
      undiscounted net cash flows over the expected period the asset will be
      utilized, as well as market values and conditions. The computation of
      expected future undiscounted net cash flows can be complex and involves a
      number of subjective assumptions. Any changes in these factors or





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assumptions
could impact the assessed value of an asset and result in an impairment charge
equal to the amount by which its carrying value exceeds its actual or estimated
fair value.





*
    We
      account for leases as either operating, capital, or financing leases
      depending on the underlying terms. The determination of the classification
      of leases is complex and in certain situations requires a significant
      level of judgment. Leases are generally accounted for as operating leases
      to the extent the underlying lease does not: (i) transfer ownership by the
      end of the lease term, (ii) contain a bargain purchase option, (iii)
      include a lease term equal to or greater than 75% of the economic life of
      the leased property, or (iv) include minimum lease payments for which the
      present value equals or exceeds 90% of the fair value of the underlying
      leased property. Properties under operating leases are not included on the
      balance sheet and are accounted for in the statement of operations as
      facility lease expense for actual rent paid to the extent any increases in
      rent is considered to be contingent and not determinable. In cases where
      there are rent escalator provisions that have fixed or determinable
      increases, the operating leases are accounted for as the total rent for
      the term of the lease, including both base rent and fixed annual
      increases, on a straight-line basis over the lease term. This accounting
      treatment results in greater facility lease expense than the actual rent
      paid in the earlier years of the respective leases and less facility lease
      expense than the actual rent paid in the later years of the lease. Those
      leases that meet one of the criteria described above cannot be accounted
      for as operating leases but are accounted for as capital leases. For
      properties under capital lease arrangements, a liability is established on
      the balance sheet based on the present value of the rent payments not to
      exceed the fair value of the underlying leased property, including base
      rent, fixed annual increases and any other payment obligations over the
      lease term, and a corresponding long-term asset is recorded. Lease
      payments are allocated between principal and interest on the lease
      obligation and the capital lease asset is depreciated over the term of the
      lease. Typically, capital lease treatment results in greater depreciation
      and interest than actual lease payments paid in the early years of the
      leases and less depreciation and interest than actual rent paid in the
      later years of the leases. Properties that are sold and leased-back and
      for which we have continuing involvement are accounted for as financings,
      in which the property remains on the balance sheet and a financing
      obligation is recorded generally equal to the purchase price of the
      properties sold. The impact on the statement of operations is similar to a
      capital lease.





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**Common-size
Statements of Operations and Period-to-Period Percentage
Change**





The
following table sets forth, for the periods indicated, certain items from our
Consolidated Statements of Operations as a percentage of total revenues and the
percentage change of the dollar amounts from period to period:





Year-to-YearPercentage
      of Revenues
    
    Percentage
      IncreaseYears
      Ended December 31,
    
    (Decrease)2004
    
    2003
    
    2002
    
    2004-2003
    
    2003-2002Revenues:
    
    
    100.0
    %
    
    100.0
    %
    
    100.0
    %
    
    56.7
    %
    
    34.5
    %Expenses:Community
      operations
    
    
    69.4
    
    
    60.9
    
    
    60.4
    
    
    78.5
    
    
    35.6General
      and administrative
    
    
    8.3
    
    
    11.8
    
    
    14.0
    
    
    9.3
    
    
    13.9Depreciation
      and amortization
    
    
    10.3
    
    
    6.0
    
    
    6.0
    
    
    169.8
    
    
    34.4Facility
      lease expense
    
    
    12.0
    
    
    16.7
    
    
    18.0
    
    
    13.5
    
    
    24.4Total
      operating expenses
    
    
    100.0
    
    
    95.4
    
    
    98.4
    
    
    64.2
    
    
    30.4Income
      (loss) from continuing operations
    
    
    -
    
    
    4.6
    
    
    1.6
    
    
    N/A
    
    
    288.1Other
      income (expense)Interest
      income
    
    
    0.2
    
    
    0.3
    
    
    0.3
    
    
    (10.4
    )
    
    65.6Interest
      expense
    
    
    (13.3
    )
    
    (9.2
    )
    
    (9.0
    )
    
    126.1
    
    
    37.8Other,
      net
    
    
    0.5
    
    
    1.0
    
    
    2.7
    
    
    (21.9
    )
    
    (51.0
    )Net
      other expense
    
    
    (12.7
    )
    
    (7.9
    )
    
    (6.0
    )
    
    150.3
    
    
    76.7Loss
      from continuing operations before income taxes
    
    
    (12.7
    )
    
    (3.3
    )
    
    (4.4
    )
    
    496.2
    
    
    1.0Provision
      for income taxes
    
    
    (0.4
    )
    
    (0.2
    )
    
    -
    
    
    184.2
    
    
    N/ALoss
      from continuing operations
    
    
    (13.1
    )
    
    (3.5
    )
    
    (4.4
    )
    
    478.0
    
    
    7.2Income
      (loss) from discontinued operations
    
    
    0.3
    
    
    (0.5
    )
    
    0.1
    
    
    N/A
    
    
    N/ANet
      loss
    
    
    (12.8
    %)
    
    (4.0
    %)
    
    (4.3
    %)
    
    401.7
    %
    
    25.2
    %








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Comparison
of the Years Ended December 31, 2004 and 2003







*Total
Operating Revenues:* Community revenue and other service revenue for the year ended December 31,
2004, increased by $120.6 million to $313.3 million from $192.7 million in 2003,
or 62.6%. This increase is primarily due to additional revenue related to the
acquisition or lease of 81 communities from January 1, 2003, to the end of 2004,
of which 43 occurred prior to December 31, 2003. Of the 81 communities, we
had formerly managed 57. These additional communities represent an increase in
revenue of approximately $110.7 million for 2004. The remaining increase of $9.9
million, or 8.2%, is primarily due to an increase in occupancy rate and average
revenue per unit. Our occupancy rate increased by 4.8 percentage points to 82.2%
for 2004 from 77.4% for 2003. Occupancy grew from marketing initiatives in
existing communities and from the acquisition or leasing of additional
communities with higher occupancy levels. Average monthly revenue per unit was
$2,861 for 2004 compared to $2,767 for 2003, an increase of approximately $94,
or 3.4%. Revenue per unit was adversely affected by restructures in pricing,
including the offering of incentives in certain competitive markets to induce
improved occupancy levels. The increase in revenue per unit was primarily
attributable to amortization of deferred move-in fees that was higher in 2004
than in 2003.





Management
fees decreased by $5.6 million in the year ended December 31, 2004, compared to
2003. This is primarily due to the termination, expiration, or sale of various
communities under management contracts during 2003 and 2004. During 2003 and
2004, we terminated management agreements related to 78 communities, 57 of which
we now lease.





*Community
Operations:* Community operating expenses for the year ended December 31, 2004, increased
$97.0 million to $220.6 million from $123.6 million for 2003, or 78.5%. This
increase is primarily due to increasing the acquisition or lease of 81
communities referred to above, which accounted for approximately $70.9 million
of the increase. Additional liability insurance expense of $18.7 million was
recorded primarily related to the adverse judgment against us as described under
"Legal Proceedings." The balance of the increase in community operating expenses
of $7.4 million was due to increases in personnel costs and increases in
insurance, repairs and maintenance, food services, utilities, supplies, bad
debts, and property taxes. Excluding the reserves and accruals related to the
litigation referred to above, community operating expenses as a percentage of
total operating revenue increased to 63.5% in 2004 from 60.9% in 2003, primarily
as a result of the additional insurance costs .





*General
and Administrative:* General
and administrative (G&A) expenses for the year ended December 31, 2004,
increased $2.3 million to $26.3 million from $24.0 million for 2003, or 9.3%. As
a percentage of total operating revenues, G&A expenses decreased to 8.3% for
2004, compared to 11.8% for 2003, primarily as a result of increased revenue
arising from the acquisition or lease of the 81 communities referred to above.
We experienced increases of approximately $1.7 million in personnel costs, which
represented both added personnel and compensation increases (including a salary
for Mr. Baty, who received no salary prior to 2004). The rest of the increase
was primarily due to increases in legal and accounting fees related to our
restated financial statements and compliance with the Sarbanes-Oxley Act and
related securities laws. Since approximately 9.4% of the communities we operated
were managed rather than owned or leased at December 31, 2004 (26.9% at
December 31, 2003), G&A expense as a percentage of operating revenues
for all communities, including managed communities for which the operating
revenue is not included in our consolidated financial statements, may be more
meaningful for industry-wide and year-to-year comparisons. These percentages
were 6.5% and 6.3% for 2004 and 2003, respectively.





*Depreciation
and Amortization:* Depreciation
and amortization for the year ended December 31, 2004, increased $20.6 million
to $32.7 million from $12.1 million for 2003. ** The
increase was primarily the result of depreciation arising from capital lease
treatment associated with the leasing of 64 additional communities since January
1, 2003 (the Emeritrust II communities lease at September 30, 2003, the
lease of four of the eight communities from Baty at December 31, 2003, the
CPM/JEA transaction at April 1, 2004, and the





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Emeritrust I
communities lease at October 1, 2004), and depreciation associated with
five communities acquired from Alterra through mortgage financing in December
2003, all of which are discussed in "Significant Transactions". In 2004, this
represents 10.3% of total operating revenues compared to 6.0% for 2003.


*Facility
Lease Expense* :
Facility lease expense for the year ended December 31, 2004, was $38.4 million
compared to $33.8 million for the year ended December 31, 2003, representing an
increase of $4.6 million, or 13.5%. Approximately $3.6 million of the increase
represents rental expense from the eight communities we began leasing in May
2003, four communities which we began leasing in December 2003, and a single
community we began leasing in June 2004. The balance of the increase is
attributable to performance-based lease inflators of existing leases. We leased
75 communities under operating leases as of December 31, 2004, compared to 76
communities as of December 31, 2003. Facility lease expense as a percentage of
revenues was 12.0% and 16.7% for the years ended December 31, 2004 and 2003,
respectively.





*Interest
Income:* Interest
income for the year ended December 31, 2004, was $595,000 versus $664,000 for
the year ended December 31, 2003. This decrease was primarily attributable to an
interest-bearing note that was paid off in the first quarter of
2004.





*Interest
Expense:* Interest
expense for the year ended December 31, 2004, was $42.4 million compared to
$18.8 million for the year ended December 31, 2003. an increase of $23.7
million, or 126.1%. Of this amount, $1.7 million resulted from the
write-off of loan fees associated with the financing transaction involving 11
communities completed in July 2004. The balance of the increase of
$22.0 million was primarily attributable to interest resulting from capital
lease and financing treatment associated with the leasing of 64 additional
communities since January 1, 2003 (the Emeritrust II communities lease at
September 30, 2003, the lease of four of the eight communities from Baty at
December 31, 2003, the CPM/JEA transactions at April 1, 2004, HCP
transactions at July 30, 2004 and the Emeritrust I communities lease at
October 1, 2004), and mortgage interest expense resulting from the
acquisition of five communities in December 2003, all of which are discussed in
"Significant Transactions". As a percentage of total operating revenues,
interest expense increased to 13.3% from 9.2% for the year ended December 31,
2004 and 2003, respectively.





*Other,
net:* Other,
net decreased by $442,000 to $1.6 million in income for the year ended December
31, 2004, from $2.0 million in income for the year ended December 31, 2003. The
amount for 2004 includes a gain of $265,000 related to the Grand Terrace land
sale, amortization of deferred gains of approximately $2.2 million, partially
offset by our portion of Alterra’s net loss for December 2003 and January 2004
totaling $794,000, impairment of assets previously held for development of
$447,000, and other smaller miscellaneous items. We changed our policy in
relation to charging resident late fees on delinquent rent in October 2003,
which resulted in income of $310,000 and $61,000 in 2004 and 2003, respectively.
In 2004, we recognized income of $134,000 on investments in our non-qualified
deferred compensation plan. The amount for 2003 includes a gain of $1.4 million
on the sale of our investment in ARV Assisted Living common stock in April 2003
and amortization of deferred gains of approximately $932,000 related to two
transactions, in 2003.





*Income
taxes* . 
The provision for income taxes for the year ended December 31, 2004, was
principally due to the HCP sale-leaseback of properties occurring in July 2004
that generated approximately $32.0 million of taxable gain.  This gain and
other taxable income create Federal alternative minimum tax and state income and
franchise tax liabilities of approximately $1.2 million. The 2003 provision for
income taxes relates to sale-leaseback of properties that occurred in the third
quarter of 2003.





*Net
Income (Loss) and Property-Related Expense:* In
comparing the net losses for 2003 and 2004 it is important to consider our
property-related expenses, which includes depreciation and amortization,
facility lease expense and interest expense that is directly related to our
communities, and which includes capital lease accounting treatment, finance
accounting treatment or straight-line accounting treatment of rent





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escalators
for many of our leases. These accounting treatments all result in greater
property-related expense than actual lease payments made in the early years of
the affected leases and less property-related expense than actual lease payments
made in later years.





The net
loss reflected in our consolidated statement of operations for the year ended
December 31, 2004, was $40.5 million, including the reserves from the $18.7
million accrual related to litigation referred to above.  Our
property-related expense for this period was $113.5 million, of which $94.5
million was associated with our leases due to the effects of lease accounting
referred to above. Our actual capital and operating lease payments during this
period were $75.2 million.  Correspondingly, the net loss of $8.1 million
for the year ended December 31, 2003, reflected property-related expense of
$64.7 million, of which $45.7 million was associated with our leases. Our actual
capital and operating lease payments for this period were $41.0 million. 
The increase in total property-related expense is due primarily to the
acquisition and lease of 81 additional communities since January 1, 2003. 
The amount by which the property-related expense associated with our leases
exceeded our actual lease payments was $4.7 million for the year ended December
31, 2003, compared to $19.3 million for the year ended December 31, 2004, an
increase of $14.6 million.  This increase is primarily attributable to
capital lease accounting treatment of leases for 64 of the 81 communities
referred to above.





It should
be remembered that, notwithstanding the effects of lease accounting treatment,
the actual lease payments required under most of our leases will continue to
increase annually and, as a result, we will need to increase our revenues and
our results from community operations to cover these increases.





*Income
(Loss) from Discontinued Operations* : ** Income
from discontinued operations for the year ended December 31, 2004, was
approximately $991,000 compared to a loss of $896,000 for the comparable period
in 2003. Discontinued operations for the year ended December 31, 2004, included
a gain on sale of one facility of approximately $687,000 and for the year ended
December 31, 2003, included a loss on impairment of an asset of
$950,000.





*Preferred
dividends:* For the
year ended December 31, 2004 and 2003, the preferred dividends were
approximately $3.7 million and $6.2 million, respectively. This decrease of $2.5
million is primarily due to a decrease of $2.3 million in dividends for the
Series A preferred stock and an decrease of $198,000 in dividends for the Series
B preferred stock. The Series A preferred stock was repurchased in July and
August 2003. For the last eighteen quarters, we have not declared cash dividends
on our preferred stock but have been accruing such accumulated and unpaid
dividends. The terms of our preferred stock provide that accumulated and unpaid
dividends accrue at a higher rate than dividends that are paid currently. The
amount of dividends attributable to such higher rates is $1.4 million and $1.7
million for 2004 and 2003, respectively.





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Comparison
of the Years Ended December 31, 2003 and 2002





*Total
Operating Revenues:* Total
operating revenues for the year ended December 31, 2003, increased by $52.0
million to $202.9 million from $150.9 million in 2002, or 34.5%. Approximately
$36.3 million of the increase reflects revenue from 24 communities that we began
leasing in late 2002 and eight communities we began leasing in the second
quarter of 2003. The balance of the change in revenue is primarily the result of
increases in the average monthly revenue per unit due to our rate enhancement
program and fewer managed communities throughout 2003 compared to 2002. Average
monthly revenue per unit was $2,767 for 2003 compared to $2,577 for 2002, an
increase of approximately 7.4%. These increases were partially offset by a
decrease in the occupancy rate of 3.5 percentage points to 77.4% for 2003 from
80.9% for 2002. Management fees decreased by $649,000 in the year ended December
31, 2003, compared to 2002. This is primarily due to the termination,
expiration, or sale of various communities under management contracts during
2003. As of December 31, 2003, we managed 47 communities compared to 96 as of
December 31, 2002, a decline of 48 managed communities. Of the 48 previously
managed communities, 29 were leased and included in our consolidated portfolio
at December 31, 2003.





*Community
Operations:* Community operating expenses for the year ended December 31, 2003, increased
$32.4 million to $123.6 million from $91.2 million for 2002, or 35.6%.
Approximately $28.0 million of the increase reflects operating expense from 24
communities that we began leasing in October 2002 and eight communities we began
leasing in the second quarter of 2003. The balance of this change was due to
increases in personnel costs and increases in utilities, food services, health,
and workers’ compensation insurance premiums. Community operating expenses as a
percentage of total operating revenue increased to 60.9% in 2003 from 60.4% in
2002, primarily as a result of these increased expenses.





*General
and Administrative:* General
and administrative (G&A) expenses for the year ended December 31, 2003,
increased $2.9 million to $24.0 million from $21.1 million for 2002, or 13.9%.
We experienced increases of approximately $2.7 million in personnel costs
related to acquisitions, health and workers’ compensation insurance, and other
acquisition related expenses. As a percentage of total operating revenues,
G&A expenses decreased to 11.8% for 2003, compared to 14.0% for 2002,
primarily as a result of increased revenues due to additional communities in our
consolidated portfolio. Since approximately 25% of the communities we operated
were managed rather than owned or leased, G&A expense as a percentage of
operating revenues for all communities, including managed communities for which
the operating revenue is not included in our consolidated financial statements,
may be more meaningful for industry-wide comparisons. These percentages were
6.3% and 6.1% for 2003 and 2002, respectively.





*Depreciation
and Amortization:* Depreciation
and amortization for the year ended December 31, 2003, and 2002, were
approximately $12.1 million and $9.0 million, respectively. The increase was
primarily the result of additional depreciation resulting from capital lease
treatment of the Emeritrust II lease and the March 2002 four communities lease,
which are discussed under “Significant Transactions”. In both 2003 and 2002,
this represents 6.0% of total operating revenues.


*Facility
Lease Expense* :
Facility lease expense for the year ended December 31, 2003, was $33.8 million
compared to $27.2 million for the year ended December 31, 2002, representing a
increase of $6.6 million, or 24.4%. This increase reflects rental expense from
24 communities that we began leasing in October 2002 and eight communities we
began leasing in the second quarter of 2003. Rental increases of approximately
$1.2 million based on community performance under certain of our leases in 2003
was offset by the termination of leases for two communities in 2002. We leased
76 communities under operating leases as of December 31, 2003, compared to 63
communities as of December 31, 2002. Facility lease expense as a percentage of
revenues decreased to 16.7% from 18.0% for the years ended December 31, 2003,
and 2002, respectively.





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*Interest
Income:* Interest
income for the year ended December 31, 2003, was $664,000 versus $401,000 for
the year ended December 31, 2002. This is primarily attributable to a higher
return on certain restricted deposits related to a sale-leaseback transaction in
the fourth quarter of 2002.





*Interest
Expense:* Interest
expense for the year ended December 31, 2003, was $18.8 million compared to
$13.6 million for the year ended December 31, 2002. This increase of $5.2
million, or 37.8%, is primarily attributable to higher amounts of outstanding
debt in 2003 compared to 2002, and to additional interest resulting from capital
lease treatment of the Emeritrust II lease and the March 2002 lease of four
communities, and the finance accounting treatment of the sale-leaseback
transaction in connection with the repurchase of the Series A Preferred Stock,
all of which are discussed in "Significant Transactions". As a percentage of
total operating revenues, interest expense increased to 9.2% from 9.0% for the
year ended December 31, 2003 and 2002, respectively.





*Other,
net:* Other,
net decreased by $2.1 million to $2.0 million in income for the year ended
December 31, 2003, from $4.1 million income for the year ended December 31,
2002. The amount for 2003 includes a gain of $1.4 million on the sale of our
investment in ARV Assisted Living common stock in April 2003 and amortization of
deferred gains of approximately $700,000 related to two transactions, in 2003.
The amount for the year 2002 includes a $5.1 million gain related to discounts
we received upon the payoff of existing financing, net of certain costs related
to the transaction. This gain was offset by approximately $1.2 million in
write-offs of existing loan fees related to a sales-leaseback transaction and a
refinancing transaction.





*Income
taxes* . Income
taxes are due primarily because of gains on sale-leaseback transactions
involving several communities in the third quarter of 2003, which have been
deferred for accounting purposes. We were required to pay an alternative minimum
income tax for 2003 on our federal income tax return and, in certain states that
have alternative minimum income tax provisions, we paid income or franchise
tax.





*Income
(Loss) from Discontinued Operations* : ** Loss from
discontinued operations for the year ended December 31, 2003 was approximately
$896,000 compared to an income of $247,000 for the comparable period in 2002.
Discontinued operations for the year ended December 31, 2003, included a loss on
impairment of an asset of $950,000.





*Preferred
dividends:* For the
year ended December 31, 2003 and 2002, the preferred dividends were
approximately $6.2 million and $7.3 million, respectively. This decrease of $1.1
million is primarily due to a decrease of $1.4 million in dividends for the
Series A preferred stock, partially offset by an increase of $256,000 in
dividends for the Series B preferred stock. The Series A preferred stock was
repurchased in July and August 2003. For the last fourteen quarters prior to
December 31, 2003, we had not declared cash dividends on our preferred stock but
have been accruing such accumulated and unpaid dividends. The terms of our
preferred stock provide that accumulated and unpaid dividends accrue at a higher
rate than dividends that are paid currently. The amount of dividends
attributable to such higher rates is $1.7 million and $2.1 million for 2003 and
2002, respectively.








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*Same
Community Comparison*





Three
months ended December 31, 2004, and 2003:




We
operated 83 owned or leased communities on a comparable basis during both the
three months ended December 31, 2004 and 2003. The following table sets forth a
comparison of same community results of operations, excluding general and
administrative expenses and any reserve related to the adverse judgment against
us as described under "Legal Proceedings," for the three months ended December
31, 2004 and 2003.


**Three
      Months ended December 31,****(In
      thousands)****Dollar**
    
    **%
      Change****2004**
    
    **2003**
    
    **Change**
    
    **Fav
      / (Unfav)**Revenue
    
    $
    48,317
    
    $
    44,379
    
    $
    3,938
    
    
    8.9
    %Community
      operating expenses
    
    
    (31,081
    )
    
    (27,746
    )
    
    (3,335
    )
    
    (12.0
    )Community
      operating income
    
    
    17,236
    
    
    16,633
    
    
    603
    
    
    3.6Depreciation
      & amortization
    
    
    (2,295
    )
    
    (2,313
    )
    
    18
    
    
    0.8Facility
      lease expense
    
    
    (7,997
    )
    
    (7,899
    )
    
    (98
    )
    
    (1.2
    )Operating
      income
    
    
    6,944
    
    
    6,421
    
    
    523
    
    
    8.1Interest
      expense, net
    
    
    (3,377
    )
    
    (3,706
    )
    
    329
    
    
    8.9Operating
      income after interest expense
    
    $
    3,567
    
    $
    2,715
    
    $
    852
    
    
    31.4
    %




The same
communities represented $48.3 million or 51.4% of our total revenue of $94.1
million for the fourth quarter of 2004. Same community revenues increased by
$3.9 million or 8.9% for the quarter ended December 31, 2004, from the
comparable period in 2003. This was primarily due to average occupancy which
increased to 84.2% in the fourth quarter of 2004 from 77.5% in the fourth
quarter of 2003, accounting for approximately $3.5 million of the increase. The
remainder of the increase of $433,000 was due to the increase in the average
monthly revenue per unit. Community operating expenses increased by $3.3 million
to $31.1 million from $27.7 million. The increases in community operating
expenses were primarily driven from census-related increases in salaries and
personnel costs, repairs and maintenance, food costs, supplies, utilities, bad
debts, and property taxes. Facility lease expense for the fourth quarter of 2004
increased primarily due to various rent escalators related to certain leased
facilities. For the quarter ended December 31, 2004, our operating income after
interest expense increased to $3.6 million from $2.7 million for the comparable
period of 2003, primarily as a result of a combination of increased occupancy
and rates, partially offset by increased community operating expenses. The
reserve for the adverse judgment against us allocated to these communities was
$9.9 million.










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Year
ended December 31, 2004, and 2003:




We
operated 83 owned or leased communities on a comparable basis during both the
twelve months ended December 31, 2004 and 2003. The following table sets forth a
comparison of same community results of operations, excluding general and
administrative expenses and any reserve related to the adverse judgment against
us as described under "Legal Proceedings," for 2004 and 2003.





**Year
      Ended December 31,****(In
      thousands)****Dollar**
    
    **%
      Change****2004**
    
    **2003**
    
    **Change**
    
    **Fav
      / (Unfav)**Revenue
    
    $
    184,846
    
    $
    174,807
    
    $
    10,039
    
    
    5.7
    %Community
      operating expenses
    
    
    (119,012
    )
    
    (113,084
    )
    
    (5,928
    )
    
    (5.2
    )Community
      operating income
    
    
    65,834
    
    
    61,723
    
    
    4,111
    
    
    6.7Depreciation
      & amortization
    
    
    (9,130
    )
    
    (9,094
    )
    
    (36
    )
    
    (0.4
    )Facility
      lease expense
    
    
    (31,739
    )
    
    (31,071
    )
    
    (668
    )
    
    (2.1
    )Operating
      income
    
    
    24,965
    
    
    21,558
    
    
    3,407
    
    
    15.8Interest
      expense, net
    
    
    (16,219
    )
    
    (13,779
    )
    
    (2,440
    )
    
    (17.7
    )Operating
      income after interest expense
    
    $
    8,746
    
    $
    7,779
    
    $
    967
    
    
    12.4
    %




The same
communities represented $184.8 million or 58.1% of our total revenue of $317.9
million for the year ended December 31, 2004. Same community revenues increased
by $10.0 million or 5.7% for the year ended December 31, 2004, from the year
ended December 31, 2003. The increase in revenue per unit was primarily
attributable to amortization of deferred move-in fees that was higher in 2004
than in 2003. The increase in occupancy to 80.7% in 2004 from 77.6% in 2003
accounted for approximately $5.8 million of the increase. We had an increase in
same community average monthly revenue per unit to $2,849 for 2004, from $2,781
for 2003. This is an increase of $68 or 2.4%, and accounted for approximately
$4.2 million of the increase. Community operating expenses increased by $5.9
million to $119.0 million from $113.1 million. The increases in community
operating expenses were primarily driven by census-related increases in salaries
and personnel costs, repairs and maintenance, food costs, bad debts, supplies,
utilities, property taxes, insurance, and travel. Facility lease expense for the
year ended December 31, 2004, increased primarily due to variable rent
escalators related to certain leased communities. For the year ended December
31, 2004, our operating income after interest expense increased to $8.7 million
from $7.8 million for 2003, primarily as a result of a combination of increased
occupancy and rates, partially offset by increased community operating expenses.
The reserve for the adverse judgment against us allocated to these communities
was $9.9 million.








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**Liquidity
and Capital Resources**





For the
year ended December 31, 2004, net cash provided by operating activities was
$22.1 million  compared
to $8.4 million for the prior year . Depreciation
and amortization provided cash of $32.9 million. Increases in current
liabilities provided cash of approximately $32.9 million primarily
due to an increase in other current liabilities of $25.7
million. Net cash
used in increases in current assets were approximately $4.1 million ,
primarily from increases in prepaid expenses.





Net cash
used in investing activities amounted to $3.4 million for the year ended
December 31, 2004 , and was comprised
primarily of management and lease acquisition costs of $8.8 million , acquisition
of property and equipment of $4.5 million , advances
to affiliates of $1.5
million, and acquisitions
of assets in lease transactions of $1.1
million. This was
partially offset by proceeds from sale of property and equipment of $11.4
million . Net
cash used in investing activities amounted to $10.5 million for the year ended
December 31, 2003, and was comprised
primarily of management and lease acquisition costs of $12.6
million, a $7.7
million investment in Alterra, which includes transaction costs , acquisition
of property and equipment of $2.7
million, and the purchase of a minority partner's interest of $2.5
million, which was
partially offset by proceeds from sale of property and equipment of $11.3
million, proceeds
from sale of investment securities of $2.9
million, and repayment
of advances to affiliates of $1.5
million.





For the
year ended December 31, 2004, net cash used in financing activities was $14.3
million primarily
from long-term debt repayments of $33.2 million , repayment
of capital lease and financing obligations of $8.8 million , and an increase
in restricted deposits of $336,000,
partially offset by
proceeds from long-term borrowings of $26.6 million . For the
year ended December 31, 2003, net cash provided by financing activities was $1.2
million primarily
from the repurchase of Series A Preferred Stock for $20.5
million, repayment
of capital lease and financing obligations of $4.8
million, and an
increase in restricted deposits of $1.6
million, offset by
proceeds from long-term borrowings and financings of $28.8
million.





We have
incurred significant operating losses since our inception and have a working
capital deficit of $71.9 million, although $14.7 million represents deferred
revenue and unearned revenue and $10.5 million of preferred dividends is due
only if declared by our board of directors, who are currently discussing
declaring and paying the dividends in arrears on the Series B preferred stock to
the extent financing is available. No agreement has been reached. Additionally
due to the adverse judgment against us as described under “Legal Proceedings” an
additional reserve was recorded for $18.7 million in accordance with our
self-insured pool agreement as discussed under "*Summary of Significant
Accounting Policies and Use of Estimates*." We believe there are substantial
grounds for an appeal and that the damage award was not justified by the facts
or the law in the case presented. We are appealing the verdict and on March 16,
2005, have posted funds in the amount of $1.7 million in order to stay the
proceedings while the appellate process runs its course, which could be anywhere
from 18 months to three years. We will not be required to pay additional amounts
until the appeal and further litigation is completed or the case is settled. We
have $32.0 million of 6.25% convertible subordinated debentures that will come
due January 1, 2006. Of the $32.0 million, $21.5 million is owned by directors
and officers or their affiliates (see Note “(9) **** Convertible
Debentures” of “Notes to Consolidated Financial Statements”). In 2004, 2003, and
2002, we reported positive net cash from operating activities in our
consolidated statements of cash flows. At times in the past, however, we have
been dependent upon third party financing or disposition of assets to fund
operations and we cannot guarantee that, if necessary in the future, such
transactions will be available timely or at all, or on terms attractive to us.





In March
2005, we closed a debt restructuring transaction that reduces the effective
interest rate by approximately 2.75% on $21.4 million of debt, extends the
maturity to February 2008, and improves annual cash flows and earnings by
approximately $1.6 million and $550,000, respectively, exclusive of transaction
charges, as further described below.




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On
September 30, 2003, we consolidated three previous financings with Health
Care REIT, Inc. (“HCN”) into a single $25.8 million leasehold mortgage
financing, secured by 32 communities and maturing on June 30, 2007. The debt had
interest at an initial rate of 12.13% per annum with periodic increases up to
13%. The consolidated loan required monthly payments of interest during the
first year and monthly payments of principal and interest, based on a 10-year
amortization, thereafter. We made a cash principal reduction of $6.0 million on
August 2, 2004. The balance on the note as of March 2, 2005, was approximately
$19.5 million.





We
modified the existing note in full substitution with Healthcare Realty Trust,
Incorporated ("HRT"), an unrelated third party lender. HCN sold the loan to HRT,
and assigned substantially all of the leasehold mortgages and all additional
collateral securing the loan pursuant to a certain Loan Purchase Agreement
between HCN, HRT, and us. We and HRT agreed to modify, amend, and restate the
loan. The restated loan has a maturity date of February 28, 2008. Interest
accrues on the principal amount outstanding at the fixed rate of 10% per annum.
Commencing on the first day of the first month after the commencement date and
on the first day of each month thereafter, we will make monthly interest only
payments sufficient to pay all interest accrued. On the maturity date, we will
make a balloon payment equal to the outstanding balance of this note including
the outstanding principal balance, all accrued and unpaid interest and all
charges, expenses, and other amounts payable by us to HRT. We will not have the
privilege of prepaying on the note in whole or in part at any time without the
prior written consent of HRT, at HRT's sole discretion. In addition, the note
contains certain subjective default clauses, which, as a remedy, allows HRT to
declare the loan to be immediately due and payable.





In
connection with the loan modification, HRT also extended an additional $1.8
million to us on the same terms as the restated loan from HRT to pay off certain
transaction cost advances that matured in March 2006 and had an interest rate of
12.0% (increasing to 12.5% in April 2005).





In 2002,
and continuing in the first quarter of 2003 we refinanced substantially all of
our debt obligations, extending the maturities of such financings to dates in
2005 or thereafter, at which time we will need to refinance or otherwise repay
the obligations. As a consequence of our property and lease transactions in
2004, our long-term debt has decreased from $141.1 million at December 31, 2003,
to $54.7 million at December 31, 2004, our
obligations under operating
leases have decreased from $358.3 million to $321.9
million, and our capital
lease and financing obligations have increased from $221.1 million to $629.5
million . In
particular, the number of communities we lease
increased from 109 at December 31, 2003 to 158 at
December 31, 2004 . We
believe that, on the basis of the operating results of these communities (many
of which we managed) prior to the commencement of the leases, the cash flow from
such communities will be adequate to support the increased lease obligations.
Many of our debt instruments and leases contain "cross-default" provisions
pursuant to which a default under one obligation can cause a default under one
or more other obligations to the same lender or lessor. Such
cross-default provisions affect 6 owned assisted living properties and 154
operated under leases .
Accordingly, any event of default could cause a material adverse effect on our
financial condition if such debt or leases are cross-defaulted. Defaults can
include certain financial covenants, which generally relate to lease coverage
and cash flow. In addition, we are required to maintain the leased properties in
a reasonable and prudent manner. For the year ended December 31, 2003, we
expected to be in compliance at least through 2004 and for the foreseeable
future. However, in 2004, we were in violation of one or more covenants in
certain of our leases, but have been able to obtain waivers from the owners such
that we were still deemed to be in compliance and thus, were not in default.





Management
believes that we will be able to sustain positive operating cash flow at least
through 2005 and for the foreseeable future and will have adequate cash from
operations for all necessary investing and financing activities including
required debt service and capital expenditures.





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Contents








The
following table summarizes our contractual obligations at December 31,
2004, exclusive of the refinancing discussed above (In thousands):





**Principal
      Payments Due by Period****Less
      than**
    
    
    
    
    
    **After
      5****Contractual
      Obligations**
    
    **Total**
    
    **1
      year**
    
    **1-3
      years**
    
    **4-5
      years**
    
    **years**Long-term
      debt, including current portion
    
    $
    54,661
    
    $
    4,133
    
    $
    25,433
    
    $
    21,457
    
    $
    3,638Capital
      lease and financing obligations including current portion
    
    
    629,524
    
    
    15,479
    
    
    39,883
    
    
    53,122
    
    
    521,040Operating
      leases
    
    
    321,912
    
    
    36,998
    
    
    75,517
    
    
    77,535
    
    
    131,862Convertible
      debentures
    
    
    32,000
    
    
    -
    
    
    32,000
    
    
    -
    
    
    -$
    1,038,097
    
    $
    56,610
    
    $
    172,833
    
    $
    152,114
    
    $
    656,540











The
following table summarizes interest on our contractual obligations at December
31, 2004 , (In
thousands):





**Interest
      Due by Period****Less
      than**
    
    
    
    
    
    **After
      5****Contractual
      Obligations**
    
    **Total**
    
    **1
      year**
    
    **1-3
      years**
    
    **4-5
      years**
    
    **years**Long-term
      debt
    
    $
    14,685
    
    $
    4,874
    
    $
    7,531
    
    $
    1,737
    
    $
    543Capital
      lease and financing obligations
    
    
    404,982
    
    
    41,745
    
    
    80,179
    
    
    74,369
    
    
    208,689Convertible
      debentures
    
    
    3,000
    
    
    2,000
    
    
    1,000
    
    
    -
    
    
    -$
    422,667
    
    $
    48,619
    
    $
    88,710
    
    $
    76,106
    
    $
    209,232





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**Recent
Accounting Pronouncements**





In
January 2003, the FASB issued Interpretation No. 46 (FIN No. 46). This
Interpretation was revised in December 2003 (FIN No. 46R) and addresses
consolidation by business enterprises of VIE's. A VIE is subject to the
consolidation provisions of FIN No. 46R if it cannot support its financial
activities without additional subordinated financial support from third parties
or its equity investors lack any one of the following characteristics: the
ability to make decisions about its activities through voting rights, the
obligation to absorb losses of the entity if they occur, or the right to receive
residual returns of the entity if they occur. FIN No. 46R requires a VIE to be
consolidated by its primary beneficiary. The primary beneficiary is the party
that holds the variable interests that expose it to a majority of the entity’s
expected losses and/or residual returns. For purposes of determining a primary
beneficiary, all related party interests must be combined with our actual
interests in the VIE. The application of this Interpretation is immediate for
VIE's created or altered after January 31, 2003, and is effective at the end of
the first quarter of 2004 for variable interest entities that existed prior to
February 1, 2003.





We have
evaluated the impact of FIN No. 46R on all our current related-party management
agreements, including those more fully discussed under the section denoted as
“Emeritrust Transactions”, as well as other management agreements and other
arrangements with potential VIE's. We doe not believe we have any VIE's that
require consolidation.





In May
2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. For public enterprises,
like us, this statement is effective for financial instruments entered into or
modified after May 31, 2003, and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. Management has determined
that none of our current financial instruments are covered by this
pronouncement.





In
December 2004, the FASB issued FASB Statement No. 123 Revised (R) “Share-Based
Payment”. This statement requires us to recognize in the income statement
expense for compensation cost related to share based payments including stock
options and employee stock purchase plans. FASB No. 123R would eliminate our
ability to account for share-based awards to employees using APB Opinion 25,
“Accounting for Stock Issued to Employees” and would require that the
transactions use a fair value method as of the grant date. FASB 123R addresses
the accounting for transactions in which we receive employee services in
exchange for equity instruments or liabilities that are based on the fair value
of our equity instruments or that may be settled through the issuance of such
equity instruments. FASB 123R is effective for us after June 15, 2005. We are
currently evaluating the impact of this statement on our financial
statements.





**Impact
of Inflation**





To date,
inflation has not had a significant impact on Emeritus. Inflation could,
however, affect our future revenues and operating income due to our dependence
on the senior resident population, most of whom rely on relatively fixed incomes
to pay for our services. The monthly charges for the resident's unit and
assisted living services are influenced by the location of the community and
local competition. Our ability to increase revenues in proportion to increased
operating expenses may be limited. We typically do not rely to a significant
extent on governmental reimbursement programs. In pricing our services, we
attempt to anticipate inflation levels, but there can be no assurance that we
will be able to respond to inflationary pressures in the future.





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**Risk
Factors**





Our
business, results of operations and financial condition are subject to many
risks, including, but not limited to, those set forth below:





The
following important factors, among others, could cause actual operating results
to differ materially from those expressed in forward-looking statements included
in this report and presented elsewhere by our management from time to time. Do
not place undue reliance on these forward-looking statements, which speak only
as of the date of this report. A number of the matters and subject areas
discussed in this report refer to potential future circumstances, operations and
prospects, and therefore, are not historical or current facts. The discussion of
such matters and subject areas is qualified by the inherent risks and
uncertainties surrounding future expectations, which may materially differ from
our actual future experience involving any one or more of such matters and
subject areas as a result of various factors, including: possible excess
assisted living capacity in our market areas affecting our occupancy and pricing
levels; uncertainties in increasing occupancy and pricing, generally; effective
management of costs and the effects of cost increases beyond our control, such
as utilities and insurance; the difficulty in reducing and eliminating
continuing operating losses; vulnerability to defaults in our debt and lease
financing as a result of noncompliance with various covenants; the effects of
cross-default terms; competition; and uncertainties relating to construction,
licensing, environmental, and other matters that affect acquisition, disposition
and development of assisted living communities. We have attempted to identify,
in context, certain of the factors that may cause actual future experience and
results to differ from our current expectations regarding the relevant matter or
subject area. We are not obligated to release publicly the results of any
revisions to these forward-looking statements that may be made to reflect events
or circumstances after the date of this report or to reflect the occurrence of
unanticipated events. These and other factors are discussed in more detail
below.





*We
have incurred losses since we began doing business and may continue to incur
losses for the foreseeable future.* We
organized and began operations in July 1993 and have operated at a loss since we
began doing business. For 2004, 2003, and 2002, we recorded net losses before
preferred dividends of $40.5 million, $8.1 million, and $6.5 million,
respectively (as discussed in detail under “ *Net
Income (Loss) and Property-Related Expense”* in *“* Comparison
of the Years Ended December 31, 2004 and 2003 ”). We
believe that the historically aggressive growth of our portfolio through
acquisitions and developments and related financing activities, as well as our
inability (along with much of the assisted living industry) to increase
occupancy rates at our communities, were among the causes of these losses. To
date, at many of our communities, we have been generally able to stabilize
occupancy and rate structures to levels that have resulted in positive cash flow
but not earnings for the company as a whole. Our operations may not become
profitable in line with our current expectations or may not become profitable at
all.





*If we
cannot generate sufficient cash flow to cover required interest, principal and
lease payments, we risk defaults on our debt agreements and
leases.* At
December 31, 2004, we had total debt of $54.7 million, with minimum principal
payments of about $4.1 million due in 2005. At
December 31, 2004, we were obligated under both long-term operating and capital
leases requiring minimum annual cash lease payments of which $94.2 million is
payable in 2005 . In
addition, we will have approximately $5.3 million and $20.1 million in principal
amount of debt repayment obligations that become due in 2006 and 2007,
respectively. We also have $32.0 million of debentures that are due on January
1, 2006. If we are unable to generate sufficient cash flow to make such payments
as required and are unable to renegotiate payments or obtain additional equity
or debt financing, a lender could foreclose on our communities secured by the
respective indebtedness or, in the case of an operating lease, could terminate
our lease, resulting in loss of income and asset value. In some cases, our
indebtedness is secured by a particular community and a pledge of our interests
in a subsidiary entity that owns that community. In the event of a default, a
lender could avoid judicial procedures required to foreclose on real property by
foreclosing on our pledge instead, thus accelerating its acquisition of that
community. Furthermore, because of cross-default and cross-collateralization
provisions in certain of our





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mortgage
and sale-leaseback agreements, if we default on one of our payment obligations,
we could adversely affect a significant number of our communities.





*Because
we are highly leveraged, we may not be able to respond to changing business and
economic conditions or continue with selected acquisitions.* A
substantial portion of our future cash flow will be devoted to debt service and
lease payments. In the past, we have frequently been dependent on third party
financing and disposition of assets to fund these obligations in full and we may
be required to do so in the future. In addition, we are periodically required to
refinance these obligations as they mature. As a consequence of acquisitions of
communities, we have substantially increased our leverage in 2004. Our long-term
debt has decreased from $141.1 million at December 31, 2003, to $54.7 million at
December 31, 2004, but, our
obligations under long-term leases, both capital and operating, have increased
from $579.4 million to $1,356.4
million. These circumstances reduce our flexibility and ability to respond to
our business needs, including changing business and financial conditions such as
increasing interest rates and opportunities to expand our business through
selected acquisitions.





*We
may be unable to increase or stabilize our occupancy rates that would result in
positive earnings.* In
previous years, we have been unable to increase our occupancy to levels that
would result in net income on a sustained basis. Our historical losses have
resulted, in part, from occupancy levels that were lower than anticipated when
we acquired or developed our communities. While our occupancy levels increased
in 2004, during the last three years prior to that, occupancy levels declined,
although 2003 occupancy was nearly flat, excluding the effects of acquired
communities. We cannot guarantee that our occupancy levels will
increase.





*We
will occasionally seek additional funding through public or private financing,
including equity financing.* We may
not find adequate equity, debt, or sale-leaseback financing when we need it or
on terms acceptable to us. This could affect our ability to finance our
operations or refinance our properties to avoid the consequences of default and
foreclosure under our existing financing as described above. In addition, if we
raise additional funds by issuing equity securities, our shareholders may
experience dilution of their investment.





*If we
fail to comply with financial covenants contained in our debt instruments, our
lenders may accelerate the related debt.* From
time to time, we failed to comply with certain covenants in our financing
agreements. In the future, we may not be able to comply with these covenants,
which generally relate to matters such as cash flow, debt coverage ratios, and
certain subjective performance standards. If we fail to comply with any of these
requirements and are not able to obtain waivers, our lenders could accelerate
the related indebtedness so that it becomes due and payable prior to its stated
due date. We may be unable to pay or refinance this debt if it becomes
due.


*Our
liability insurance may be insufficient to cover the liabilities we
face.*In
recent years, participants in the long-term-care industry have faced an
increasing number of lawsuits alleging negligence, malpractice, or other related
legal theories. Many of these suits involve large claims and significant legal
costs. We expect we occasionally will face such suits because of the nature of
our business. For general liability and professional liability insurance for
2004, we formed a wholly owned captive insurance company domiciled in the U.S,
which provides general and professional liability on a claims made basis.
Because we are responsible for a self-insured retention, funding losses up to
the captive limits through premiums or paid in capital and losses in excess of
the captive limits, we are ultimately responsible for the full loss of
professional and general liability claims. Claims against us, regardless of
their merit or eventual outcome, may also undermine our ability to attract
residents or expand our business and would require management to devote time to
matters unrelated to the operation of our business. We currently do not carry
general and professional liability insurance other than through our captive
insurance subsidiary and although we review our liability insurance annually, we
may not be able to obtain third party liability insurance coverage in the future
or, if available, on acceptable terms. During the past several years, retained
losses relating to high self-insured retention and annual premiums have
increased significantly, which have substantially increased our costs associated
with insurance and claims defense. In February 2005, a San Antonio, Texas, jury
found one of our assisted living communities negligent in the care of a
resident. The jury awarded a verdict against us in the amount of $1.5 million in
compensatory damages and $18 million in punitive damages. The verdict was in
connection with an action that alleged negligence brought by the relatives of a
resident at one of our assisted living facilities. We are immediately appealing
the verdict.










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*We
face risks associated with selective acquisitions.* We
intend to continue to seek selective acquisition opportunities. However, we may
not succeed in identifying any future acquisition opportunities or completing
any identified acquisitions. The acquisition of communities presents a number of
risks. Existing communities available for acquisition may frequently serve or
target different market segments than those we presently serve. It may be
necessary in these cases to reposition and renovate acquired communities or turn
over the existing resident population to achieve a resident care level and
income profile that is consistent with our objectives. In the past, these
obstacles have delayed the achievement of acceptable occupancy levels and
increased operating and capital expenditures. As a consequence, we currently
plan to target assisted living communities with established operations, which
could reduce the number of acquisitions we can complete and increase the
expected cost. Even in these acquisitions, however, we may need to make staff
and operating management personnel changes to successfully integrate acquired
communities into our existing operations. We may not succeed in repositioning
acquired communities or in effecting any necessary operational or structural
changes and improvements on a timely basis. We also may face unforeseen
liabilities attributable to the prior operator of the acquired communities,
against whom we may have little or no recourse.





*We
expect competition in our industry to increase, which could cause our occupancy
rates and resident fees to decline.* The
long-term care industry is highly competitive, and given the relatively low
barriers to entry and continuing health care cost containment pressures, we
expect that our industry will become increasingly competitive in the future. We
believe that the industry is experiencing over-capacity in several of our
markets, thereby intensifying competition and adversely affecting occupancy
levels and pricing. We compete with other companies providing assisted living
services as well as numerous other companies providing similar service and care
alternatives, such as home healthcare agencies, independent living facilities,
retirement communities, and skilled nursing facilities. We expect that
competition will increase from new market entrants, as assisted living
residences receive increased market awareness and more states decide to include
assisted living services in their Medicaid programs. Many of these competitors
may have substantially greater financial resources than we do. Increased
competition may limit our ability to attract or retain residents or maintain our
existing rate structures. This could lead to lower occupancy rates or lower rate
structures in our communities.





*We
also cannot predict the effect of the healthcare industry trend toward managed
care on the assisted living marketplace.* Managed
care, an arrangement whereby service and care providers agree to sell
specifically defined services to public or private payers in an effort to
achieve more efficiency with respect to utilization and cost, is not currently a
significant factor in the assisted living marketplace. However, managed care
plans sponsored by insurance companies or HMOs may in the future affect pricing
and the range of services provided in the assisted living
marketplace.





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*If
development of new assisted living facilities outpaces demand, we may experience
decreased occupancy, depressed margins, and diminished operating
results.* We
believe that some assisted living markets have become or are on the verge of
becoming overbuilt. The barriers to entry in the assisted living industry are
not substantial. Consequently, the development of new assisted living facilities
could outpace demand. Overbuilding in the markets in which we operate could thus
cause us to experience decreased occupancy and depressed margins and could
otherwise adversely affect our operating results.





*Market
forces could undermine our efforts to attract seniors with sufficient
resources.* We rely
on our residents’ abilities to pay our fees from their own or familial financial
resources. Generally, only seniors with income or assets meeting or exceeding
the comparable median in the region where our assisted living communities are
located can afford our fees. Inflation or other circumstances may undermine the
ability of seniors to pay for our services. If we encounter difficulty in
attracting seniors with adequate resources to pay for our services, our
occupancy rates may decline.





*Our
labor costs may increase and may not be matched by corresponding increases in
rates we charge to our residents.* We
compete with other providers of assisted living services and long-term care in
attracting and retaining qualified and skilled personnel. We depend on our
ability to attract and retain management personnel responsible for the
day-to-day operations of each of our communities. If we are unable to attract or
retain qualified communitiy management personnel, our results of operations may
suffer. In addition, possible shortages of nurses or trained personnel may
require us to enhance our wage and benefits packages to compete in the hiring
and retention of personnel. We also depend on the available labor pool of
semi-skilled and unskilled employees in each of the markets in which we operate.
As a result of these and other factors, our labor costs may increase and may not
be matched by corresponding increases in rates we charge to our
residents.





*We
face possible environmental liabilities at each of our
properties.* Under
various federal, state, and local environmental laws, ordinances, and
regulations, a current or previous owner or operator of real property may be
held liable for the costs of removal or remediation of certain hazardous or
toxic substances, including asbestos-containing materials that could be located
on, in or under its property. These laws and regulations often impose liability
whether or not the owner or operator knew of, or was responsible for, the
presence of the hazardous or toxic substances. We could face substantial costs
of any required remediation or removal of these substances, and our liability
typically is not limited under applicable laws and regulations. Our liability
could exceed our properties’ value or the value of our assets. We may be unable
to sell or rent our properties, or borrow using our properties as collateral, if
any of these substances is present or if we fail to remediate them properly.
Under these laws and regulations, if we arrange for the disposal of hazardous or
toxic substances such as asbestos-containing materials at a disposal site, we
also may be liable for the costs of the removal or of the hazardous or toxic
substances at the disposal site. In addition to liability for these costs, we
could be liable for governmental fines and injuries to persons or
properties.





*Some
of our facilities generate infectious medical waste due to the illness or
physical condition of the residents, including, for example, blood-soaked
bandages, swabs, and other medical waste products, and incontinence products of
those residents diagnosed with an infectious disease.* The
management of infectious medical waste, including handling, storage,
transportation, treatment, and disposal, is subject to regulation under various
laws, including federal and state environmental laws. These environmental laws
set forth the management requirements, as well as permit, record-keeping,
notice, and reporting obligations. Each of our facilities has an agreement with
a waste management company for the proper disposal of all infectious medical
waste. Any finding that we are not in compliance with these environmental laws
could adversely affect our business and financial condition. Because these
environmental laws are amended from time to time, we cannot predict when and to
what extent liability may arise. In addition, because these environmental laws
vary from state to state, expansion of our operations to states where we do not
currently operate may subject us to additional restrictions on the manner in
which we operate our facilities.





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*Our
chief executive officer has personal interest that may conflict with ours due to
his interest in Holiday Retirement Corporation and Columbia-Pacific Group,
Inc.* Mr. Baty
is a principal shareholder, director, and Chairman of the Board of Holiday
Retirement Corporation, and is the principal owner of Columbia-Pacific Group,
Inc. Substantially all of the independent living facilities operated by Holiday
are owned by partnerships that are controlled by Mr. Baty and Holiday. Mr.
Baty’s varying financial interests and responsibilities include the acquisition,
financing, and refinancing of independent living facilities and the development
and construction of, and capital raising activities to finance new facilities.
Columbia-Pacific and affiliated partnerships operate assisted living communities
and independent living facilities, many of which we manage under various
management agreements. The financial interests and management and financing
responsibilities of Mr. Baty with respect to Holiday and Columbia-Pacific and
their affiliated partnerships could present conflicts of interest with us,
including potential competition for residents in markets where both companies
operate and competing demands for the time and efforts of Mr. Baty.





*Because
Mr. Baty is both our Chief Executive Officer as well as Holiday’s Chairman of
the Board and is the principal owner of Columbia-Pacific, circumstances could
arise that would distract him from our operations.* Our
interests and those of Holiday and Columbia-Pacific interests may, on some
occasions, be incompatible. We have entered into a noncompetition agreement with
Mr. Baty, but this noncompetition agreement does not limit Mr. Baty’s current
role with Holiday or its related partnerships, so long as assisted living is
only an incidental component of Holiday’s operation or management of independent
living facilities.





*We
have entered into agreements with a number of entities that are owned or
controlled by Mr. Baty, whose interests with respect to these companies
occasionally may conflict with ours.* We have
entered into agreements, including most of our management agreements, with a
number of entities that are owned or controlled by Mr. Baty. Under these
agreements, we provide management and other services to senior housing and
assisted living communities owned by these entities and we have material
agreements with these entities relating to the purchase, sale, and financing of
a number of our operating communities. There is a risk that the administration
of these and any future arrangements could be adversely affected by these
continuing relationships because our interests and those of Mr. Baty may not be
consistent at all times.





*Some
of our recent transactions and the operations of certain communities that we
manage are supported financially by Mr. Baty with limited guarantees and through
his direct and indirect ownership of such communities; we would be unable to
benefit from these transactions and managed communities without this support.* The
company has 7 communities owned by entities controlled by Mr. Baty which involve
limited guarantees by Mr. Baty and rely on his direct and indirect ownership of
the communities involved.  As described in the “Fretus Lease” Mr. Baty is
guarantor of a portion of the debt and is the administrative member of
Fretus. ** As
described above under "HCP Transaction" and in accordance with an amendment to
the lease, effective July 30, 2004, Mr. Baty unconditionally and irrevocably
guaranteed the payment when due of all costs, expense, fees, rents and other
sums payable by us in the full, faithful and prompt performance when due. 
The guaranty is limited to an aggregate amount of $3,000,000. The guaranty is
still in place and Mr. Baty has not been called upon for any
payments . The
company has paid no consideration to Mr. Baty for the guaranty. As
described under "Emeritrust I Communities Lease" and in accordance with an
amendment to the lease, effective September 30, 2004, Mr. Baty personally
guaranteed the prompt payment and performance of the lease obligations. The
guaranty is still in place and Mr. Baty has not been called upon for any
payments. The company has paid Mr. Baty consideration based upon the cash flow
agreement as described above under the "Emeritrust I Communities Lease." We
believe that we would be unable to take advantage of these transactions and
management opportunities without Mr. Baty’s individual and financial support.
The ongoing administration of these transactions, however, could be adversely
affected by these continuing relationships because our interests and those of
Mr. Baty may not be consistent at all times. In addition, we cannot guarantee
that such support will be available in the future.





**53**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents


*We
may be unable to attract and retain key management personnel.* We
depend upon, and will continue to depend upon, the services of Mr. Baty. The
loss of Mr. Baty’s services, in part or in whole, could adversely affect our
business and our results of operations. Mr. Baty has financial interests and
management responsibilities with respect to Holiday and its related
partnerships. As a result, he does not devote his full time and efforts to
Emeritus. We may be unable to attract and retain other qualified executive
personnel critical to the success of our business.





*Our
costs of compliance with government regulations may significantly increase in
the future.* Federal,
state, and local authorities heavily regulate the healthcare industry.
Regulations change frequently, and sometimes require us to make expensive
changes in our operations. A number of legislative and regulatory initiatives
relating to long-term care are proposed or under study at both the federal and
state levels that, if enacted or adopted, could adversely affect our business
and operating results. We cannot predict to what extent legislative or
regulatory initiatives will be enacted or adopted or what effect any initiative
would have on our business and operating results. Changes in applicable laws and
new interpretations of existing laws can significantly affect our operations, as
well as our revenues, particularly those from governmental sources, and our
expenses. Our residential communities are subject to varying degrees of
regulation and licensing by local and state health and social service agencies
and other regulatory authorities. While these regulations and licensing
requirements often vary significantly from state to state, they typically
address:





*  fire
safety,




*  sanitation,




*  staff
training,




*  staffing
patterns,




*  living
accommodations such as room size, number of bathrooms, and ventilation,
and




*  health-related
services.





We may be
unable to satisfy all regulations and requirements or to acquire and maintain
any required licenses on a cost-effective basis.





*In
addition, with respect to our residents who receive financial assistance from
governmental sources for their assisted living services, we are subject to
federal and state regulations that prohibit certain business practices and
relationships.* Failure
to comply with these regulations could prevent reimbursement for our healthcare
services under Medicaid or similar state reimbursement programs. Our failure to
comply with such regulations also could result in fines and the suspension or
inability to renew our operating licenses. Federal, state, and local governments
occasionally conduct unannounced investigations, audits, and reviews to
determine whether violations of applicable rules and regulations exist. Devoting
management and staff time and legal resources to such investigations, as well as
any material violation by us that is discovered in any such investigation, audit
or review, could strain our resources and affect our profitability. In addition,
regulatory oversight of construction efforts associated with refurbishment could
cause us to lose residents and disrupt community operations.





**54**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





*Our
stock price has been highly volatile, and a number of factors may cause our
common stock price to decline.* The
market price of our common stock has fluctuated and could fluctuate
significantly in the future in response to various factors and events,
including, but not limited to:





*  the
liquidity of the market for our common stock;




*  variations
in our operating results;




*  variations
from analysts’ expectations; and




*  new
statutes or regulations, or changes in the interpretation of existing statutes
or regulations, affecting the healthcare industry generally or the assisted
living residence business in particular.





In
addition, the stock market in recent years has experienced broad price and
volume fluctuations that often have been unrelated to the operating performance
of particular companies. These market fluctuations also may cause the market
price of our common stock to decline.





*Our
share ownership and certain other factors may impede a proposed takeover of our
business.* As of
February 28, 2005, Mr. Baty controls about 43% of our outstanding common stock.
Together, our directors and executive officers own, directly and indirectly,
over 71% of the voting power of our outstanding common and preferred stock. Accordingly,
Mr. Baty and the other members of our board and management would have
significant influence over the outcome of matters submitted to our shareholders
for a vote, including matters that would involve a change of control of
Emeritus. Further, our Articles of Incorporation require a two-thirds
supermajority vote to approve a business combination of Emeritus with another
company that is not approved by the board of directors. Accordingly, the current
management group and board of directors could prevent approval of such a
business combination. We currently have a staggered board in which only
one-third of the board stands for election each year. Thus, absent removals and
resignations, a complete change in board membership could not be accomplished in
fewer than approximately two calendar years.












**55**


Table of Contents





**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK**





The table
below provides information about our financial instruments entered into for
purposes other than trading that are sensitive to changes in interest rates. For
our debt and capital lease and financing obligations, the table
presents principal repayments in thousands of dollars and current weighted
averages of interest rates on these obligations as of December 31,
2004.  For our
debt obligations with variable interest rates, the rate presented reflect the
current rate in effect at the end of 2004.
















Expected
      maturity date (In thousands)2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    Thereafter
    
    Total
    
    Fair
      value
    
    Average
      interest rateLong-term
      debt:Fixed
      rate
    
    $
    18,981
    
    $
    23,685
    
    $
    41,632
    
    $
    46,234
    
    $
    28,345
    
    $
    524,678
    
    $
    683,555
    
    $
    583,160
    
    
    6.84
    %Variable
      rate
    
    $
    631
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    -
    
    $
    631
    
    $
    631
    
    
    5.14
    %
















Our
earnings are affected by changes in interest rates as a result of our short-term
and long-term borrowings. We manage this risk by obtaining fixed rate borrowings
when possible . At
December 31, 2004, our variable rate borrowings totaled approximately
$631,000 . Currently,
all our variable rate borrowings are based upon the prime rate.





Additionally,
we have certain operating lease obligations based on LIBOR which are subject to
a LIBOR floor of 2.75%. As of
December 31, 2004, the LIBOR rates were above the floor . If LIBOR
interest rates were to average 2% more, our annual facility lease expense and
net loss would increase by approximately $0.7 million for the Fretus
lease . This
amount is determined by considering the impact of hypothetical interest rates on
our outstanding variable rate borrowings as of December 31, 2004, and does not
consider changes in the actual level of borrowings that may occur subsequent to
December 31, 2004 . As
LIBOR rates continue to increase above the floor, we will be exposed to higher
interest expense costs which manifest themselves in the form of additional lease
expense. This analysis also does not consider the effects of the reduced level
of overall economic activity that could exist in such an environment, nor does
it consider actions that management might be able to take with respect to our
financial structure to mitigate the exposure to such a change.








**56**


Table of Contents


**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA**





The
financial statements and the Report of Independent Registered Public Accounting
Firm are listed after Item 15 and are included beginning on Page
F-1.








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





None.








**ITEM 9A. CONTROLS AND PROCEDURES**





*Evaluation
of disclosure controls and procedures*





The
Company maintains a set of disclosure controls and procedures and internal
controls designed to ensure that information required to be disclosed in its
filings under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in the Security and
Exchange Commission’s (SEC) rules and forms. Disclosure controls and procedures
include controls and procedures designed to ensure that information required to
be disclosed by us in reports we file or submit under the Exchange Act is
accumulated and communicated to our management, including our chief executive
officer and chief financial officer, as appropriate, to allow timely decisions
regarding disclosure. It should be noted that any system of controls, however
well designed and operated, can provide only reasonable, and not absolute,
assurance that the objectives of the system are met.





Our
current management, with the participation of our chief executive officer and
chief financial officer, has evaluated the effectiveness of our disclosure
controls and procedures as of December 31, 2004, which included an evaluation of
disclosure controls and procedures applicable to the period covered by the
filing of this periodic report. As noted below, we and our independent auditors
have identified material weaknesses in our internal controls and procedures as
they existed as of December 31, 2004.





As a part
of this process, in December 2004 management and our independent auditors
reported to our audit committee on certain matters involving internal controls
that they considered to be material weaknesses under the standards established
by the American Institute of Certified Public Accountants. As communicated to
the audit committee by the Company's independent auditors, these internal
controls related to (i) accounting personnel with insufficient depth, skills and
experience in evaluating complex leasing and other transactions and (ii)
insufficient formalized procedures to ensure that all relevant documents related
to complex leasing transactions were made available to internal accounting
personnel and the Company's independent auditors and were adequately reviewed by
internal accounting personnel.





Based on
this evaluation and subject to the information set forth in this Item 9A, our
chief executive officer and chief financial officer have concluded that our
disclosure controls and procedures were inadequate as of December 31, 2004.
The evaluation has revealed no evidence of any fraud, intentional misconduct or
concealment on the part of Company personnel.





**57**


Table of Contents


The
Company's management has identified a number of issues relating to the
improvement of its internal controls and is in the process of taking steps to
address them, including:







·
    Evaluate
      hiring additional accounting personnel and reorganizing the accounting
      department to ensure that accounting personnel with the adequate
      experience, skills and knowledge relating to complex leasing and financing
      transactions are directly involved in the review and accounting evaluation
      of such transactions;




·
    Including
      internal personnel and outside accounting consultants, if necessary, early
      in a transaction to obtain additional guidance as to the application of
      generally accepted accounting principles to a proposed
      transaction;




·
    Establishing
      clear responsibilities for our real estate personnel and accounting
      personnel and increasing the formal interaction, responsibility and
      coordination between such personnel;




·
    Documenting
      the review, analysis and related conclusions with respect to complex
      leasing transactions;




·
    Requiring
      senior accounting personnel and the chief accounting officer to review
      such transactions in order to evaluate, document and approve their
      accounting treatment.





Since
October 2004, we believe that our disclosure controls and procedures have
improved due to the scrutiny of such matters by management and the audit
committee as described above. We believe that our controls and procedures will
continue to improve as we complete the implementation of the actions
identified.





The
certifications of our chief executive officer and chief financial officer
required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 are
attached as exhibits to this Form 10-K. The disclosures set forth in this Item
9A contain information concerning the evaluation of our disclosure controls and
procedures, and changes in internal control over financial reporting, referred
to in paragraph 4 of the certifications. The officer certifications should be
read in conjunction with this Item 9A for a more complete understanding of the
topics presented.





*Changes
in internal controls*





There
were no changes during the fourth quarter of 2004 in the Company’s internal
control over financial reporting in connection with this evaluation that has
materially affected, or is reasonably likely to materially affect, our internal
control over financial reporting.








**ITEM 9B. OTHER INFORMATION**





None.





**58**


Table of Contents





**PART III**





**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
REGISTRANT**





The
information required by this Item is incorporated herein by reference to
"Executive Officers of the Registrant" in Part I of this Form 10-K and in our
definitive Proxy Statement relating to our 2005 annual meeting of shareholders
(the "Proxy Statement") to be filed with the SEC pursuant to Regulation
14A .








**ITEM 11. EXECUTIVE COMPENSATION**





The
information required by this Item is incorporated herein by reference to our
Proxy Statement to be filed with the SEC pursuant to Regulation 14A .








**ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND****RELATED
STOCKHOLDER MATTERS**





The
information required by this Item is incorporated herein by reference to our
Proxy Statement to be filed with the SEC pursuant to Regulation 14A .




**Equity
Compensation Plan Information**





The
following table provides information about our common stock that may be issued
upon the exercise of options under our existing equity compensation plans and
arrangements as of December 31, 2004, including the 1995 Stock Incentive Plan
and the Employee Stock Purchase Plan . The
material terms of each of these plans and arrangements are described in note 12
to the December 31, 2004, consolidated financial statements .














Number
      of shares remaining
    
    Total
      ofNumber
      of shares to be
    
    
    
    available
      for future issuance
    
    sharesissued
      upon exercise of
    
    Weighted-average
      exercise
    
    under
      equity compensation
    
    reflected
      inoutstanding
      options,
    
    price
      of outstanding options,
    
    plans
      (excluding shares
    
    columns
      (a)warrants
      and rights
    
    warrants
      and rights
    
    reflected
      in column (a)) (1)
    
    and
      (c)Plan
      Category
    
    (a)
    
    (b)
    
    (c)
    
    (d)Equity
      compensation plansapproved
      by shareholders
    
    
    1,558,954
    
    $
    3.06
    
    
    488,415
    
    
    2,047,369Equity
      compensation plansnot
      approved by shareholders
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
    
    
    1,558,954
    
    $
    3.06
    
    
    488,415
    
    
    2,047,369




__________________




(1)
Represents 224,025 shares available for purchase under the Employee Stock
Purchase Plan and
264,390 shares available for grant under the 1995 Stock Incentive Plan, which
includes director stock options.





**59**


Table of Contents







**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS**





The
information required by this Item is incorporated herein by reference to our
Proxy Statement to be filed with the SEC pursuant to Regulation 14A .








**ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES******





The
information required by this Item is incorporated herein by reference to our
Proxy Statement to be filed with the SEC pursuant to Regulation 14A.










**60**


Table of Contents





**PART IV**





**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES**





(a)  *The
following documents are filed as a part of the report:*





(1)  *FINANCIAL
STATEMENTS* . The
following financial statements of the Registrant and the Report of Independent
Registered Public Accounting Firm therein are filed as part of this Report on
Form 10-K:





**Page**Report
      of Independent Registered Public Accounting Firm
    F-2Consolidated Balance Sheets
    F-3Consolidated Statements of Operations
    F-4Consolidated
      Statements of Cash Flows
    F-5Consolidated Statements of Shareholders’ Deficit and
      Comprehensive Operations
    F-7Notes
      to Consolidated Financial Statements
    F-8





(2)  *FINANCIAL
STATEMENT SCHEDULES.*





Report of Independent Registered Public Accounting Firm
      on Financial Statement Schedule......
    S-1Schedule II Valuation and Qualifying
      Accounts.........................................................
    S-2





Other
financial statement schedules have been omitted because the information required
to be set forth therein is not applicable, is immaterial, or is shown in the
consolidated financial statements or notes thereto.





(3) *EXHIBITS:*
The following exhibits are filed as a part of, or incorporated by reference
into, this Report on Form 10-K:





**Footnote****Number**
    
    **Description**
    
    **Number**
3.1
    
    Restated
      Articles of Incorporation of registrant (Exhibit 3.1).
    
    (2)3.2
    
    Amended
      and Restated Bylaws of the registrant (Exhibit 3.2).
    
    (1)4.1
    
    Forms
      of 6.25% Convertible Subordinated Debenture due 2006 (Exhibit 4.1).
    
    (2)4.2
    
    Indenture
      dated February 15, 1996, between the registrant and Fleet National Bank
      ("Trustee") (Exhibit 4.2).
    
    (2)4.3
    
    Preferred
      Stock Purchase Agreement (including Designation of Rights and Preferences
      of Series A Convertible ExchangeableRedeemable
      Preferred Stock of Emeritus Corporation Agreement, Registration of Rights
      Agreement and ShareholdersAgreement)
      dated October 24, 1997, between the registrant ("Seller") and Merit
      Partners, L.L.C. ("Purchaser") (Exhibit 4.1).
    
    (12)10.1
    
    Amended
      and Restated 1995 Stock Incentive Plan (Exhibit 99.1).
    
    (14)10.2
    
    Stock
      Option Plan for Nonemployee Directors (Exhibit 10.2).
    
    (2)10.3
    
    Form
      of Indemnification Agreement for officers and directors of the registrant
      (Exhibit 10.3).
    
    (1)**10.4**
    
    **Noncompetition
      Agreements entered into between the registrant and each of the following
      individuals:**10.4.1
    Daniel
      R. Baty (Exhibit 10.4.1), Raymond R. Brandstrom (Exhibit 10.4.2) and Frank
      A. Ruffo (Exhibit 10.4.3).
    
    (2)**10.9**
    
    **Rosewood
      Court in Fullerton, California, the Arbor at Olive Grove in Phoenix,
      Arizona, Renton Villa in Renton,****Washington,
      Seabrook in Everett, Washington, Laurel Lake Estates in Vorhees, New
      Jersey, Green Meadows--****Allentown
      in Allentown, Pennsylvania, Green Meadows--Dover in Dover, Delaware, Green
      Meadows--Latrobe in****Latrobe,
      Pennsylvania, Green Meadows--Painted Post in Painted Post, New York,
      Heritage Health Center in****Hendersonville,
      North Carolina. The following agreements are representative of those
      executed in connection with****these
      properties:**10.9.1
    Lease
      Agreement dated March 29, 1996, between the registrant ("Lessee") and
      Health Care Property Investors,Inc.
      ("Lessor")(Exhibit 10.10.1).
    
    (3)10.9.2
    First
      Amendment Lease Agreement dated April 25, 1996, by and between the
      registrant ("Lessee") and HealthCare
      Property Investors, Inc. ("Lessor") (Exhibit 10.10.2).
    
    (3)

**61**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
10.9.3
    
    Amended
      and Restated Master Lease Agreement dated September 18, 2002, between
      Health Care PropertyInvestors,
      Inc., HCPI Trust, Texas HCP Holding, L.P. ("Lessor") and Emeritus
      Corporation, ESC III, L.P.("Lessee").
    
    (27)10.9.4
    Promissory
      Note between Emeritus Corporation ("Maker") Health Care Property
      Investors, Inc. ("Lender"), datedSeptember
      18, 2002.
    
    (27)**10.11**
    
    **Summer
      Wind in Boise, Idaho**10.11.1
    Lease
      Agreement dated as of August 31, 1995, between AHP of Washington, Inc. and
      the registrant (Exhibit10.18.1).
    
    (1)10.11.2
    First
      Amended Lease Agreement dated as of December 31, 1996, by and between the
      registrant and AHP ofWashington,
      Inc.(Exhibit 10.16.2).
    
    (5)**10.13**
    
    **The
      Palisades in El Paso, Texas, Amber Oaks in San Antonio, Texas and Redwood
      Springs in San Marcos, Texas. The****following
      agreements are representative of those executed in connection with these
      properties.**10.13.1
    Lease
      Agreement dated April 1, 1997, between ESC III, L.P. D/B/A Texas-ESC III,
      L.P. ("Lessee") and TexasHCP
      Holding , L.P. ("Lessor") (Exhibit 10.4.1).
    
    (6)10.13.2
    First
      Amendment to Lease Agreement dated April 1, 1997, between Lessee and Texas
      HCP Holding , L.P. Lessor(Exhibit
      10.4.2).
    
    (6)10.13.3
    Guaranty
      dated April 1, 1997, by the registrant ("Guarantor") in favor of Texas HCP
      Holding , L.P. (Exhibit 10.4.3).
    
    (6)10.13.4
    Assignment
      Agreement dated April 1, 1997, between the registrant ("Assignor") and
      Texas HCP Holding , L.P.("Assignee")(Exhibit
      10.4.4).
    
    (6)**10.15**
    
    **Green
      Meadows Communities**10.15.1
    Consent
      to Assignment of and First Amendment to Asset Purchase Agreement dated
      September 1, 1995, amongthe
      registrant, The Standish Care Company and Painted Post Partnership,
      Allentown Personal Car GeneralPartnership,
      Unity Partnership, Saulsbury General Partnership and P. Jules Patt
      (collectively, the "Partnerships"),together
      with Asset Purchase Agreement dated July 27, 1995, among The Standish Care
      Company and thePartnerships
      (Exhibit 10.24.1).
    
    (1)10.15.2
    Agreement
      to Provide Administrative Services to an Adult Home dated October 23,
      1995, between the registrantand
      P. Jules Patt and Pamela J. Patt (Exhibit 10.24.6).
    
    (1)10.15.3
    Assignment
      Agreement dated October 19, 1995, between the registrant, HCPI Trust and
      Health Care PropertyInvestors,
      Inc. (Exhibit 10.24.8).
    
    (1)10.15.4
    Assignment
      and Assumption Agreement dated August 31, 1995, between the registrant and
      The Standish CareCompany
      (Exhibit 10.24.9).
    
    (1)10.15.5
    Guaranty
      dated October 19, 1995, by Daniel R. Baty in favor of Health Care Property
      Investors, Inc., and HCPITrust
      (Exhibit 10.24.10).
    
    (1)10.15.6
    Guaranty
      dated October 19, 1995, by the registrant in favor of Health Care Property
      Investors, Inc. (Exhibit10.24.11).
    
    (1)10.15.7
    Second
      Amendment to Agreement to provide Administrative Services to an Adult Home
      dated January 1, 1997,between
      Painted Post Partners and the registrant (Exhibit 10.2).
    
    (10)**10.16**
    
    **Carolina
      Communities**10.16.1
    Lease
      Agreement dated January 26, 1996, between the registrant and HCPI Trust
      with respect to CountrysideFacility
      (Exhibit 10.23.1).
    
    (2)10.16.3
    Promissory
      Note dated as of January 26, 1996, in the amount of $3,991,190 from
      Heritage Hills Retirement, Inc.("Borrower")
      to Health Care Property Investors, Inc. ("Lender") (Exhibit 10.23.4).
    
    (2)10.16.4
    Loan
      Agreement dated January 26, 1996, between the Borrower and the Lender
      (Exhibit 10.23.5).
    
    (2)10.16.5
    Guaranty
      dated January 26, 1996, by the registrant in favor of the Borrower
      (Exhibit 10.23.6).
    
    (2)10.16.6
    Deed
      of Trust with Assignment of Rents, Security Agreement and Fixture Filing
      dated as of January 26, 1996, byand
      among Heritage Hills Retirement, Inc. ("Grantor"), Chicago Title Insurance
      Company ("Trustee") and HealthCare
      Property Investor, Inc. ("Beneficiary") (Exhibit 10.23.7).
    
    (2)10.16.7
    Lease
      Agreement dated as of January 26, 1996, between the registrant and Health
      Care Property Investor, Inc.with
      respect to Heritage Lodge Facility (Exhibit 10.23.8).
    
    (2)10.16.8
    Lease
      Agreement dated as of January 26, 1996, between the registrant and Health
      Care Property Investor, Inc.


**62**
Table of Contents
****
****
**Footnote****Number**
    
    **Description**
    
    **Number**
with
      respect to Pine Park Facility (Exhibit 10.23.9).
    
    (2)10.16.9
    Lease
      Agreement dated January 26, 1996, between the registrant and HCPI Trust
      with respect to Skylyn Facility(Exhibit
      10.23.10).
    
    (2)10.16.10
    Lease
      Agreement dated January 26, 1996, between the registrant and HCPI Trust
      with respect to Summit PlaceFacility
      (Exhibit 10.23.11).
    
    (2)10.16.11
    Amendment
      to Deed of Trust dated April 25, 1996, between Heritage Hills Retirement,
      Inc. ("Grantor"), andHealth
      Care Property Investors, Inc. ("Beneficiary") (Exhibit 10.21.12).
    
    (5)**10.18**
    
    **Garrison
      Creek Lodge in Walla Walla, Washington, Cambria in El Paso Texas, and
      Sherwood Place in Odessa,****Texas.
      The following agreements are representative of those executed in
      connection with these properties:**10.18.1
    Lease
      Agreement dated July, August and September 1996, between the registrant
      ("Lessee") and American HealthProperties,
      Inc. ("Lessor") (Exhibit 10.3.1).
    
    (4)10.18.2
    First
      Amendment to Lease Agreement dated December 31, 1996, between the
      registrant ("Lessee") and AHP ofWashington,
      Inc, ("Lessor") (Exhibit 10.35.2).
    
    (5)**10.2**
    
    **Rosewood
      Court in Fullerton, California, The Arbor at Olive Grove in Phoenix,
      Arizona, Renton Villa in Renton,****Washington,
      Seabrook in Everett, Washington and Laurel Lake Estates in Voorhees, New
      Jersey, Green Meadows--****Allentown
      in Allentown, Pennsylvania, Green Meadows--Dover in Dover, Delaware, Green
      Meadows--Latrobe in****Latrobe,
      Pennsylvania, Green Meadows--Painted Post in Painted Post, New York. The
      following agreements are****representative
      of those executed in connection with these
      properties:**10.20.1
    Second
      Amended Lease Agreement dated as of December 30, 1996, by and between the
      registrant and HealthCare
      Property Investors, Inc. (Exhibit 10.37.1).
    
    (5)**10.21**
    
    **Cooper
      George Partners Limited Partnership**10.21.2
    Partnership
      Interest Purchase Agreement dated June 4, 1998, between Emeritus Real
      Estate L.L.C. IV ("Seller")and
      Columbia Pacific Master Fund 98 General Partnership ("Buyer") (Exhibit
      10.3.2).
    
    (15)10.21.4
    Amended
      and Restated Agreement of Limited Partnership of Cooper George Partners
      Limited Partnership datedJune
      29, 1998, between Columbia Pacific Master Fund '98 General Partnership,
      Emeritus Real Estate IV, L.L.C.and
      Bella Torre De Pisa Limited Partnership (Exhibit 10.3.4).
    
    (15)10.22
    
    Registration
      Rights Agreement dated February 8, 1996, with respect to the registrant's
      6.25% Convertible SubordinatedDebentures
      due 2006 (Exhibit 10.44).
    
    (2)10.23
    
    Registration
      Rights Agreement dated February 8, 1996, with respect to the registrant's
      6.25% Convertible SubordinatedDebentures
      due 2006 (Exhibit 10.45).
    
    (2)10.24
    
    Office
      Lease Agreement dated April 29, 1996, between Martin Selig ("Lessor") and
      the registrant ("Lessee") (Exhibit 10.8)
    
    (3)**10.25**
    
    **Colonie
      Manor in Latham, New York, Bassett Manor in Williamsville, New York, West
      Side Manor in Liverpool,****New
      York, Bellevue Manor in Syracuse, New York, Perinton Park Manor in
      Fairport, New York, Bassett Park****Manor
      in Williamsville, New York, Woodland Manor in Vestal, New York, East Side
      Manor in Fayetteville, New****York
      and West Side Manor in Rochester, New York. The following agreement is
      representative of those executed in****connection
      with these properties:**10.25.1
    Lease
      Agreement dated September 1, 1996, between Philip Wegman ("Landlord") and
      Painted Post Partners("Tenant")
      (Exhibit 10.4.1).
    
    (4)10.25.2
    Agreement
      to Provide Administrative Services to an Adult Home dated September 2,
      1996, between the registrantand
      Painted Post Partners ("Operator") (Exhibit 10.4.2).
    
    (4)10.25.3
    First
      Amendment to Agreement to Provide Administrative Services to an Adult Home
      dated January 1, 1997,between
      Painted Post Partners and the registrant (Exhibit 10.1).
    
    (10)**10.26**
    
    **Columbia
      House Communities.**10.26.1
    Management
      Services Agreement between the Registrant ("Manager") and Columbia House,
      L.L.C. ("Lessee")dated
      November 1, 1996, with respect to Camlu Retirement (Exhibit 10.6.1).
    
    (4)10.26.2
    Management
      Services Agreement dated January 1, 1998, between the registrant
      ("Manager") and Columbia HouseL.L.C.
      ("Lessee") with respect to York.
    
    (13)10.26.4
    Management
      Services Agreement dated June 1, 1997, between the registrant ("Manager")
      and Columbia HouseL.L.C.
      ("Owner") with respect to Autumn Ridge (Exhibit 10.3.1).
    
    (9)10.26.6
    Assignment
      and First Amendment to Agreement to Provide Management Services dated
      September 1, 1997,


**63**
Table of Contents
****

**Footnote****Number**
    
    **Description**
    
    **Number**
between
      the registrant, Columbia House, L.L.C., Acorn Service Corporation and
      Camlu Coeur d'Alene, L.L.C.with
      respect to Camlu.
    
    (13)10.26.7
    Assignment
      and First Amendment to Agreement to Provide Management Services dated
      September 1, 1997,between
      the registrant, Columbia House, L.L.C., Acorn Service Corporation and
      Autumn Ridge Herculaneum,L.L.C.
      with respect to Autumn Ridge.
    
    (13)10.26.8
    Management
      Services Agreement dated January 1, 1998, between the registrant
      ("Manager") and Columbia HouseL.L.C.
      ("Owner") with respect to Park Lane
    
    (13)**10.27**
    
    **Vickery
      Towers in Dallas, Texas**10.27.1
    Partnership
      Interest Purchase and Sale Agreement dated June 4, 1998, between ESC GP
      II, Inc. and EmeritusProperties
      IV, Inc. (together "Seller") and Columbia Pacific Master Fund 98 General
      Partnership and Daniel R.Baty
      (together "Purchaser") (Exhibit 10.4.1).
    
    (15)10.27.2
    Amended
      and Restated Agreement of Limited Partnership of ESC II, LP dated June 30,
      1998, between ColumbiaPacific
      Master Fund '98 General Partnership and Daniel R. Baty
      (10.4.2).
    
    (15)10.27.3
    Agreement
      to Provide Management Services To An Independent and Assisted Living
      Facility dated June 30,1998,
      between ESC II, LP ("Owner") and ESC III, LP ("Manager") (Exhibit
      10.4.3).
    
    (15)**10.29**
    
    **Development
      Properties in Auburn, Massachusetts, Louisville, Kentucky and Rocky Hill,
      Connecticut. The following****agreements
      are representative of those executed in connection with these
      properties:**10.29.1
    Lease
      Agreement dated February 1996, between the registrant ("Lessee") and LM
      Auburn Assisted Living L.L.C.,and
      LM Louisville Assisted Living L.L.C., ("Landlords") with respect to the
      development properties in Auburnand
      Louisville (Exhibit 10.58.1).
    
    (5)10.29.2
    Amended
      and Restated Lease Agreement dated February 26, 1996, between the
      registrant ("Lessee") and LMRocky
      Hill Assisted Living Limited Partnership, ("Landlord") with respect to the
      development property in RockyHill
      (Exhibit 10.58.2).
    
    (5)10.29.3
    Lease
      Agreement dated October 10, 1996, between the registrant ("Lessee") and LM
      Chelmsford Assisted LivingL.L.C.,
      ("Landlord") with respect to the development property in Chelmsford
      (Exhibit 10.58.3).
    
    (5)10.29.4
    Promissory
      Note in the amount of $1,255,000 dated December 1996, between the
      registrant ("Lender") and LMAuburn
      Assisted Living L.L.C., ("Borrower") with respect to the development
      property in Auburn (Exhibit10.58.4).
    
    (5)10.29.5
    Promissory
      Note in the amount of $1,450,000 dated January 1997, between the
      registrant ("Lender") and LMLouisville
      Assisted Living L.L.C., ("Borrower") with respect to the development
      property in Louisville (Exhibit10.58.5).
    
    (5)10.29.6
    Promissory
      Note in the amount of $1,275,000 dated January 1997, between the
      registrant ("Lender") and LMRocky
      Hill Assisted Living Limited Liability Partnership, ("Borrower") with
      respect to the development propertyin
      Rocky Hill (Exhibit 10.58.6).
    
    (5)10.29.7
    Promissory
      Note in the amount of $300,000 dated January 1997, between the registrant
      ("Lender") and LMChelmsford
      Assisted Living L.L.C., ("Borrower") with respect to the development
      property in Chelmsford(Exhibit
      10.58.7).
    
    (5)10.29.8
    Real
      Estate Purchase and Sale Agreement under the purchase option on the lease
      dated January 1, 2000, betweenAuburn
      Land L.L.C. ("Seller") and Emeritus Properties XIV, L.L.C. ("Buyer") dated
      August 26, 2002.
    
    (27)10.29.9
    Sublease
      Termination and Release Agreement between Sage Assisted Living L.L.C.
      ("Landlord") and EmeritusProperties
      XIV, L.L.C. ("Tenant") dated August 26, 2002.
    
    (27)10.29.10
    Leasehold
      Mortgage, Security Agreement, Assignment of Leases and Rents, Financing
      Statement and FixtureFiling
      between the registrant ("Mortgagor"), in favor of Health Care REIT, Inc..
      ("Mortgagee") with respect to theAuburn,
      Massachusetts, Facility dated August 28, 2003.
    
    (32)10.29.11
    Leasehold
      Mortgage, Security Agreement, Assignment of Leases and Rents, Financing
      Statement and FixtureFiling
      between the registrant ("Mortgagor"), in favor of Health Care REIT, Inc..
      ("Mortgagee") with respect to theLouisville,
      Kentucky, Facility dated August 28, 2003.
    
    (32)10.29.12
    Leasehold
      Mortgage, Security Agreement, Assignment of Leases and Rents, Financing
      Statement and FixtureFiling
      between the registrant ("Mortgagor"), in favor of Health Care REIT, Inc..
      ("Mortgagee") with respect to theRocky
      Hill, Connecticut, Facility dated August 28, 2003.
    
    (32)


**64**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
10.29.13
    Second
      Amendment to Lease Agreement between HCRI Eddy Pond Properties Trust
      ("Landlord") and theRegistrant
      ("Tenant") with respect to the Auburn, Massachusetts, Facility dated June
      30, 2003.
    
    (32)10.29.14
    Second
      Amendment to Lease Agreement between HCRI Stone Creek Properties, LLC
      ("Landlord") and theRegistrant
      ("Tenant") with respect to the Louisville, Kentucky, Facility dated June
      30, 2003.
    
    (32)10.29.15
    Second
      Amendment to Lease Agreement between HCRI Cold Spring Properties, LLC
      ("Landlord") and theRegistrant
      ("Tenant") with respect to the Rocky Hill, Connecticut, Facility dated
      June 30, 2003.
    
    (32)10.29.16
    Promissory
      Note in the amount of $3,100,000 dated August 28, 2003, between the
      registrant ("Borrower") andHealth
      Care REIT, Inc.. ("Lender") secured by the mortgage on the Ridgeland,
      Mississippi property.
    
    (32)**10.31**
    
    **Senior
      Management Employment Agreements and Amendments entered into between the
      registrant and each of the****following
      individuals:**10.31.1
    Frank
      A. Ruffo (Exhibit 10.6.2) and Raymond R. Brandstrom (Exhibit 10.6.5).
    
    (9)10.31.2
    Raymond
      R. Brandstrom (Exhibit 10.11.1) and Frank A. Ruffo (Exhibit 10.11.3)
    
    (9)**10.32**
    
    **La
      Casa Grande in New Port Richey, Florida, River Oaks in Englewood, Florida,
      and Stanford Centre in Altamonte****Springs,
      Florida. The following agreements are representative of those executed in
      connection with these properties.**10.32.1
    Stock
      Purchase Agreement dated September 30, 1996, between Wayne Voegele, Jerome
      Lang, Ronald Carlson,Thomas
      Stanford, Frank McMillan, Lonnie Carlson, and Carla Holweger ("Seller")
      and the registrant("Purchaser")
      with respect to La Casa Grande (Exhibit 10.1).
    
    (7)10.32.2
    First
      Amendment to Stock Purchase Agreement dated January 31, 1997, between the
      Seller and the registrant withrespect
      to La Case Grande (Exhibit 10.2).
    
    (7)10.32.3
    Stock
      Purchase Agreement dated September 30, 1996, between the Seller and the
      registrant with respect to LaCasa
      Grande (Exhibit 10.2).
    
    (7)10.32.4
    First
      Amendment to Stock Purchase Agreement dated January 31, 1997, between the
      Seller and the registrant withrespect
      to River Oaks (Exhibit 10.4).
    
    (7)10.32.5
    Stock
      Purchase Agreement dated September 30, 1996, between the Seller and the
      registrant with respect toStanford
      Centre (Exhibit 10.5).
    
    (7)10.32.6
    First
      Amendment to Stock Purchase Agreement dated January 31, 1997, between the
      Seller and the registrant withrespect
      to Stanford Centre (Exhibit 10.6).
    
    (7)**10.33**
    
    **Painted
      Post Partnership**10.33.1
      Painted Post Partners Partnership Agreement dated October 1, 1995 (Exhibit
      10.24.7).
    
    (1)10.33.2
    First
      Amendment to Painted Post Partners Partnership Agreement dated October 22,
      1996, between Daniel R.Baty
      and Raymond R. Brandstrom (Exhibit 10.20.20).
    
    (5)10.33.3
    Indemnity
      Agreement dated November 3, 1996, between the registrant and Painted Post
      Partners (Exhibit 10.3).
    
    (10)10.33.4
    First
      Amendment to Indemnity Agreement dated January 1, 1997, between the
      registrant and Painted PostPartners
      (Exhibit 10.4).
    
    (10)10.33.5
    Undertaking
      and Indemnity Agreement dated October 23, 1995, between the registrant, P.
      Jules Patt and Pamela J.Patt
      and Painted Post Partnership (Exhibit 10.5).
    
    (10)10.33.6
    First
      Amendment to Undertaking and Indemnity Agreement dated January 1, 1997,
      between Painted post Partnersand
      the registrant (Exhibit 10.6).
    
    (10)10.33.7
    First
      Amendment to Non-Competition Agreement between the registrant and Daniel
      R. Baty (Exhibit 10.1.1) andRaymond
      R. Brandstrom (Exhibit 10.1.2).
    
    (11)**10.34**
    
    **Ridgeland
      Court in Ridgeland, Mississippi**10.34.1
    Master
      Agreement and Subordination Agreement dated September 5, 1997, between the
      registrant, EmeritusProperties
      I, Inc., and Mississippi Baptist Health Systems, Inc. (Exhibit 10.1.1).
    
    (12)10.34.2
    License
      Agreement dated September 5, 1997, between the registrant and its
      subsidiary and affiliated corporationsand
      Mississippi Baptist Health Systems, Inc. (Exhibit 10.1.2).
    
    (12)10.34.3
    Economic
      Interest Assignment Agreement and Subordination Agreement dated September
      5, 1997, between theregistrant,
      Emeritus Properties I, Inc., and Mississippi Baptist Health Systems, Inc.
      (Exhibit 10.1.3).
    
    (12)10.34.4
    Operating
      Agreement for Ridgeland Assisted Living, L.L.C. dated December 23, 1998,
      between the registrant,Emeritrust
      Properties XI, L.L.C. and Mississippi Baptist Medical Enterprises, Inc.
      (Exhibit 10.46.4)
    
    (16)10.34.5
    Purchase
      and Sale Agreement dated December 23, 1998, between the registrant and
      Meditrust Company L.L.C..


**65**
Table of Contents
****
**Footnote****Number**
    
    **Description**
    
    **Number**
(Exhibit
      10.46.5).
    
    (16)10.34.6
    Purchase
      and Sale Agreement by and between Mississippi Baptist Medical Enterprises,
      Inc. ("Seller"), ESC-RIDGELAND,
      LLC ("Purchaser"), Emeritus Properties XI, LLC ("Emeritus XI"), and
      Ridgeland Assisted LivingLLC
      ("Company") dated September 29, 2003.
    
    (32)10.34.7
    Lease
      Agreement between HCRI Ridgeland Pointe Properties, LLC ("Landlord") and
      Ridgeland Assisted Living,LLC
      ("Tenant") dated September 29, 2003.
    
    (32)10.36
    
    Amendment
      to Office Lease Agreement dated September 6, 1996, between Martin Selig
      ("Lessor") and the registrant.
    
    (13)**10.37**
    
    **Villa
      Del Rey in Escondido, California**10.37.1
    Purchase
      and Sale Agreement dated December 19, 1996, between the registrant
      ("Purchaser") and NorthwestRetirement
      ("Seller") (Exhibit 10.1.1).
    
    (6)**10.38**
    
    **Development
      Property in Paso Robles, California**10.38.1
    Agreement
      of TDC/Emeritus Paso Robles Associates dated June 1, 1995, between the
      registrant and TDCConvalescent,
      Inc. (Exhibit 10.2.1).
    
    (6)10.38.7
    Purchase
      and Sale Agreement between TDC Convalescent, Inc. ("Seller") and the
      registrant ("Purchaser") datedMarch
      26, 2002.
    
    (25)**10.41**
    
    **Development
      Property in Danville, Illinois**10.41.1
    Purchase
      and Sale Agreement dated October 14, 1997, between South Bay Partners,
      Inc. ("Purchaser") and ElksLodge
      No. 332, BPOE ("Seller") (Exhibit 10.74.1).
    
    (13)10.41.2
    Assignment
      and Assumption of Purchase and Sale Agreement dated October 21, 1997,
      between South BayPartners,
      Inc. and the registrant (Exhibit 10.74.2)
    
    (13)10.45
    
    1998
      Employee Stock Purchase Plan (Exhibit 99.2).
    
    (14)**10.49**
    
    **Richland
      Gardens in Richland, Washington, Charlton Place in Tacoma Washington, The
      Pines of Goldsboro in****Goldsboro,
      North Carolina, Silverleaf Manor in Meridian, Mississippi and Wilburn
      Gardens in Fredericksburg,****Virginia.
      The following agreement is representative of those executed in connection
      with these properties.**10.49.1
    Agreement
      To Provide Management Services To An Assisted Living Facility dated
      February 2, 1998, betweenRichland
      Assisted, L.L.C. ("Owner") and Acorn Service Corporation ("Manager")
      (Exhibit 10.9.1).
    
    (15)**10.5**
    
    **Richland
      Gardens in Richland, Washington, The Pines of Goldsboro in Goldsboro,
      North Carolina, Silverleaf Manor****in
      Meridian, Mississippi, Wilburn Gardens in Fredericksburg, Virginia and
      Park Lane in Toledo, Ohio. The following****agreement
      is representative of those executed in connection with these
      properties.**10.50.1
    Marketing
      Agreement dated February 2, 1998, between Acorn Service Corporation
      ("Acorn") and RichlandAssisted,
      L.L.C. ("RAL.L.C.") (Exhibit 10.10.1).
    
    (15)**10.51**
    
    **Kirkland
      Lodge in Kirkland, Washington**10.51.1
    Purchase
      and Sale Agreement dated December 23, 1998, between the registrant and
      Meditrust Company L.L.C.(Exhibit
      10.46.5).
    
    (16)10.51.2
    Loan
      Agreement dated December 28, 1998, between Emeritus Properties X, L.L.C.
      and Guaranty Federal Bank(Exhibit
      10.65.2).
    
    (16)10.51.3
    Promissory
      Note Agreement dated December 28, 1998, between Emeritus Properties X,
      L.L.C. and GuarantyFederal
      Bank (Exhibit 10.65.3).
    
    (16)10.51.4
    Guaranty
      Agreement dated December 28, 1998, between the registrant and Guaranty
      Federal Bank (Exhibit10.65.3).
    
    (16)**10.52**
    
    **Emeritrust
      communities**10.52.1
    Purchase
      and Sale Agreement dated December 30, 1998, between the registrant,
      Emeritus Properties VI, Inc.,ESC
      I, L.P. and AL Investors L.L.C. (Exhibit 10.66.1).
    
    (16)10.52.2
    Supplemental
      Purchase Agreement in Connection with Purchase of Facilities dated
      December 30, 1998, betweenthe
      registrant, Emeritus Properties I, Inc. Emeritus Properties VI, Inc., ESC
      I, L.P. and AL Investors L.L.C.(Exhibit
      10.66.2).
    
    (16)10.52.3
    Management
      Agreement with Option to Purchase dated December 30, 1998, between the
      registrant, EmeritusManagement
      I LP, Emeritus Properties I, Inc, ESC I, L.P., Emeritus Management L.L.C.
      and AL Investors L.L.C.(Exhibit
      10.66.3).
    
    (16)10.52.4
    Guaranty
      of Management Agreement and Shortfall Funding Agreement dated December 30,
      1998, between the


**66**
Table of Contents
**Footnote****Number**
    
    **Description**
    
    **Number**
registrant
      and AL Investors L.L.C. (Exhibit 10.66.4).
    
    (16)10.52.5
    Put
      and Purchase Agreement dated December 30, 1998, between Daniel R. Baty and
      AL Investors L.L.C. (Exhibit10.66.5)
      Second Emeritrust.
    
    (16)10.52.6
    First
      Amendment to Management Agreement with Option to Purchase (AL I -
      Emeritrust 25 Facilities) datedMarch
      22, 2001, between the registrant, Emeritus Management I LP, and AL
      Investors L.L.C.
    
    (24)10.52.7
    Amendment
      to Guaranty of Management Agreement and Shortfall Funding Agreement
      (Emeritrust 25) datedMarch
      22, 2001, between the registrant and AL Investors L.L.C.
    
    (24)10.52.8
    Second
      Amendment to Put and Purchase Agreement (AL I - Emeritrust 25 Facilities)
      dated March 22, 2001,between
      Daniel R. Baty and AL Investors L.L.C.
    
    (24)10.52.9
    Second
      Amendment to Management Agreement with Option to Purchase (AL I -
      Emeritrust 25 Facilities) datedJanuary
      1, 2002, between the registrant, Emeritus Management I LP, and AL
      Investors L.L.C.
    
    (24)10.52.10
    Third
      Amendment to Put and Purchase Agreement (AL I - Emeritrust 25 Facilities)
      dated January 1, 2002,between
      Daniel R. Baty and AL Investors L.L.C.
    
    (24)10.52.11
    Waiver,
      Consent, and Amendment to Management Agreement dated May 1, 2002, (AL
      I-Laurel Place) betweenEmeritus
      Management, L.L.C., the registrant, and AL I Investors,
    L.L.C.
    
    (25)10.52.12
    Third
      Amendment to Management Agreement with Option to Purchase by and among
      Emeritus ManagementLLC
      ("Emeritus Management"), Emeritus Management I LP ("Texas Management"),
      Emeritus Corporation("Emeritus"),
      and AL Investors LLC ("AL Investors"), effective June 30,
      2003.
    
    (31)10.52.13
    Fourth
      Amendment to Management Agreement with Option to Purchase by and among
      Emeritus ManagementLLC
      ("Emeritus Management"), Emeritus Management I LP ("Texas Management"),
      Emeritus Corporation("Emeritus"),
      and AL Investors LLC ("AL Investors"), dated September 30, 2003, effective
      January 2, 2004.
    
    (31)10.52.14
    Side
      Letter to Management Agreement with Option to Purchase by and among
      Emeritus Management LLC("Emeritus
      Management"), Emeritus Management I LP ("Texas Manager"), Emeritus
      Corporation ("Emeritus"),and
      AL Investors LLC ("AL Investors"), effective June 30,
2003.
    
    (31)10.52.15
    Fourth
      Amendment to Management Agreement with Option to Purchase by and among
      EmeritusManagement
      LLC ("Emeritus Management"), Emeritus Management I LP ("Texas
      Management"), EmeritusCorporation
      ("Emeritus"), and AL Investors LLC ("AL Investors"), effective April 1,
      2004.
    
    (40)10.52.16
    Fifth
      Amendment to Management Agreement by and among Emeritus Management LLC
      ("EmeritusManagement"),
      Emeritus Corporation ("Emeritus"), and AL Investors LLC ("AL Investors"),
      effectiveJune
      1, 2004.
    
    (42)**10.53**
    
    **Emeritrust
      II communities**10.53.1
    Supplemental
      Purchase Agreement in Connection with Purchase of Facilities (AL II — 14
      Operating Facilities)dated
      March 26, 1999, between the registrant, Emeritus Properties I, Inc., ESC
      G.G. I, Inc., ESC I, L.P. and ALInvestors
      II LLC (Exhibit 10.1.1).
    
    (17)10.53.2
    Management
      Agreement with Option to Purchase (AL II — 14 Operating Facilities) dated
      March 26, 1999,between
      the registrant, Emeritus Management I LP, Emeritus Properties I, Inc., ESC
      G.P. I, Inc., ESC I, L.P. andAL
      Investors II LLC (Exhibit 10.1.3).
    
    (17)10.53.3
    Guaranty
      of Management Agreement (AL II--14 Operating Facilities) dated March 26,
      1999, between theregistrant
      and AL Investors II L.L.C. (Exhibit 10.1.3).
    
    (17)10.53.4
    Supplemental
      Purchase Agreement in Connection with Purchase of Facilities (AL II — 5
      Development Facilities)dated
      March 26, 1999, between the registrant, Emeritus Properties I, Inc. and AL
      Investors Development LLC(Exhibit
      10.1.4).
    
    (17)10.53.5
    Management
      Agreement with Option to Purchase (AL II — 5 Development Facilities) dated
      March 26, 1999,between
      the registrant, Emeritus Properties I, Inc., Emeritus Management LLC and
      AL Investors DevelopmentLLC
      (Exhibit 10.1.5).
    
    (17)10.53.6
    Guaranty
      of Management Agreement and Shortfall Funding Agreement (AL II — 5
      Development Facilities) datedMarch
      26, 1999, between the registrant and AL Investors Development LLC (Exhibit
      10.1.6).
    
    (17)10.53.7
    Put
      and Purchase Agreement (AL II Holdings--14 Operating Facilities and 5
      Development Facilities) dated March26,
      1999, between Daniel R. Baty and AL II Holdings L.L.C., AL Investors II
      L.L.C. and AL InvestorsDevelopment
      L.L.C. (Exhibit 10.1.7).
    
    (17)


**67**
Table of Contents
**Footnote****Number**
    
    **Description**
    
    **Number**
10.53.8
    Second
      Amendment to Management Agreement (AL II - 14 Operating Facilities) (GMAC)
      dated March 22, 2001,between
      the registrant, Emeritus Management L.L.C., Emeritus Management I, and AL
      Investors II L.L.C.
    
    (24)10.53.9
    Second
      Amendment to Put and Purchase Agreement (AL II Holdings - 14 Operating
      Facilities and 5 DevelopmentFacilities)
      dated March 22, 2001, between Daniel R. Baty and AL II Holdings L.L.C., AL
      Investors II L.L.C. andAL
      Investors Development L.L.C.
    
    (24)10.53.10
    First
      Amendment to Management Agreement (AL II - 5 Development Facilities) dated
      January 1, 2002, betweenthe
      registrant, Emeritus Management L.L.C., and AL Investors Development
      L.L.C.
    
    (24)10.53.11
    Third
      Amendment to Put and Purchase Agreement (AL II Holdings - 14 Operating
      Facilities and 5 DevelopmentFacilities)
      dated January 1, 2002, between Daniel R. Baty and AL II Holdings L.L.C.,
      AL Investors II L.L.C., andAL
      Investors Development L.L.C.
    
    (24)10.53.12
    Third
      Amendment to Management Agreement (AL II - 14 Operating Facilities) (GMAC)
      dated January 1, 2002,between
      the registrant, Emeritus Management L.L.C., Emeritus Management I LP, and
      AL Investors II L.L.C.
    
    (24)10.53.13
    Fourth
      Amendment to Management Agreement (AL II - 14 Operating Facilities) (GMAC)
      dated June 30, 2003,between
      the registrant, Emeritus Management L.L.C., Emeritus Management I LP, and
      AL Investors II L.L.C.
    
    (31)10.53.14
    Amended
      and Restated Loan Agreement between Health Care REIT, Inc. ("Lender") and
      the registrant("Borrower")
      dated September 30, 2003.
    
    (31)10.53.15
    Amended
      and Restated Note for $25.8 million between Health Care REIT, Inc.
      ("Lender") and the registrant("Borrower")
      dated September 30, 2003.
    
    (31)10.53.16
    Amended
      and Restated Leasehold Mortgage/Deed of Trust, Security Agreement,
      Assignment of Leases andRents,
      Financing Statement and Fixture Filing by the registrant ("Trustor") and
      Commonwealth Land TitleInsurance
      Company, Mid South Title Co., Lawyers Title of Arizona, Inc., Transnation
      Title & Escrow, Inc.,Carson
      Mills, AmeriTitle, William Fairbanks, Lawyers Title Realty Services, Inc.,
      Transnation Title InsuranceCompany
      (collectively "Trustee") in favor of Health Care REIT, Inc.
      ("Beneficiary") dated September 30, 2003.
    
    (31)10.53.17
    Warrant
      for the Purchase of Shares of Common Stock by Emeritus Corporation
      ("Issuer"), for Senior Housing PartnersI,
      LP ("Holder") for an aggregate of 400,000 shares, dated September 30,
      2003.
    
    (31)10.53.18
    Master
      Agreement between Owners and Emeritus Corporation Regarding Sale of AL II
      Assisted Living Portfolio,dated
      September 30, 2003.
    
    (31)10.53.19
    Second
      Amended and Restated Loan Agreement between Healthcare Realty Trust and
      EmeritusCorporation
      and dated as of March 3, 2005.
    
    (51)10.53.20
    Second
      Amended and Restated Note**between
      Emeritus Corporation and Healthcare Realty TrustIncorporated
      and dated as of March 3, 2005.
    
    (51)10.53.21
    Loan
      Purchase Agreement among Healthcare Realty Trust Incorporated, Health Care
      REIT, Inc., andEmeritus
      Corporation and dated as of March 3, 2005.
    
    (51)10.53.22
    Intercreditor
      Agreement between Health Care REIT, Inc. and Healthcare Realty Trust
      Incorporated anddated
      as of March 3, 2005.
    
    (51)**10.54**
    
    **Meadow
      Lodge at Drum Lodge Hill in Chelmsford,
    Massachusetts**10.54.1
    Purchase
      and Sales Agreement dated April 23, 1999, between LM Chelmsford Assisted
      Living, L.L.C. ("Seller")and
      the registrant ("purchaser") (Exhibit 10.1.1).
    
    (18)**10.55**
    
    **Meadow
      Lodge at Drum Hill in Chelmsford, Massachusetts, Cobblestones at Fairmont
      in Manassas, Virginia,****Kirkland
      Lodge in Kirkland, Washington and Ridgeland Pointe in Ridgeland,
      Mississippi. The following agreements****are
      representative of those executed in conjunction with these
      properties.**10.55.1
    Fixed
      Rate Noted dated September 29, 1999, between Amresco Capital, L.P.
      ("Payee") and the registrant("Maker")
      (Exhibit 10.2.1).
    
    (18)10.55.2
    Mortgage
      and Security Agreement dated September 29, 1999, between Amresco Capital,
      L.P. (Mortgagee") andthe
      registrant ("mortgagor") (Exhibit 10.2.2).
    
    (18)10.55.3
    Unsecured
      Promissory Note in the amount of $4,400,000 dated August 28, 2003, between
      the registrant("Borrower")
      and Health Care REIT, Inc.. ("Lender")
    
    (32)10.55.4
    Lease
      Agreement between HCRI Drum Hill Properties, LLC ("Landlord") and Emeritus
      Properties IX, LLC("Tenant")
      dated September 29, 2003.
    
    (32)


**68**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
10.55.5
    Lease
      Agreement between HCRI Fairmont Properties, LLC ("Landlord") and Emeritus
      Properties XII, LLC("Tenant")
      dated September 29, 2003.
    
    (32)10.55.6
    Lease
      Agreement between HCRI Kirkland Properties, LLC ("Landlord") and Emeritus
      Properties X, LLC("Tenant")
      dated September 29, 2003.
    
    (32)10.55.7
    Guaranty
      ("guaranty") is executed as of September 29, 1999, by Emeritus
      Corporation, a Washington corporation(singularly
      and collectively referred to as "guarantor"), for the benefit of Amresco
      Capital, L.P., a Delawarelimited
      partnership ("lender").
    
    (49)10.55.8
    Cash
      Management and Security Agreement dated as of September 29, 1999, among
      Emeritus Properties XII, LLC(the
      "borrower"), Emeritus Corporation (the "manager"), and Amresco Capital,
      L.P. (together with its successorsand
      assigns, the "lender").
    
    (49)10.55.9
    Assumption
      Agreement (“Agreement”) effective as of September 29, 2003, by and
      between EmeritusProperties IX,
      LLC, a Washington limited liability company (“original borrower” or
      “operating lessee”), HCRIDrum
      Hill Properties, LLC, a Delaware limited liability company (“new
      borrower”), and JP Morgan Chase Bank(“lender”).
    
    (49)10.55.10
    Assumption
      of Obligations of Guarantor (“Agreement”) made and entered into as of
      September 29, 2003, by andamong
      Health Care REIT, Inc., a Delaware corporation (the “assuming guarantor”),
      Emeritus Corporation, aWashington
      corporation (the “original guarantor”), and JP Morgan Chase Bank (the
      “lender”).
    
    (49)10.55.11
    Subordination
      and Standstill Agreement ( “Agreement”) dated as of the 29 day of
      September, 2003, byand
      among HCRI Drum Hill Properties, LLC, a Delaware limited liability company
      (“new borrower”), Health Care REIT,Inc.,
      a Delaware corporation (“HC REIT”), Emeritus Properties IX, LLC, a
      Washington limited liability company(“operating
      lessee”), Emeritus Corporation, a Washington corporation (“lease
      guarantor”), JP Morgan Chase Bank(“lender”).
    
    (49)10.56
    
    Series
      B Preferred Stock Purchase Agreement dated as of December 10, 1999,
      between Emeritus Corporation and SaratogaPartners
      IV, L.P. (Exhibit 4.1).
    
    (19)10.57
    
    Designation
      of Rights and Preferences of Series B Convertible Preferred Stock as filed
      with the Secretary of State ofWashington
      on December 29, 1999 (Exhibit 4.2).
    
    (19)10.58
    
    Shareholders
      Agreement dated as of December 30, 1999, among Emeritus Corporation,
      Daniel R. Baty, B.F., LimitedPartnership
      and Saratoga Partners IV, L.P. (Exhibit 4.3).
    
    (19)10.59
    
    Registration
      Rights Agreement dated as of December 30, 1999, between Emeritus
      Corporation and Saratoga Partners IV, L.P.(Exhibit
      4.4).
    
    (19)**10.60**
    
    Investment
      Agreement dated as of December 30, 1999, among Emeritus Corporation,
      Daniel R. Baty, B.F., LimitedPartnership
      and Saratoga Partners IV, L.P., Saratoga Partners IV, L.P. and Saratoga
      Management Company L.L.C. (Exhibit4.5).
    
    (19)**10.62**
    
    **Emerald
      Hills in Auburn**10.62.2
    Lease
      agreement dated September 5, 2001, between Health Care Property Investors,
      Inc. ("Lessor"), and EmeritusCorporation
      ("Lessee").
    
    (24)**10.65**
    
    **Loyalton
      of Hattiesburg in Hattiesburg, Mississippi**10.65.2
    Purchase
      agreement for Hattiesburg between ALCO XII L.L.C. ("Seller") and the
      registrant ("Purchaser") datedMarch
      27, 2002.
    
    (25)**10.66**
    
    **Loyalton
      of Biloxi in Biloxi, Mississippi**10.66.2
    Lease
      agreement dated September 5, 2001, between Health Care Property Investors,
      Inc. ("Lessor"), and EmeritusCorporation
      ("Lessee").
    
    (24)10.67
    
    Amended
      1998 Employee Stock Purchase Plan (as amended and restated on May 19,
      1999, and August 17, 2001).(Appendix
      B).
    
    (23)**10.68**
    
    **Kingsley
      Place at Alexandria, Louisiana; Kingsley Place at Lake Charles, Louisiana;
      Kingsley Place at Lafayette,****Louisiana;
      Kingsley Place of Shreveport, Louisiana; Kingsley Place of Henderson,
      Texas; Kingsley Place at Oakwell****Farms,
      Texas; Kingsley Place at the Medical Center, Texas; Kingsley Place at
      Stonebridge, Texas. The following****agreements
      are representative of those executed in connection with these
      properties:**10.68.1
    Horizon
      Bay Lease Facilities Purchase Agreement between Integrated Living
      Communities of Alexandria,L.L.C.,
      Integrated Living Communities of Lake Charles, L.L.C., Integrated Living
      Communities of Lafayette,


**69**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
L.L.C.,
      Integrated Living Communities of Henderson, L.P., Integrated Living
      Communities of Oakwell, L.P.,Integrated
      Living Communities of San Antonio, L.P., and Integrated Living Communities
      of McKinney, L.P.,(collectively,
      the "Seller") and the registrant ("Purchaser") dated April 4,
      2002.
    
    (25)10.68.2
    Horizon
      Bay Purchase Agreement between the registrant ("Purchaser") and Senior
      Lifestyle Shreveport, L.L.C("Seller"),
      dated April 17, 2002.
    
    (25)10.68.3
    First
      Amendment to the Horizon Bay Lease Facilities Purchase Agreement between
      the registrant ("Purchaser")and
      Integrated Living Communities of Alexandria, L.L.C., Integrated Living
      Communities of Lake Charles,L.L.C.,
      Integrated Living Communities of Lafayette, L.L.C., Integrated Living
      Communities of Henderson, L.P.,Integrated
      Living Communities of Oakwell, L.P., Integrated Living Communities of San
      Antonio, L.P., andIntegrated
      Living Communities of McKinney, L.P., (collectively, the "Seller") dated
      May 1, 2002.
    
    (25)10.68.4
    First
      Amendment to the Horizon Bay Purchase Agreement between the registrant
      ("Purchaser") and SeniorLifestyle
      Shreveport, L.L.C. ("Seller"), dated May 1, 2002.
    
    (25)10.68.5
    Amended
      and restated funding agreement between the registrant and HB-ESC I,
      L.L.C., HB-ESC II, L.L.C., andHB-ESC
      V, L.P., dated May 1, 2002.
    
    (25)10.68.6
    Agreement
      to provide management services to assisted living facilities (Lafayette)
      between HB-ESC II, L.P., andthe
      registrant dated May 1, 2002.
    
    (25)10.68.7
    Agreement
      to provide management services to assisted living facilities (Lake
      Charles) between HB-ESC II, L.P.,and
      the registrant dated May 1, 2002.
    
    (25)10.68.8
    Agreement
      to provide management services to assisted living facilities (Alexandria)
      between HB-ESC II, L.P.,and
      the registrant dated May 1, 2002.
    
    (25)10.68.9
    Agreement
      to provide management services to assisted living facilities (Shreveport)
      between HB-ESC I, L.P., andthe
      registrant dated May 1, 2002.
    
    (25)10.68.10
    Agreement
      to provide management services to assisted living facilities (Henderson)
      between HB-ESC V, L.P.,and
      the registrant dated May 9, 2002.
    
    (25)10.68.11
    Agreement
      to provide management services to assisted living facilities (Medical
      Center) between HB-ESC V,L.P.,
      and the registrant dated May 9, 2002.
    
    (25)10.68.12
    Agreement
      to provide management services to assisted living facilities (Oakwell
      Farms) between HB-ESC V,L.P.,
      and the registrant dated May 9, 2002.
    
    (25)10.68.13
    Agreement
      to provide management services to assisted living facilities (Stonebridge)
      between HB-ESC V, L.P.,and
      the registrant dated May 9, 2002.
    
    (25)10.68.14
    Second
      Amendment to the Horizon Bay Purchase Agreement between the registrant
      ("Purchaser") and SeniorLifestyle
      Shreveport, L.L.C. ("Seller"), dated May 31, 2002.
    
    (25)10.68.15
    Third
      Amendment to the Horizon Bay Purchase Agreement between the registrant
      ("Purchaser") and SeniorLifestyle
      Shreveport, L.L.C. ("Seller"), dated June 14, 2002.
    
    (25)10.68.16
    Fourth
      Amendment to the Horizon Bay Purchase Agreement between the registrant
      ("Purchaser") and SeniorLifestyle
      Shreveport, L.L.C. ("Seller"), dated June 28, 2002.
    
    (25)10.68.17
    Termination
      of Amended and Restated Funding Agreement by and between Emeritus
      Corporation ("Emeritus")and
      HB-ESC I, LLC, HB-ESC II, LLC, and HB-ESC V, LP (collectively "HB
      Entities") effective June 30, 2003.
    
    (31)10.68.18
    Global
      Amendment to Management Agreements by and between Emeritus Corporation
      ("Emeritus") and HB-ESCI,
      LLC, HB-ESC II, LLC, HB-ESC IV, LP, and HB-ESC V, LP (collectively "HB
      Licenses") effective June 30,2003
    
    (31)10.68.19
    Assignment
      and assumption of leases by and among HB-ESCII, LLC ("Assignor"), Emeritus
      Corporation,("Assignee"),
      and Daniel R. Baty, ("Guarantor"), dated December 31,
2003.
    
    (33)10.68.20
    Assignment
      and assumption of lease agreement (KP Stonebridge) by and among HB-ESC V,
      L.P., (“Assignor”),ESC
      IV, L.P., doing business in Texas as Texas-ESC IV, L.P. (“Assignee”),
      EMERITUS CORPORATION,(“Emeritus”),
      DANIEL R. BATY, (“Existing Guarantor”), and HR ACQUISITION OF SAN ANTONIO,
      LTD.,formerly
      known as Capstone Capital of San Antonio, Ltd., d/b/a Cahaba of San
      Antonio, Ltd. (“Lessor”), datedDecember
      31, 2003.
    
    (33)10.68.21
    Assignment
      and assumption of lease agreement (KP Henderson) by and among HB-ESC V,
      L.P., (“Assignor”),ESC
      IV, L.P., doing business in Texas as Texas-ESC IV, L.P. (“Assignee”),
      EMERITUS CORPORATION,


**70**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
(“Emeritus”),
      DANIEL R. BATY, (“Existing Guarantor”), and HR ACQUISITION OF SAN ANTONIO,
      LTD.,formerly
      known as Capstone Capital of San Antonio, Ltd., d/b/a Cahaba of San
      Antonio, Ltd. (“Lessor”), datedDecember
      31, 2003.
    
    (33)10.68.22
    Assignment
      and assumption of lease agreement (KP Medical) by and among HB-ESC V,
      L.P., (“Assignor”), ESCIV,
      L.P., doing business in Texas as Texas-ESC IV, L.P. (“Assignee”), EMERITUS
      CORPORATION,(“Emeritus”),
      DANIEL R. BATY, (“Existing Guarantor”), and HR ACQUISITION OF SAN ANTONIO,
      LTD.,formerly
      known as Capstone Capital of San Antonio, Ltd., d/b/a Cahaba of San
      Antonio, Ltd. (“Lessor”), datedDecember
      31, 2003.
    
    (33)10.68.23
    Assignment
      and assumption of lease agreement (KP Oakwell) by and among HB-ESC V,
      L.P., (“Assignor”), ESCIV,
      L.P., doing business in Texas as Texas-ESC IV, L.P. (“Assignee”), EMERITUS
      CORPORATION,(“Emeritus”),
      DANIEL R. BATY, (“Existing Guarantor”), and HR ACQUISITION OF SAN ANTONIO,
      LTD.,formerly
      known as Capstone Capital of San Antonio, Ltd., d/b/a Cahaba of San
      Antonio, Ltd. (“Lessor”), datedDecember
      31, 2003.
    
    (33)10.68.24
    Master
      Lease Agreement between HB-ESC I, LLC ("Landlord"), and Emeritus
      Corporation ("Tenant") datedDecember
      31, 2003.
    
    (36)**10.71**
    
    **Lodge
      at Eddy Pond, Massachusetts. The following agreements are representative
      of those executed in connection****with
      the property:**10.71.1
    Loan
      Agreement between Heller Healthcare Finance, Inc. ("Lender") and Emeritus
      Properties XIV, L.L.C.("Borrower")
      dated August 26, 2002.
    
    (27)10.71.2
    Promissory
      Note A between Heller Healthcare Finance, Inc. ("Holder") and Emeritus
      Properties XIV, L.L.C.("Maker")
      dated August 26, 2002.
    
    (27)10.71.3
    Subordinate
      Promissory Note B between Heller Healthcare Finance, Inc. ("Holder") and
      Emeritus Properties XIV,L.L.C.
      ("Maker") dated August 26, 2002.
    
    (27)10.71.4
    Real
      Property Mortgage with Power of Sale and Security Agreement
      (Massachusetts) dated August 21, 2002.
    
    (27)10.71.5
    Collateral
      Assignment of Management Agreement and Waiver of Property Management and
      Broker Liens datedAugust
      26, 2002.
    
    (27)10.71.6
    Guaranty
      by registrant ("Guarantor") to Heller Healthcare Finance, Inc. ("Lender")
      dated August 26, 2002.
    
    (27)10.71.7
    Lease
      and Rent Assignment Agreement between Emeritus Properties XIV, L.L.C.
      ("Assignor") to HellerHealthcare
      Finance, Inc. ("Assignee") dated August 21, 2002.
    
    (27)10.71.8
    Side
      Letter regarding Deutsche Bank Refinancing and the registrants intent on
      refinancing with Heller HealthcareFinance,
      Inc. ("Lender") dated August 26, 2002.
    
    (27)10.71.9
    Senior
      Housing Rider between Emeritus Properties XIV, L.L.C. ("Borrower"),
      Emeritus Corporation ("Manager")and
      Heller Healthcare Finance, Inc. ("Lender") dated August 26,
      2002.
    
    (27)10.71.10
    Hazardous
      Materials Indemnity Agreement between Emeritus Properties XIV, L.L.C.
      ("Borrower"), EmeritusCorporation
      ("Guarantor") and Heller Healthcare Finance, Inc. ("Lender") dated August
      26, 2002.
    
    (27)**10.72**
    
    **Champion
      Oaks, Texas, Collin Oaks, Texas, Galleria Oaks, Alabama, Loyalton of
      Austin, Texas, Loyalton of Lake****Highlands,
      Texas, Memorial Oaks, Texas, Meridian Oaks, Indiana, Sugar Land Oaks,
      Texas, Tanglewood Oaks,****Texas,
      Woodbridge Estates, Texas, Village Oaks at Chandler, Arizona, Cielo Vista,
      Texas, Conway, Florida,****Farmers
      Branch, Texas, Fort Wayne, Indiana, Glendale, Arizona, Greenwood, Indiana,
      Hollywood Park, Texas,****Las
      Vegas, Nevada, Melbourne, Florida, Mesa, Arizona, Orange Park, Florida,
      Southpoint, Florida, Tuskawilla,****Florida.
      The following agreements are representative of those executed in
      connection with the properties:**10.72.1
    Master
      Lease Agreement between various subsidiaries and affiliates of Fretus
      Investors L.L.C. ("Landlord") andEmeritus
      Properties-NGH, L.L.C. and ESC-NGH, L.P. ("Tenant") dated October 1,
      2002.
    
    (26)**10.73**
    
    **Concorde,
      Nevada, Courtyard at the Willows, Washington, Fulton Villa, California,
      Juniper Meadows, Idaho, La****Casa
      Grande, Florida , Lodge at Eddy Pond, Massachusetts, River Oaks, Florida,
      Silver Pines, Iowa ,****Springmeadows,
      Montana, Stanford Centre, Florida, Villa del Rey, California. The
      following agreements are****representative
      of those executed in connection with these
      properties:**10.73.1
    Master
      Lease by Emeritus Realty II, LLC, Emeritus Realty III, LLC, Emeritus
      Realty V, LLC, Emeritus RealtyVII,
      LLC, Emeritus Realty XIV, LLC, Emeritus Realty Puyallup, LLC, Emeritus
      Realty Bozeman, LLC, ESC-Port
      St. Richie, LLC, (collectively “Lessor”) and Emeritus Corporation,
      Emeritus Properties II, Inc., Emeritus


**71**
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**Footnote****Number**
    
    **Description**
    
    **Number**
Properties
      III, Inc., Emeritus Properties V, Inc., Emeritus Properties XIV, LLC,
      ESC-New Port Richey, LLC,ESC-Bozeman,
      LLC, dated December 6, 2002.
    
    (28)10.73.2
    Loan
      Agreement by and between General Electric Capital Corporation, a Delaware
      corporation, and EmeritusRealty
      II, LLC, Emeritus Realty III, LLC, Emeritus Realty V, LLC, Emeritus Realty
      VII, LLC, Emeritus RealtyXIV,
      LLC, Emeritus Realty Bozeman, LLC, Emeritus Realty Puyallup, LLC, ESC-Port
      St. Richie. LLC, datedDecember
      6, 2002.
    
    (28)10.73.3
    Promissory
      Note A by Emeritus Realty II, LLC, Emeritus Realty III, LLC, Emeritus
      Realty V, LLC, EmeritusRealty
      VII, LLC, Emeritus Realty XIV, LLC, Emeritus Realty Bozeman, LLC, Emeritus
      Realty Puyallup, LLC,ESC-Port
      St. Richie. LLC, to General Electric Capital Corporation, a Delaware
      corporation, dated December 6,2002
    
    (28)10.73.4
    Subordinated
      Promissory Note B by ESC-Port St. Richie, LLC, a Washington limited
      liability company, toGeneral
      Electric Capital Corporation, dated December 6, 2002.
    
    (28)10.73.5
    Loan
      Agreement by and between Emeritus Realty Corporation, a Nevada corporation
      and Health Care PropertyInvestors,
      Inc., a Maryland corporation, dated December 6, 2002.
    
    (28)10.73.6
    Promissory
      Note by Emeritus Realty Corporation, a Nevada corporation, to Health Care
      Property investors, Inc., aMaryland
      corporation, dated December 6, 2002.**10.74**
    
    **Hearthside
      Issaquah, Washington. The following agreements are representative of those
      executed in connection with****these
      properties:**10.74.1
    Second
      Amendment to Loan Agreement by and between Emeritus Properties XIII, LLC
      ("Borrower") and GMACCommercial
      Mortgage Corporation, ("Lender") dated January 29, 2003.
    
    (28)10.74.2
    Restatement,
      Amendment, and Bifurcation of Promissory Note A between Emeritus
      Properties XIII, LLC("Borrower"),
      and GMAC Commercial Mortgage Corporation ("Lender") dated January 29,
      2003.
    
    (28)10.74.3
    Restatement,
      Amendment, and Bifurcation of Promissory Note B between Emeritus
      Properties XIII, LLC("Borrower"),
      and GMAC Commercial Mortgage Corporation ("Lender") dated January 29,
      2003.
    
    (0)10.74.4
    Amendment
      to Promissory Note between M&M Properties ("Holder") and Emeritus
      Corporation and EmeritusProperties
      XIII, LLC ("Maker") dated January 29, 2003.
    
    (28)**10.75**
    
    **Loyalton
      of Bloomsburg, Pennsylvania; Loyalton of Creekview, Pennsylvania; Loyalton
      of Harrisburg, Pennsylvania;****Loyalton
      of Danville, Virginia; Loyalton of Harrisonburg, Virginia; Loyalton of
      Roanoke, Virginia; Loyalton of****Greensboro,
      North Carolina; Loyalton of Ravenna, Ohio. The following agreements are
      representative of those****executed
      in connection with these properties:**10.75.1
    Lease
      Agreement by HR Acquisition I Corporation ("Tenant"), Capstone Capital of
      Pennsylvania, Inc., and HRTHoldings,
      Inc. (collectively the "Lessor") and Emeritus Corporation ("Lessee") dated
      May 1, 2003.
    
    (29)10.75.2
    Promissory
      Note by Emeritus Corporation ("Maker"), for HR ACQUISITION I CORPORATION
      ("Payee") forprincipal
      amount of $600,000.00 dated May 1, 2003.
    
    (29)10.75.3
    Bill
      of Sale, Blanket Conveyance and Assignment by BCC at Bloomsburg, Inc.
      ("Tenant") and BCC Developmentand
      Management Co. ("Manager") to and for the benefit of Capstone Capital of
      Pennsylvania, Inc. ("HCRTAssignee")
      and Emeritus Corporation ("Emeritus Assignee") dated May 1,
      2003.
    
    (29)10.75.4
    Bill
      of Sale, Blanket Conveyance and Assignment by ALCO VI, LLC ("Tenant") and
      Balance Care atMechanicsburg,
      Inc. ("Manager") to and for the benefit of Capstone Capital of
      Pennsylvania, Inc. ("HCRTAssignee")
      and Emeritus Corporation ("Emeritus Assignee") dated May 1,
      2003.
    
    (29)10.75.5
    Bill
      of Sale, Blanket Conveyance and Assignment by Extended Care Operators of
      Harrisburg, LLC ("Tenant")and
      BCC at Harrisburg, Inc. ("Manager") to and for the benefit of Capstone
      Capital of Pennsylvania, Inc. ("HCRTAssignee")
      and Emeritus Corporation ("Emeritus Assignee") dated May 1,
      2003.
    
    (29)10.75.6
    Bill
      of Sale, Blanket Conveyance and Assignment by ALCO XI, LLC ("Tenant") and
      BCC at Danville, Inc.("Manager")
      to and for the benefit of HRT Holdings, Inc. ("HCRT Assignee") and
      Emeritus Corporation("Emeritus
      Assignee") dated May 1, 2003.
    
    (29)10.75.7
    Bill
      of Sale, Blanket Conveyance and Assignment by ALCO IX, LLC ("Tenant") and
      BCC at Harrisonburg, Inc.("Manager")
      to and for the benefit of HRT Holdings, Inc. ("HCRT Assignee") and
      Emeritus Corporation("Emeritus
      Assignee") dated May 1, 2003.
    
    (29)10.75.8
    Bill
      of Sale, Blanket Conveyance and Assignment by ALCO X, LLC ("Tenant") and
      BCC at Roanoke, Inc.


**72**
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**Footnote****Number**
    
    **Description**
    
    **Number**
("Manager")
      to and for the benefit of HRT Holdings, Inc. ("HCRT Assignee") and
      Emeritus Corporation("Emeritus
      Assignee") dated May 1, 2003.
    
    (29)10.75.9
    Bill
      of Sale, Blanket Conveyance and Assignment by Extended Care Operators of
      Greensboro, LLC ("Tenant")and
      BCC at Greensboro, Inc. ("Manager") to and for the benefit of HR
      Acquisition I Corporation ("HCRTAssignee")
      and Emeritus Corporation ("Emeritus Assignee") dated May 1,
      2003.
    
    (29)10.75.10
    Bill
      of Sale, Blanket Conveyance and Assignment by Extended Care Operators of
      Ravenna, LLC ("Tenant") andBCC
      at Ravenna, Inc. ("Manager") to and for the benefit of HR Acquisition I
      Corporation ("HCRT Assignee")and
      Emeritus Corporation ("Emeritus Assignee") dated May 1,
    2003.
    
    (29)10.75.11
    Operations
      and Transfer Agreement by and among BCC at Bloomsburg, Inc. (“Tenant”),
      BCC Development andManagement
      Co. (“Manager”) and Balanced Care Corporation (“Parent”) and Emeritus
      Corporation (“NewOperator”)
      and Capstone Capital of Pennsylvania, Inc. (“Owner”) dated April 30,
      2003.
    
    (29)10.75.12
    Operations
      and Transfer Agreement by and among ALCO VI, LLC (“Tenant”), Balanced Care
      at Mechanicsburg,Inc.
      (“Manager”) and Balanced Care Corporation (“Parent”) and Emeritus
      Corporation (“New Operator”) andCapstone
      Capital of Pennsylvania, Inc. (“Owner”) dated April 30,
    2003.
    
    (29)10.75.13
    Operations
      and Transfer Agreement by and among Extended Care Operators of Harrisburg,
      LLC (“Tenant”), BCCat
      Harrisburg, Inc. (“Manager”) and Balanced Care Corporation (“Parent”) and
      Emeritus Corporation (“NewOperator”)
      and HR Acquisition I Corporation (“Owner”) dated April 30,
      2003.
    
    (29)10.75.14
    Operations
      and Transfer Agreement by and among ALCO XI, LLC (“Tenant”), BCC at
      Danville, Inc.(“Manager”)
      and Balanced Care Corporation (“Parent”) and Emeritus Corporation (“New
      Operator”) and HRTHoldings,
      Inc. (“Owner”) dated April 30, 2003.
    
    (29)10.75.15
    Operations
      and Transfer Agreement by and among ALCO IX, LLC (“Tenant”), BCC at
      Harrisonburg, Inc.(“Manager”)
      and Balanced Care Corporation (“Parent”) and Emeritus Corporation (“New
      Operator”) and HRTHoldings,
      Inc. (“Owner”) dated April 30, 2003.
    
    (29)10.75.16
    Operations
      and Transfer Agreement by and among ALCO X, LLC (“Tenant”), BCC at
      Roanoke, Inc.(“Manager”)
      and Balanced Care Corporation (“Parent”) and Emeritus Corporation (“New
      Operator”) and HRTHoldings,
      Inc. (“Owner”) dated April 30, 2003.
    
    (29)10.75.17
    Operations
      and Transfer Agreement by and among Extended Care Operators of Greensboro,
      LLC (“Tenant”),BCC
      at Greensboro, Inc. (“Manager”) and Balanced Care Corporation (“Parent”)
      and Emeritus Corporation(“New
      Operator”) and HR Acquisition I Corporation (“Owner”) dated April 30,
      2003.
    
    (29)10.75.18
    Operations
      and Transfer Agreement by and among Extended Care Operators of Ravenna,
      LLC (“Tenant”), BCCat
      Ravenna, Inc. (“Manager”) and Balanced Care Corporation (“Parent”) and
      Emeritus Corporation (“NewOperator”)
      and HR Acquisition I Corporation (“Owner”) dated April 30,
      2003.
    
    (29)10.75.19
    Assignment
      and Assumption Agreement by and among BCC at Bloomsburg, Inc. (the
      “Tenant”), BCCDevelopment
      and Management Co. (“Manager”) and Emeritus Corporation (the “Assignee”)
      dated April 30,2003
    
    (29)10.75.20
    Assignment
      and Assumption Agreement by and among ALCO VI, LLC (the “Tenant”),
      Balanced Care atMechanicsburg,
      Inc. (“Manager”) and Emeritus Corporation (the “Assignee”) dated April 30,
      2003.
    
    (29)10.75.21
    Assignment
      and Assumption Agreement by and among Extended Care Operators of
      Harrisburg, LLC (the“Tenant”),
      BCC at Harrisburg, Inc. (“Manager”) and Emeritus Corporation (the
      “Assignee”) dated April 30, 2003.
    
    (29)10.75.22
    Assignment
      and Assumption Agreement by and among ALCO XI, LLC (the “Tenant”), BCC at
      Danville, Inc.(“Manager”)
      and Emeritus Corporation (the “Assignee”) dated April 30,
      2003.
    
    (29)10.75.23
    Assignment
      and Assumption Agreement by and among ALCO IX, LLC (the “Tenant”), BCC at
      Harrisonburg,Inc.
      (“Manager”) and Emeritus Corporation (the “Assignee”) dated April 30,
      2003.
    
    (29)10.75.24Assignment
      and Assumption Agreement by and among ALCO X, LLC (the “Tenant”), BCC at
      Roanoke, Inc.(“Manager”)
      and Emeritus Corporation (the “Assignee”) dated April 30,
      2003.
    
    (29)10.75.25
    Assignment
      and Assumption Agreement by and among Extended Care Operators of
      Greensboro, LLC (the“Tenant”),
      BCC at Greensboro, Inc. (“Manager”) and Emeritus Corporation (the
      “Assignee”) dated April 30,2003
    
    (29)10.75.26
    Assignment
      and Assumption Agreement by and among Extended Care Operators of Ravenna,
      LLC (the“Tenant”),
      BCC at Ravenna, Inc. (“Manager”) and Emeritus Corporation (the “Assignee”)
      dated April 30, 2003.
    
    (29)


**73**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
10.75.27
    Leasehold
      Mortgage with Security Agreement and Assignment of Rents for location:
      Bloomsburg, Pennsylvania,by
      Emeritus Corporation ("Mortgagor"), for the benefit of Capstone Capital of
      Pennsylvania, Inc.("Mortgagee"),dated
      May 1, 2003.
    
    (29)10.75.28
    Leasehold
      Mortgage with Security Agreement and Assignment of Rents for location:
      Mechanicsburg,Pennsylvania,
      by Emeritus Corporation ("Mortgagor"), for the benefit of Capstone Capital
      of Pennsylvania,Inc.("Mortgagee"),
      dated May 1, 2003.
    
    (29)10.75.29
    Leasehold
      Mortgage with Security Agreement and Assignment of Rents for location:
      Harrisburg, Pennsylvania,by
      Emeritus Corporation ("Mortgagor"), for the benefit of Capstone Capital of
      Pennsylvania, Inc.("Mortgagee"),dated
      May 1, 2003.
    
    (29)10.75.30
    Leasehold
      Deed of Trust with Security Agreement and Assignment of Rents for
      location: Danville, Virginia, byEmeritus
      Corporation ("Grantor"), for the benefit of HRT Holdings,
      Inc.("Beneficiary"), dated May 1, 2003.
    
    (29)10.75.31
    Leasehold
      Deed of Trust with Security Agreement and Assignment of Rents for
      location: Harrisonburg, Virginia,by
      Emeritus Corporation ("Grantor"), for the benefit of HRT Holdings,
      Inc.("Beneficiary"), dated May 1, 2003.
    
    (29)10.75.32
    Leasehold
      Deed of Trust with Security Agreement and Assignment of Rents for
      location: Roanoke, Virginia, byEmeritus
      Corporation ("Grantor"), for the benefit of HRT Holdings,
      Inc.("Beneficiary"), dated May 1, 2003.
    
    (29)10.75.33
    Leasehold
      Deed of Trust with Security Agreement and Assignment of Rents for
      location: Greensboro, NorthCarolina,
      by Emeritus Corporation ("Grantor"), for the benefit of HR Acquisition I
      Corporation ("Beneficiary"),dated
      May 1, 2003
    
    (29)10.75.34
    Leasehold
      Deed of Trust with Security Agreement and Assignment of Rents for
      location: Ravenna, Ohio, byEmeritus
      Corporation ("Grantor"), for the benefit of HR Acquisition I Corporation
      ("Beneficiary"), dated May 1,2003
    
    (29)**10.76**
    
    **Emeritus
      Oaks of Silverdale, Washington. The following agreements are
      representative of those executed in****connection
      with this property:**10.76.1
    Lease
      Agreement by WASHINGTON LESSOR - SILVERDALE, INC., ("Lessor"), and
      ESC-Silverdale, LLC,("Lessee")
      dated August 15, 2003, effective November 1, 2003.
    
    (49)10.76.2
    Guaranty
      given by Emeritus Corporation ("Guarantor"), in favor of WASHINGTON LESSOR
      - SILVERDALE,INC.,
      ("Lessor") dated August 15, 2003.
    
    (49)**10.77**
    
    **The
      Palms at Loma Linda, California, The Springs at Oceanside, California, The
      Fairways of Augusta, Kansas,****Liberal
      Springs, Kansas, Loyalton of Broadmoor, Colorado. The following agreements
      are representative of those****executed
      in connection with this property:**10.77.1
    Loan
      Assumption Agreement by and between LaSalle Bank National Association,
      formerly known as LaSalleNational
      Bank as Trustee for GMAC commercial Mortgage Pass-through certificates,
      series 1998-C2. ("Lendor"),ALS
      Financing Inc. ("Borrower"), Emeritus Properties XVI, Inc. ("Purchaser"),
      Alterra Healthcare Corporation("Alterra"),
      and Emeritus Corporation ("New Indemnitor"), dated December 31, 2003,
      effective January 1, 2004.
    
    (34)10.77.2
    Assumption
      by Emeritus Properties XVI, Inc., (“New Borrower”), of $25,000,000 Loan
      (the “Loan”) originallymade
      by GMAC Commercial Mortgage Corporation, (“Original Lender”), to ALS
      Financing, Inc., a Kansascorporation
      (“Existing Borrower”), pursuant to that certain Loan Agreement, dated as
      of June 30, 1998, by andbetween
      Original Lender and Existing Borrower (the “Loan Agreement”), which Loan
      is evidenced by that certainPromissory
      Note, dated July 30, 1998, and made by Existing Borrower payable to the
      order of Original Lender inthe
      stated principal amount of $25,000,000.00 (the “Note”), is secured by
      certain security instruments(collectively,
      the “Security Instruments”; and the Loan Agreement, the Note, and the
      Security Instruments,together
      with any and all other instruments and documents evidencing, securing, or
      otherwise pertaining to theLoan
      are hereinafter referred to collectively as the “Loan Documents”)
      encumbering five assisted living facilitieslocated
      in Kansas, Colorado, and California (collectively, the “Projects”), and is
      now owned and held by LaSalleBank
      National Association, formerly known as LaSalle National Bank, as Trustee
      for GMAC CommercialMortgage
      Securities, Inc., Commercial Mortgage Pass-Through Certificates, Series
      1998-C2 (“Lender”), datedDecember
      31, 2003.
    
    (34)10.77.3
    Assignment,
      Amendment and Restatement of Lease Agreement by and between ALS FINANCING,
      INC.,(“ALS”),
      EMERITUS PROPERTIES XVI, INC. (“Emeritus XVI”) and ALTERRA HEALTHCARECORPORATION
      ("Alterra") dated December 31, 2003.
    
    (34)


**74**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
10.77.4
    CONVEYANCE
      AND OPERATIONS TRANSFER AGREEMENT (the “Agreement”) by and among ALSFINANCING,
      INC., (the "Seller"), ALTERRA HEALTHCARE CORPORATION, (“Alterra”), and
      EMERITUSPROPERTIES
      XVI, INC., (the "Purchaser") is made and entered into as of the 31st day
      of December, 2003 (the"Execution
      Date").
    
    (34)10.77.5
    UNCONDITIONAL
      GUARANTY OF PAYMENT AND PERFORMANCE (this “Guaranty”), by
      EMERITUSCORPORATION,
      a Washington corporation (“Guarantor”), in favor of LASALLE BANK NATIONALASSOCIATION,
      FORMERLY KNOWN AS LASALLE NATIONAL BANK, AS TRUSTEE FOR GMACCOMMERCIAL
      MORTGAGE PASS-THROUGH CERTIFICATES, SERIES 1998-C2 (“Lender”) is made as
      ofthe
      31st day of December, 2003, and is effective as of January 1,
      2004.
    
    (34)**10.78**
    
    **Royalton
      Court Kent, Washington. The following agreements are representative of
      those executed in connection with****this
      property:**10.78.1
    Agreement
      to provide management services to assisted living facility by and between
      Royalton/Kent, LLC,("Licensee")
      and Emeritus Corporation, ("Manager") dated February 16,
    2003.
    
    (36)**10.79**
    
    **Loyalton
      of Folsom, California; The Lakes, Florida; Canterbury Woods,
      Massachusetts; Beckett Meadows,****Texas;
      Creekside, Texas; Oak Hollow, Texas; Pinehurst, Texas; Stonebridge, Texas,
      Desert Springs, Texas;****Austin
      Gardens, California; Kingsley Place Shreveport, Louisiana; Silverleaf
      Manor, Mississippi;****Pine
      Meadow, Mississippi; Pines of Goldsboro, North Carolina; Loyalton of
      Rockford, Illinois;****Charleston
      Gardens, West Virginia; Arbor Gardens at Corona, California; and Manor at
      Essington, Illinois.****The
      following agreements are representative of those executed in connection
      with these properties:**10.79.1
    Purchase
      and Sale Agreement ("Agreement") by and between Lodi Care Group LLC,
      Aurora Bay/Columbus,L.L.C.,
      Aurora Bay/Hattiesburg, L.L.C., Spring Creek Group, Ltd., Bedford Care
      Group, Ltd.,Tyler
      Group, Ltd., White Rock Care Group, Ltd., El Paso Care Group, Ltd., and
      Lubbock Group, Ltd.,(each
      of the foregoing individually, a "Seller" and collectively, "Sellers") and
      Emeritus Corporation,"Purchaser")
      and Aurora Bay Investments, LLC, ("ABI"), and JCI, LLC, ("JCI" and
      together with ABI,the
      "Guarantors") dated March, 30, 2004 (the "Execution Date").
    
    (38)10.79.2
    Purchase
      and Sale Agreement ("Agreement") by and among (i) The Lakes Assisted
      Living, LLC,Sacramento
      County Assisted LLC, Rockford Retirement Residence, LLC, HB-ESC I,LLC,
      Canterbury Woods Assisted Living, LLC, Autumn Ridge Herculaneum, L.L.C.,Meridian
      Assisted, L.L.C., Goldsboro Assisted, L.L.C., Cape May Assisted Living,
      LLC,Travis
      County Assisted Living LP, Richland Assisted, L.L.C., Silver Lake AssistedLiving
      LLC, Charleston Assisted Living, LLC, and Joliet Assisted L.L.C., (each of
      theforegoing
      individually, a "Seller" and collectively, the "Sellers") and (ii)
      Emeritus Corporation,("Purchaser")
      dated March, 31, 2004 (the "Execution Date").
    
    (38)10.79.3
    Master
      Lease agreement between NHP Senior Housing, Inc., ("Landlord"), and
      EmeritusCorporation,
      ("Tenant"), dated March 31, 2004 to be effective as of April 1,
      2004(the
      "Effective Date").
    
    (38)10.79.4
    Master
      Lease among the Entities Listed on Schedule 1A (collectively, "Landlord"),
      and the Entities Listedon
      Schedule 1B (collectively, "Tenant"), for the respective real properties
      and improvements thereon(each
      a "Facility" and collectively, the "Facilities"), dated March 31, 2004, to
      be effective as ofApril
      1, 2004 (the "Effective Date").
    
    (38)10.79.5
    Nomination
      Agreement ("Agreement") made as of March 31, 2004, by and betweenNationwide
      Health Properties, Inc., ("NHP"), and Emeritus Corporation,
      ("Emeritus").
    
    (38)10.79.6
    Nomination
      Agreement ("Agreement") made as of March 31, 2004, by and betweenNationwide
      Health Properties, Inc., ("NHP"), and Emeritus Corporation,
      ("Emeritus").
    
    (38)10.79.7
    First
      Amendment to Master Lease made as of May 28, 2004, to be effective as of
      June 1, 2004, byand
      among Nationwide Health Properties, Inc., a Maryland corporation,
      NHTexas
      Properties Limited Partnership, a Texas limited partnership, MLD Delaware
      Trust,a
      Delaware business trust, and MLD Properties, LLC, a Delaware limited
      liability company (collectively,as
      “Landlord”), and Emeritus Corporation, a Washington corporation, and ESC
      IV, LP,a
      Washington limited partnership (collectively as “Tenant”)
    
    (42)10.79.8
    Second
      Amendment to Master Lease made as of October 1, 2004, to be effective as
      of October 1, 2004, by


**75**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
and
      among Nationwide Health Properties, Inc., a Maryland corporation,
      NHTexas
      Properties Limited Partnership, a Texas limited partnership, MLD Delaware
      Trust,a
      Delaware business trust, and MLD Properties, LLC, a Delaware limited
      liability company (collectively,as
      “Landlord”), and Emeritus Corporation, a Washington corporation, and ESC
      IV, LP,a
      Washington limited partnership (collectively as “Tenant”)
    
    (48)10.79.9
    Lease
      dated October 1, 2004, NHP Joliet, Inc., an Illinois corporation
      (“Landlord”), and EmeritusCorporation,
      a Washington corporation (“Tenant”) for an assisted living facility
      located in Joliet,Illinois.
    
    (48)**10.80**
    
    **Credit
      Agreement**10.80.1
    Credit
      Agreement between U.S. National Association and Emeritus Corporation dated
      March 16, 2004.
    
    (40)10.80.2
    Exhibit
      A to Credit Agreement; Revolving Note.
    
    (40)10.80.3
    Exhibit
      B to Credit Agreement; Pledge Agreement.
    
    (40)10.80.4
    First
      Amendment to Credit Agreement between U.S. National Association and
      Emeritus Corporationdated
      July 20, 2004.
    
    (42)10.80.5
    Certificate
      As To Authorizing Resolutions And Incumbency Certificate dated July 20,
      2004
    
    (42)10.80.6
    US
      Bank Line Of Credit Resolutions
    
    (42)**10.81**
    
    **Grand
      Terrace, California**10.81.1
    Master
      Lease Agreement as of June 1, 2004 between Grand Terrace Assisted LP, a
      limitedpartnership
      organized under the laws of the State of Washington (“Landlord”) and
      Emeritus Corporation,a
      corporation organized under the laws of the State of Washington
      (“Tenant”)
    
    (42)**10.82**
    
    **Health
      Care Properties Investors, Inc.**10.82.1
    Contract
      Of Acquisition Between Emeritus Corporation and Health Care Property
      Investors, Inc., datedJuly 30,
      2004.
    
    (42)10.82.2
    Fourth
      Amendment to Amended And Restated Master Lease (This “Amendment”) dated
      July 30 , 2004 (the“Effective
      Date”), among Health Care Property Investors, Inc., a Maryland corporation
      (“HCP”), HCPI TrustHCPI
      Trust, a Maryland real estate trust (“HCP Trust”), Emeritus Realty III,
      LLC, a Delaware limitedliability
      company (“ER-III”), Emeritus Realty V, LLC, a Delaware limited liability
      company (“ER-V”),ESC-La
      Casa Grande, LLC, a Delaware limited liability company (“La Casa Grande”)
      and Texas HCP Holding,L.P.,
      a Delaware limited partnership (“Texas HCP,” and together with HCP, HCP
      Trust, ER-III, ER-V and LaCasa
      Grande, “Lessor”), on the one hand, and Emeritus Corporation, a Washington
      Corporation (“Emeritus”),ESC
      III, L.P., a Washington limited partnership d/b/a Texas-ESC III, L.P.
      (“Texas ESC”), Emeritus PropertiesII,
      Inc., a Washington corporation (“Emeritus II”), Emeritus Properties III,
      Inc., a Washington corporation(“Emeritus
      III”), Emeritus Properties V, Inc., a Washington Corporation (“Emeritus
      V”), Emeritus PropertiesXIV,
      LLC, a Washington Limited Liability Company (“Emeritus XIV"), ESC-Bozeman,
      LLC, a WashingtonLimited
      Liability Company (“ESC Bozeman”) and ESC-New Port Richey, LLC, A
      Washington Limited LiabilityCompany
      (“ESC New Port Richey”) (collectively, As “Lessee”).
    
    (7)10.82.3
    Amendment
      of Loan Documents - Heritage Hills.
    
    (7)10.82.4
    Amended
      and Restated Secured Promissory Note - Heritage Hills.
    
    (7)**10.83**
    
    **Barrington
      Place, Lecanto, Florida; Bellaire Place, Greenville, South Carolina;
      Brookside Estates, Middleberg****Heights,
      Ohio; Dowlen Oaks, Beaumont, Texas; Eastman Estates, Longview, Texas; Elm
      Grove, Hutchinson,****Kansas;
      Emeritus Estates, Ogden, Utah; Gardens at White Chapel, Newark, Delaware;
      Harbor Pointe Shores,****Ocean
      Shores, Washington; Hunters Glen, Missoula, Montana; Lakeridge Place,
      Wichita Falls, Texas;****Meadowlands
      Terrace, Waco, Texas; Myrtlewood Estates, San Angelo, Texas; Pavilion at
      Crossing Pointe,****Orlando,
      Florida; Seville Estates, Amarillo, Texas; Saddleridge Lodge, Midland,
      Texas; Springtree, Sunrise,****Florida;
      The Terrace, Grand Terrace, California; Wilburn Gardens, Fredericksburg,
      Virginia; Woodmark****at
      Summit Ridge, Reno, Nevada.**10.83.1
    Master
      Lease Agreement between Health Care REIT, Inc.; HCRI Nevada Properties,
      Inc.; HCRI KansasProperties,
      LLC; HCRI Texas Properties, Ltd.; and Emeritus Corporation dated September
      30, 2004
    
    (43)10.83.2
    UNCONDITIONAL
      AND CONTINUING LEASE GUARANTY effective as of September 30, 2004 (the“Effective
      Date”) by Daniel R. Baty (“Guarantor”), in favor of Health Care, Inc., a
      corporationorganized
      under the laws of the State of Delaware, HCRI Nevada Properties,
      Inc., a corporation


**76**
Table of Contents

**Footnote****Number**
    
    **Description**
    
    **Number**
organized
      under the laws of the State of Nevada, HCRI Kansas Properties, LLC, a
      limited liabilityliability
      company organized under the laws of the State of Delaware, and
      HCRI Texas Properties, Ltd., alimited
      partnership organized under the laws of the State of Texas (collectively
      “Landlord”).
    
    (43)10.83.3
    Agreement
      between Emeritus Corporation and Daniel R. Baty (Cash Flow), dated
      September 30, 2004
    
    (43)10.83.4
    Agreement
      among Grand Terrace Assisted LP, MM Assisted, L.L.C., Reno Assisted
      Living,L.L.C.,
      Fredericksburg Assisted Living L.L.C., Daniel R. Baty and Emeritus
      Corporation(Purchase,
      Sale and Assignment Agreement of 4 Baty Facilities and 16 AL-I
      Facilities), dated September 30. 2004
    
    (43)10.83.5
    Master
      Agreement between AL-I and Baty (Purchase of 16 AL-I Facilities), dated
      September 30, 2004
    
    (43)21.1
    
    
    Subsidiaries
      of the registrant.
    
    (53)23.1
    
    
    Consent
      of Independent registered public accounting firm.
    
    (53)31.1
    
    
    Certification
      of Periodic Reports31.1.1
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
      the Sarbanes-Oxley Actof
      2002 for Daniel R. Baty dated March 30, 2005.
    
    (53)31.1.2
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
      the Sarbanes-Oxley Actof
      2002 for Raymond R. Brandstrom dated March 30, 2005.
    
    (53)32.1
    
    
    Certification
      of Periodic Reports32.1.1
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Actof
      2002 for Daniel R. Baty dated March 30, 2005.
    
    (53)32.1.2
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Actof
      2002 for Raymond R. Brandstrom dated March 30, 2005.
    
    (53)99.1
    
    
    Press
      Releases91.1.1
    Press
      Release dated February 25, 2005, announcing the results of a jury verdict
      and plans to appeal .
    
    (50)91.1.2
    Press
      Releases dated March 3, 2005, announcing a $21.4 million
      refinance.
    
    (51)99.1.3
    Press
      Release dated March 31, 2005, reports on fourth quarter and year 2004
      results.
    
    (52)




(1)Incorporated
by reference to the indicated exhibit filed with the Company’s Registration
Statement on Form S-1 (File No. 33-97508) declared effective onNovember
21, 1995.
(2)Incorporated
by reference to the indicated exhibit filed with the Company’s Annual Report on
Form 10-K (File No. 1-14012) on March 29, 1996.
(3)Incorporated
by reference to the indicated exhibit filed with the Company’s Second Quarter
Report on Form 10-Q (File No. 1-14012) on August 14, 1996.
(4)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 14, 1996.
(5)Incorporated
by reference to the indicated exhibit filed with the Company’s Annual Report on
Form 10-K (File No. 1-14012) on March 31, 1997.
(6)Incorporated
by reference to the indicated exhibit filed with the Company’s First Quarter
Report on Form 10-Q (File No. 1-14012) on May 15, 1997.
(7)Incorporated
by reference to the indicated exhibit filed with the Company’s Current Report on
Form 8-K (File No. 1-14012) on May 16, 1997.
(8)Incorporated
by reference to the indicated exhibit filed with the Company’s Current Report on
Form 8-K Amendment No. 1 (File No. 1-14012) on July 14,1997.
(9)Incorporated
by reference to the indicated exhibit filed with the Company’s Second Quarter
Report on Form 10-Q (File No. 1-14012) on August 14, 1997.
(10)Incorporated
by reference to the indicated exhibit filed with the Company’s Registration
Statement on Form S-3 Amendment No. 2 (File No. 333-20805) onAugust
14, 1997.
(11)Incorporated
by reference to the indicated exhibit filed with the Company’s Registration
Statement on Form S-3 Amendment No. 3 (File No. 333-20805) onOctober
29, 1997.
(12)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 14, 1997.
(13)Incorporated
by reference to the indicated exhibit filed with the Company’s Annual Report on
Form 10-K (File No. 1-14012) on March 30, 1998.
(14)Incorporated
by reference to the indicated exhibit filed with the Company’s Registration
Statement on Form S-8 (File No. 333-60323) on July 31, 1998.
(15)Incorporated
by reference to the indicated exhibit filed with the Company’s Second Quarter
Report on Form 10-Q (File No. 1-14012) on August 14, 1998
(16)Incorporated
by reference to the indicated exhibit filed with the Company’s Annual Report on
Form 10-K (File No. 1-14012) on March 31, 1999.
(17)Incorporated
by reference to the indicated exhibit filed with the Company’s First Quarter
Report on Form 10-Q (File No. 1-14012) on May 10, 1999.
(18)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 15, 1999.
(19)Incorporated
by reference to the indicated exhibit filed with the Company’s Form 8-K (File
No. 1-14012) on January 14, 2000.
(20)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 14, 2000.
(21)Incorporated
by reference to the indicated exhibit filed with the Company's Annual Report on
Form 10-K (File No. 1-14012) on April 2, 2001.
(22)Incorporated
by reference to the indicated exhibit filed with the Company's Current Report on
Form 8-K (File No. 1-14012) on July 18, 2001.
(23)Incorporated
by reference to the indicated exhibit filed with the Company's Definitive Proxy
Statement on Form DEF 14A on August 17, 2001.
(24)Incorporated
by reference to the indicated exhibit filed with the Company's Annual Report on
Form 10-K (File No. 1-14012) on March 29, 2002.
(25)Incorporated
by reference to the indicated exhibit filed with the Company’s Second Quarter
Report on Form 10-Q (File No. 1-14012) on August 14, 2002.
(26)Incorporated
by reference to the indicated exhibit filed with the Company's Form 8-K (File
No. 1-14012) on October 15, 2002.
(27)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 8, 2002.
(28)Incorporated
by reference to the indicated exhibit filed with the Company's Annual Report on
Form 10-K (File No. 1-14012) on March 27, 2003.
(29)Incorporated
by reference to the indicated exhibit filed with the Company’s First Quarter
Report on Form 10-Q (File No. 1-14012) on May 9, 2003.
(30)Incorporated
by reference to the indicated exhibit filed with the Company’s Second Quarter
Report on Form 10-Q (File No. 1-14012) on August 8, 2003.
(31)Incorporated
by reference to the indicated exhibit filed with the Company’s Form 8-K (File
No. 1-14012) on October 14, 2003.
(32)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on November 7, 2003.
(33)Incorporated
by reference to the indicated exhibit filed with the Company’s Form 8-K (File
No. 1-14012) on January 14, 2004.
(34)Incorporated
by reference to the indicated exhibit filed with the Company’s Form 8-K (File
No. 1-14012) on January 14, 2004.
(35)Incorporated
by reference to the indicated exhibit filed with the Company’s Form 8-K (File
No. 1-14012) dated March 4, 2004, filed on March 5, 2004.
(36)Incorporated
by reference to the indicated exhibit filed with the Company's Annual Report on
Form 10-K (File No. 1-14012) on March 30, 2004.
(37)Filed as
an exhibit to a Form 8-K filed on January 14, 2004, and incorporated herein by
reference.
(38)Filed as
an exhibit to a Form 8-K filed on April 12, 2004, and incorporated herein by
reference.
(39)Filed as
an exhibit to a Form 8-K filed on May 13, 2004, and incorporated herein by
reference.
(40)Filed as
an exhibit to a Form 10-Q filed on May 13, 2004, and incorporated herein by
reference.
(41)Filed as
an exhibit to a Form 8-K filed on August 13, 2004, and incorporated herein by
reference.
(42)Filed as
an exhibit to a Form 10-Q filed on August 13, 2004, and incorporated herein by
reference.
(43)Filed as
an exhibit to a Form 8-K filed on October 5, 2004, and incorporated herein by
reference.
(44)Filed as
an exhibit to a Form 8-K filed on November 8, 2004, and incorporated herein by
reference.
(45)Filed as
an exhibit to a Form 8-K filed on November 23, 2004, and incorporated herein by
reference.
(46)Filed as
an exhibit to a Form 8-K filed on December 1, 2004, and incorporated herein by
reference.
(47)Filed as
an exhibit to a Form 8-K filed on January 27, 2005, and incorporated herein by
reference.
(48)Incorporated
by reference to the indicated exhibit filed with the Company’s Third Quarter
Report on Form 10-Q (File No. 1-14012) on January 27, 2005.
(49)Incorporated
by reference to the indicated exhibit filed with the Company's Annual Report on
Form 10-K/A (File No. 1-14012) on January 27, 2005.
(50)Filed as
an exhibit to a Form 8-K filed on February 25, 2005, and incorporated herein by
reference.
(51)Filed as
an exhibit to a Form 8-K filed on March 9, 2005, and incorporated herein by
reference.
(52)Filed as
an exhibit to a Form 8-K filed on March 31, 2005, and incorporated herein by
reference.
(53)Filed
herewith.














**77**


Table of Contents





**SIGNATURES**





**Pursuant
to the requirements of 13 of 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.**








Dated: March 30,
2005


**Emeritus
Corporation**


**(Registrant)**





**By:
/s/** **Raymond
R. Brandstrom**


**Name:
Raymond R. Brandstrom**


**Title:
Vice President of Finance, Secretary,**


**and
Chief Financial Officer**








**Signature**
    **Title**
    **Date**/s/
      Daniel R. Baty
    Chief
      Executive Officer and**Daniel
      R. Baty**
    Chairman
      of the Board/s/
      Raymond R. Brandstrom
    Vice
      President of Finance, Secretary, and Chief Financial
    Officer**Raymond
      R. Brandstrom**/s/
      Patrick Carter
    Director**Patrick
      Carter**/s/
      Charles P. Durkin
    Director**Charles
      P. Durkin**/s/
      David W. Niemiec
    Director**David
      W. Niemiec**/s/
      T. Michael Young
    Director**T.
      Michael Young**/s/
      Bruce L. Busby
    Director**Bruce
      L. Busby**/s/
      Stanley L. Baty
    Director**Stanley
      L. Baty**













**78**


Table of Contents


**Index to Consolidated Financial Statements**





****
    **Page
      No.**Report
      of Independent Registered Public Accounting Firm
    F-2Consolidated
      Balance Sheets as of December 31, 2004 and 2003
    F-3Consolidated
      Statements of Operations for the years ended December 31, 2004, 2003, and
      2002
    F-4Consolidated Statements of Cash Flows for the years ended
      December 31, 2004, 2003, and 2002
    F-5Consolidated Statements of Shareholders’ Deficit and
      Comprehensive Operations for the years ended December 31, 2004, 2003, and
      2002
    F-7Notes
      to Consolidated Financial Statements
    F-8Report of Independent Registered Public Accounting Firm
      on Financial Statement Schedule
    S-1Schedule
      II--Valuation and Qualifying Accounts
    S-2











**F-1**


Table of Contents




Index to Consolidated Financial
Statements


******REPORT****OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





The Board
of Directors and Shareholders




Emeritus
Corporation




We have
audited the consolidated balance sheets of Emeritus Corporation and subsidiaries
(“the Company”) as of December 31, 2004 and 2003, and the related consolidated
statements of operations, shareholders’ deficit and comprehensive operations,
and cash flows for each of the years in the three-year period ended December 31,
2004. These consolidated financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.




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




In our
opinion, the consolidated financial statements  referred
to above present fairly, in all material respects, the financial position of
Emeritus Corporation and subsidiaries as of December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.














/s/KPMG
LLP




Seattle,
Washington


March 29,
2005













**F-2**


Table of Contents
  Index to Consolidated Financial
Statements





**EMERITUS CORPORATION****CONSOLIDATED
      BALANCE SHEETS****(In
      thousands, except share data)****ASSETS****December
      31,**
    
    **December
      31,****2004**
    
    **2003**Current
      Assets:Cash
      and cash equivalents
    
    $
    10,748
    
    $
    6,368Short-term
      investments
    
    
    1,336
    
    
    987Trade
      accounts receivable, net of allowance of $841 and $358
    
    
    3,982
    
    
    2,769Other
      receivables
    
    
    2,270
    
    
    1,961Prepaid
      expenses and other current assets
    
    
    15,201
    
    
    6,663Property
      held for sale
    
    
    7,891
    
    
    -Total
      current assets
    
    
    41,428
    
    
    18,748Long-term
      investments
    
    
    6,884
    
    
    7,678Property
      and equipment, net
    
    
    627,047
    
    
    326,595Property
      held for development
    
    
    807
    
    
    1,254Notes
      receivable from and investments in affiliates
    
    
    3,518
    
    
    2,409Restricted
      deposits
    
    
    7,642
    
    
    7,306Lease
      acquisition costs, net
    
    
    26,625
    
    
    20,223Other
      assets, net
    
    
    2,571
    
    
    5,581Total
      assets
    
    $
    716,522
    
    $
    389,794**LIABILITIES
      AND SHAREHOLDERS' DEFICIT**Current
      Liabilities:Current
      portion of long-term debt
    
    $
    4,133
    
    $
    4,750Current
      portion of capital lease and financing obligations
    
    
    15,479
    
    
    5,735Trade
      accounts payable
    
    
    9,057
    
    
    6,774Accrued
      employee compensation and benefits
    
    
    10,143
    
    
    5,885Accrued
      interest
    
    
    1,547
    
    
    1,888Accrued
      real estate taxes
    
    
    4,596
    
    
    2,702Accrued
      dividends on preferred stock
    
    
    10,539
    
    
    8,228Accrued
      insurance liability
    
    
    25,903
    
    
    1,507Other
      accrued expenses
    
    
    7,952
    
    
    8,117Deferred
      revenue
    
    
    6,516
    
    
    6,075Unearned
      rental income
    
    
    8,227
    
    
    5,372Deposit
      on sales contract
    
    
    9,212
    
    
    -Total
      current liabilities
    
    
    113,304
    
    
    57,033Long-term
      debt, less current portion
    
    
    50,528
    
    
    136,388Capital
      lease and financing obligations, less current portion
    
    
    614,046
    
    
    215,324Convertible
      debentures
    
    
    32,000
    
    
    32,000Deferred
      gain on sale of communities
    
    
    28,517
    
    
    30,438Deferred
      rent
    
    
    4,571
    
    
    4,032Other
      long-term liabilities
    
    
    1,875
    
    
    1,506Total
      liabilities
    
    
    844,841
    
    
    476,721Commitments
      and contingenciesShareholders'
      Deficit:Preferred
      stock, $.0001 par value. Authorized 5,000,000 shares.Series
      B, Authorized 70,000 shares, issued and outstanding 36,242 and 34,830
      shares atDecember
      31, 2004, and December 31, 2003, respectively
    
    
    -
    
    
    -Common
      stock, $.0001 par value. Authorized 40,000,000 shares; issued and
      outstanding10,811,531
      and 10,297,449 shares at December 31, 2004, and December 31, 2003,
      respectively
    
    
    1
    
    
    1Additional
      paid-in capital
    
    
    75,779
    
    
    72,894Accumulated
      deficit
    
    
    (204,099
    )
    
    (159,822
    )Total
      shareholders' deficit
    
    
    (128,319
    )
    
    (86,927
    )Total
      liabilities and shareholders' deficit
    
    $
    716,522
    
    $
    389,794


See
accompanying notes to consolidated financial statements.





**F-3**


Table of Contents
  Index to Consolidated Financial
Statements






**EMERITUS CORPORATION****CONSOLIDATED
      STATEMENTS OF OPERATIONS****(In
      thousands, except per share data)****Year
      Ended December 31,****2004**
    
    **2003**
    
    **2002**Revenues:Community
      revenue
    
    $
    306,872
    
    $
    188,338
    
    $
    135,566Other
      service fees
    
    
    6,385
    
    
    4,368
    
    
    4,465Management
      fees
    
    
    4,678
    
    
    10,243
    
    
    10,892Total
      operating revenues
    
    
    317,935
    
    
    202,949
    
    
    150,923Expenses:Community
      operations
    
    
    220,630
    
    
    123,630
    
    
    91,193General
      and administrative
    
    
    26,274
    
    
    24,040
    
    
    21,111Depreciation
      and amortization
    
    
    32,721
    
    
    12,126
    
    
    9,024Facility
      lease expense
    
    
    38,390
    
    
    33,831
    
    
    27,193Total
      operating expenses
    
    
    318,015
    
    
    193,627
    
    
    148,521Income
      (loss) from continuing operations
    
    
    (80
    )
    
    9,322
    
    
    2,402Other
      income (expense):Interest
      income
    
    
    595
    
    
    664
    
    
    401Interest
      expense
    
    
    (42,431
    )
    
    (18,768
    )
    
    (13,618
    )Other,
      net
    
    
    1,573
    
    
    2,015
    
    
    4,113Net
      other expense
    
    
    (40,263
    )
    
    (16,089
    )
    
    (9,104
    )Loss
      from continuing operations before income taxes
    
    
    (40,343
    )
    
    (6,767
    )
    
    (6,702
    )Provision
      for income taxes
    
    
    (1,188
    )
    
    (418
    )
    
    -Loss
      from continuing operations
    
    
    (41,531
    )
    
    (7,185
    )
    
    (6,702
    )Income
      (loss) from discontinued operations
    
    
    991
    
    
    (896
    )
    
    247Net
      loss
    
    
    (40,540
    )
    
    (8,081
    )
    
    (6,455
    )Preferred
      stock dividends
    
    
    (3,737
    )
    
    (6,238
    )
    
    (7,343
    )Gain
      on repurchase of Series A preferred stock
    
    
    -
    
    
    14,523
    
    
    -Net
      income (loss) to common shareholders
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )Basic
      income (loss) per common share:Continuing
      operations
    
    $
    (4.26
    )
    $
    0.11
    
    $
    (1.37
    )Discontinued
      operations
    
    
    0.09
    
    
    (0.09
    )
    
    0.02$
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )Diluted
      income (loss) per common share:Continuing
      operations
    
    $
    (4.26
    )
    $
    0.10
    
    $
    (1.37
    )Discontinued
      operations
    
    
    0.09
    
    
    (0.08
    )
    
    0.02$
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )Weighted
      average common shares outstanding:Basic
    
    
    10,623
    
    
    10,255
    
    
    10,207Diluted
    
    
    10,623
    
    
    11,521
    
    
    10,207





































See
accompanying notes to consolidated financial statements.





**F-4**


Table of Contents
  Index to Consolidated Financial
Statements





**EMERITUS CORPORATION****CONSOLIDATED
      STATEMENTS OF CASH FLOWS****(In
      thousands)****Year
      Ended December 31****2004**
    
    **2003**
    
    **2002**Cash
      flows from operating activities:Net
      loss
    
    $
    (40,540
    )
    $
    (8,081
    )
    $
    (6,455
    )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
    
    
    32,938
    
    
    12,450
    
    
    9,363Amortization
      of deferred gain
    
    
    (2,177
    )
    
    (962
    )
    
    (327
    )Gain
      on refinancings and sale of properties, net
    
    
    (952
    )
    
    -
    
    
    (4,410
    )Impairment
      of long-lived asset
    
    
    447
    
    
    950
    
    
    -Gain
      on sale of investment securities
    
    
    -
    
    
    (1,437
    )
    
    -Write
      down of lease acquisition costs
    
    
    -
    
    
    25
    
    
    262Write
      down of loan fees and amortization
    
    
    2,421
    
    
    1,363
    
    
    395Write
      off of deferred gain
    
    
    -
    
    
    -
    
    
    265Equity
      investment losses
    
    
    794
    
    
    -
    
    
    -Provision
      for doubtful accounts
    
    
    996
    
    
    234
    
    
    346Other
    
    
    64
    
    
    345
    
    
    364Changes
      in operating assets and liabilities, net of acquisitions:Trade
      accounts receivable
    
    
    (1,821
    )
    
    (720
    )
    
    (821
    )Other
      receivables
    
    
    2,208
    
    
    559
    
    
    (404
    )Prepaid
      expenses and other current assets
    
    
    (5,134
    )
    
    (1,055
    )
    
    (2,545
    )Trade
      accounts payable
    
    
    1,642
    
    
    2,890
    
    
    1,003Accrued
      employee compensation and benefits
    
    
    3,423
    
    
    (772
    )
    
    2,054Accrued
      interest
    
    
    (186
    )
    
    173
    
    
    (1,259
    )Accrued
      real estate taxes
    
    
    331
    
    
    (866
    )
    
    1,048Other
      accrued expenses
    
    
    1,125
    
    
    928
    
    
    (33
    )Deferred
      revenue
    
    
    461
    
    
    3,171
    
    
    1,357Other
      current liabilities
    
    
    25,690
    
    
    (808
    )
    
    3,428Security
      deposits and other long-term liabilities
    
    
    (122
    )
    
    (553
    )
    
    627Deferred
      rent
    
    
    538
    
    
    524
    
    
    314Net
      cash provided by operating activities
    
    
    22,146
    
    
    8,358
    
    
    4,572Cash
      flows from investing activities:Acquisition
      of property and equipment
    
    
    (4,491
    )
    
    (2,738
    )
    
    (11,698
    )Acquisition
      of assets in lease transactions
    
    
    (1,136
    )
    
    -
    
    
    -Purchase
      of minority partner interest
    
    
    -
    
    
    (2,500
    )
    
    (3,070
    )Sale
      of property and equipment
    
    
    11,420
    
    
    11,346
    
    
    25,010Construction
      expenditures - leased properties
    
    
    (978
    )
    
    (382
    )
    
    (1,154
    )Proceeds
      from sale of investment securities
    
    
    -
    
    
    2,949
    
    
    -Management
      and lease acquisition costs
    
    
    (8,830
    )
    
    (12,587
    )
    
    (2,229
    )Advances
      to affiliates and other managed communities
    
    
    (1,541
    )
    
    1,469
    
    
    (941
    )Proceeds
      from sales of interest in affiliates
    
    
    -
    
    
    -
    
    
    750Investment
      in Alterra
    
    
    -
    
    
    (7,678
    )
    
    -Investment
      in affiliates
    
    
    (535
    )
    
    (79
    )
    
    (2,971
    )Collection
      of notes receivable
    
    
    2,657
    
    
    -
    
    
    -Distributions
      to minority partners
    
    
    -
    
    
    (250
    )
    
    (500
    )Net
      cash provided by (used in) investing activities
    
    
    (3,434
    )
    
    (10,450
    )
    
    3,197Cash
      flows from financing activities:Increase
      in restricted deposits
    
    
    (336
    )
    
    (1,636
    )
    
    (35
    )Debt
      issue and other financing costs
    
    
    (153
    )
    
    (578
    )
    
    (3,374
    )Repurchase
      of Series A preferred stock
    
    
    -
    
    
    (20,524
    )
    
    -Proceeds
      from long-term borrowings and financing obligations
    
    
    26,620
    
    
    28,763
    
    
    120,838Repayment
      of long-term borrowings
    
    
    (33,154
    )
    
    (59
    )
    
    (125,092
    )Repayment
      of capital lease and financing obligations
    
    
    (8,768
    )
    
    (4,777
    )
    
    (2,942
    )Other
    
    
    1,459
    
    
    (30
    )
    
    (57
    )Net
      cash provided by (used in) financing activities
    
    
    (14,332
    )
    
    1,159
    
    
    (10,662
    )Net
      increase (decrease) in cash and cash equivalents
    
    
    4,380
    
    
    (933
    )
    
    (2,893
    )Cash
      and cash equivalents at the beginning of the year
    
    
    6,368
    
    
    7,301
    
    
    10,194Cash
      and cash equivalents at the end of the year
    
    $
    10,748
    
    $
    6,368
    
    $
    7,301





See
accompanying notes to consolidated financial statements





**F-5**


Table of Contents
  Index to Consolidated Financial
Statements




**EMERITUS
      CORPORATION****CONSOLIDATED
      STATEMENTS OF CASH FLOWS****(In
      thousands)****2004**
    
    **2003**
    
    **2002**Supplemental
      disclosure of cash flow information -cash
      paid during the year for interest
    
    $
    42,772
    
    $
    19,235
    
    $
    15,260cash
      paid during the year for taxes
    
    $
    1,188
    
    $
    418
    
    $
    -Noncash
      investing and financing activities:Transfer
      of property held for sale to property and equipment
    
    $
    -
    
    $
    -
    
    $
    2,028Transfer
      of property held for development to property and equipment
    
    $
    -
    
    $
    -
    
    $
    214Transfer
      of property and other assets to assets held for sale
    
    $
    7,891
    
    $
    -
    
    $
    -Unrealized
      holding gains in investment securities
    
    $
    -
    
    $
    144
    
    $
    1,383Accrued
      and in-kind preferred stock dividends
    
    $
    3,737
    
    $
    6,238
    
    $
    7,343Gain
      on repurchase of Series A preferred stock
    
    $
    -
    
    $
    14,523
    
    $
    -Common
      stock warrants issued
    
    $
    -
    
    $
    2,549
    
    $
    -Note
      from affiliates
    
    $
    -
    
    $
    1,359
    
    $
    -Debt
      assumed for acquisition of property and equipment
    
    $
    -
    
    $
    22,639
    
    $
    -Capital
      Lease and financing obligations
    
    $
    417,233
    
    $
    222,221
    
    $
    42,800Assumption
      of debt on sale-leaseback
    
    $
    (56,566
    )
    $
    (24,291
    )
    $
    -Note
      Receivable for sale of property
    
    $
    1,331
    
    $
    -
    
    $
    -








See
accompanying notes to consolidated financial statements.














**F-6**


Table of Contents
  Index to Consolidated Financial
Statements








**EMERITUS CORPORATION****CONSOLIDATED
      STATEMENTS OF SHAREHOLDERS' DEFICIT AND COMPREHENSIVE OPERATIONS****(In
      thousands, except share data)******
    
    
    
    
    
    
    
    
    
    
    
    **Accumulated****Preferred
      stock**
    
    **Common
      stock**
    
    **Additional**
    
    **other**
    
    
    
    **Total****Number**
    
    
    
    **Number**
    
    
    
    **paid-in**
    
    **comprehensive**
    
    **Accumulated**
    
    **shareholders'****of
      shares**
    
    **Amount**
    
    **of
      shares**
    
    **Amount**
    
    **capital**
    
    **income
      (loss)**
    
    **deficit**
    
    **deficit**Balances
      at December 31, 2001
    
    
    30,609
    
    $
    -
    
    
    10,196,030
    
    $
    1
    
    $
    67,686
    
    $
    (136
    )
    $
    (146,228
    )
    $
    (78,677
    )Unrealized
      gain on investmentsecurities
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    1,383
    
    
    -
    
    
    1,383Issuances
      of shares underEmployee
      Stock Purchase Plan,net
      of repurchases
    
    
    -
    
    
    -
    
    
    43,695
    
    
    -
    
    
    (73
    )
    
    -
    
    
    -
    
    
    (73
    )Options
      exercised
    
    
    -
    
    
    -
    
    
    7,501
    
    
    -
    
    
    16
    
    
    -
    
    
    -
    
    
    16Preferred
      stock dividends
    
    
    2,864
    
    
    -
    
    
    -
    
    
    -
    
    
    1,315
    
    
    -
    
    
    (7,343
    )
    
    (6,028
    )Net
      loss for the year endedDecember
      31, 2002
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (6,455
    )
    
    (6,455
    )Balances
      at December 31, 2002
    
    
    33,473
    
    
    -
    
    
    10,247,226
    
    
    1
    
    
    68,944
    
    
    1,247
    
    
    (160,026
    )
    
    (89,834
    )Unrealized
      gain on investmentsecurities
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    144
    
    
    -
    
    
    144Realized
      gain on investmentsecurities
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (1,391
    )
    
    -
    
    
    (1,391
    )Issuances
      of shares underEmployee
      Stock Purchase Plan,net
      of repurchases
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (92
    )
    
    -
    
    
    -
    
    
    (92
    )Options
      exercised
    
    
    -
    
    
    -
    
    
    50,223
    
    
    -
    
    
    122
    
    
    -
    
    
    -
    
    
    122Warrants
      issued in lease acquisition
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    2,549
    
    
    -
    
    
    -
    
    
    2,549Preferred
      stock dividends
    
    
    1,357
    
    
    -
    
    
    -
    
    
    -
    
    
    1,371
    
    
    -
    
    
    (6,238
    )
    
    (4,867
    )Gain
      on repurchase ofSeries
      A preferred stock
    
    
    
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    14,523
    
    
    14,523Net
      loss for the year endedDecember
      31, 2003
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (8,081
    )
    
    (8,081
    )Balances
      at December 31, 2003
    
    
    34,830
    
    
    -
    
    
    10,297,449
    
    
    1
    
    
    72,894
    
    
    -
    
    
    (159,822
    )
    
    (86,927
    )Issuances
      of shares underEmployee
      Stock Purchase Plan,net
      of repurchases
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    243
    
    
    -
    
    
    -
    
    
    243Options
      exercised
    
    
    -
    
    
    -
    
    
    514,082
    
    
    -
    
    
    1,215
    
    
    -
    
    
    -
    
    
    1,215Preferred
      stock dividends
    
    
    1,412
    
    
    -
    
    
    -
    
    
    -
    
    
    1,427
    
    
    -
    
    
    (3,737
    )
    
    (2,310
    )Net
      loss for the year endedDecember
      31, 2004
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    (40,540
    )
    
    (40,540
    )Balances
      at December 31, 2004
    
    
    36,242
    
    $
    -
    
    
    10,811,531
    
    $
    1
    
    $
    75,779
    
    $
    -
    
    $
    (204,099
    )
    $
    (128,319
    )
















See
accompanying notes to consolidated financial statements.







**F-7**


Table of Contents
  Index to Consolidated Financial
Statements





**EMERITUS CORPORATION**





**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS** ****





**Definitions**





Throughout
Notes to Consolidated Financial Statements certain terms are used repeatedly. In
the interest of brevity, the full reference has been abbreviated to a single
name or acronym. The following defines these abbreviated terms:





1.
    "FASB"
      refers to the Financial Accounting Standards
Board.


2.
    "VIE"
      refers to variable interest entity.


3.
    "REIT"
      refers to real estate investment trust.


4.
    "Mr.
      Baty" refers to Daniel R. Baty, the Company's chairman of the board of
      directors and chief executive officer.


5.
    "Triple-net
      lease" means a lease under which the lessee pays all operating expenses of
      the property, including taxes, licenses, utilities, maintenance, and
      insurance. The lessor receives a net rent.





**(1)**  **Description
of Business and Summary of Significant Accounting Policies**





*Description
of Business*





Emeritus
Corporation (“Emeritus” or the “Company”) is a nationally integrated assisted
living company focused on operating residential style communities. These
communities provide a residential housing alternative for senior citizens who
need help with the activities of daily living, with an emphasis on assisted
living and personal care services. As of December 31, 2004, the Company owns 6
communities and leases 158 communities. These 164 communities comprise the
communities included in the consolidated financial statements.




In
addition, the Company also provides
management services to independent and related-party owners of assisted living
communities. As of December 31, 2004, the Company managed 17
communities , for
which only management fees are recognized in the consolidated financial
statements .




The management
agreements included management agreements covering 46 communities in
connection with the Emeritrust transactions, which are referred to extensively
throughout these financial statements, through September 30, 2003 , which
were subsequently reduced to 23 Emeritrust I communities as of December 31,
2003 , and
reduced again to 5 at December 31, 2004, detailed as follows:




*  **Emeritrust
I** **:** 25
communities that the Company began managing in December 1998. Mr. Baty held an
indirect noncontrolling interest in the entity that owned these communities.
Until December 31, 2001, the Company received a base management fee of 5% of
gross revenues for these communities, but was entitled to receive up to 7%
depending on the cash flow performance of the communities managed. As of January
1, 2002, however, the Company received a base management fee of 3% of gross
revenues, but could have received up to 7% depending on the cash flow
performance of the communities managed. Additionally, the Company was required
by its management contracts to fund cash operating deficits. In May 2002, the
Company entered into an agreement for a third party to operate one of these
communities located in San Bernardino, California. The new operator had
responsibility for all economic benefits and detriments and had an option to
purchase this community from the owner of the community. In April 2003, the new
operator exercised their option to purchase this community reducing the number
of communities managed from 25 to 24. In August of 2003, the owners sold another
building in Casper, Wyoming, further reducing the number of communities managed
from 24 to 23. In March 2004, the Emeritrust I owners disposed of a community,
reducing the number of communities the Company managed to 22. In the third
quarter of 2003, the Company executed a short-term extension of the







**F-8**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**
 Table of Contents

Index to Consolidated Financial
Statements
 
 management
agreement for the remaining communities from June 30, 2003, to January 2, 2004.
This extension removed the purchase option in the original agreement.
Additionally, the Company was indemnified against any funding obligations it may
have had under the extended management agreement by certain of the Emeritrust I
investors, including Mr. Baty, one of the Company's principal shareholders.
Subsequently, the Company executed a longer term extension from January 2, 2004,
to September 30, 2005, which extension also excludes any funding obligation or
purchase option, but which may be terminated by either party with 90 days
notice. In connection with the financing extension effective April 1, 2004 , the
management agreement was amended to provide for a flat management fee of 5% of
gross revenues and amended the term to March 31, 2005, with a one-year extension
to March 31, 2006, available under certain circumstances, subject to termination
by either party on short notice.  In June 2004, the Emeritrust I owners
sold a community located in Grand Terrace, California, to an entity controlled
by Mr. Baty. This entity, in turn, leased the community to the Company. As of
September 30, 2004, 16 of the original 21 Emeritrust I Communities
were acquired by a third party REIT and leased to the Company and their
operating results are included in the consolidated financial statements
beginning October 1, 2004. The remaining five communities are still managed by
the Company.





*  **Emeritrust
II** **:** 21
communities that the Company managed in the time period from March 1999 to
September 2003. Mr. Baty held an indirect non-controlling interest in the
entities that owned these communities. As of September 30, 2003, the owners of
the Emeritrust II communities sold them to a REIT, which leased these
communities back to the Company in a master lease and these communities are
included in the Company's consolidated financial statements beginning October 1,
2004. The Emeritrust II communities consisted of:





***Emeritrust
      II Operating****:**16
      communities for which the Company had no obligation to fund cash operating
      deficits. The Company received a base management fee of 5% of gross
      revenues, but may have received up to 7% depending on the cash flow
      performance of the communities managed. As of September 30, 2003, these
      communities were included in the Company's consolidated
      results.





***Emeritrust
      II Development****:**5
      communities for which the Company was required to fund cash operating
      deficits. The Company received a base management fee of 5% of gross
      revenues, but may have received up to 7% depending on the cash flow
      performance of the communities managed. As of September 30, 2003, these
      communities were included in the Company's consolidated results.





Other
management agreements are as follows :




*
    management
      agreements covering 7 communities owned by entities controlled by Mr.
      Baty. The Company generally receives fees ranging from 5% to 6% of the
      gross revenues generated by these
communities.




*
    a
      management agreement covering one community owned by a joint venture in
      which the Company has a financial interest. The Company receives
      management fees of 6% of gross revenues for this
  community.




*
    management
      agreements covering three communities owned by independent third parties.
      The Company receives management fees based on a rate for occupied
      capacity.




*
    a
      management agreement covering one community owned by an independent third
      party. The Company receives management fees of the greater of $7,000 per
      month or 6% of gross revenue from this community, with opportunities to
      earn additional fees based on operating cash
flow.









**F-9**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**
  Table of Contents
  Index to Consolidated Financial
Statements








*Summary
of Significant Accounting Policies and Use of Estimates*





The
preparation of consolidated financial statements requires Emeritus to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues, and expenses, and related disclosure of contingent assets and
liabilities. On an ongoing basis, Emeritus evaluates its estimates, including
those related to resident programs and incentives such as move in fees, bad
debts, investments, intangible assets, impairment of long-lived assets, income
taxes, restructuring, long-term service contracts, contingencies, self-insured
retention, insurance deductibles, health insurance, and litigation. Emeritus
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates.





Emeritus
believes the following critical accounting policies are most significant to the
judgments and estimates used in the preparation of its consolidated financial
statements. Revisions in such estimates are charged to income in the period in
which the facts that give rise to the revision become known.






*
    For
      commercial general liability and professional liability insurance for
      2004, Emeritus formed a wholly owned captive insurance company domiciled
      in the U.S. The insurance policy issued by the captive is claims-made and
      insures liabilities associated with general and professional liability.
      The policy insures on a per occurrence and aggregate-limit basis in excess
      of a self-insured retention. Emeritus accrues losses based upon actuarial
      estimates of the total aggregate liability for claims occurring within the
      year plus captive related expenses. Losses, whether within the
      self-insured retention, the policy limits, or exceeding policy limits are
      covered through a self-insurance pool agreement with all managed
      communities on a per unit of capacity basis Should losses exceed actuarial
      estimates, additional expense may be accrued at the time of determination.
      The captive was capitalized and the premium structure established pursuant
      to regulatory requirements. Emeritus pays premiums based in part on a
      fixed schedule and in part as losses are actually paid. The captive is
      subject to regulatory agency oversight and is reviewed for compliance with
      applicable law. Results from these reviews may change the timing or amount
      of subsequent funding.




*
    For
      health insurance, Emeritus self-insures each covered member up to a
      certain level above which, for certain covered members,  a
      catastrophic insurance policy covers any additional costs. Health
      insurance expense is accrued based upon historical experience of the
      aggregate liability for claims incurred. If these estimates are
      insufficient, additional charges may be
required.




*
    Workers'
      compensation insurance coverage applies for specific insurable states
      (excluding Texas, New York, and the compulsory State Funds States) through
      a high deductible, fully collateralized insurance policy. The policy
      premium is based upon standard rates applied to estimated annual payroll.
      The posted collateral is greater than expected annual losses. The Company
      contracts with an independent third-party administrator to administer the
      claims; and paid claim expenses are drawn from a collateral account. The
      sum of the premium and related costs, estimated administration costs, and
      actuarial based estimated losses is accrued on a monthly basis based on
      actual payroll. The difference between the posted collateral and estimated
      actual losses is carried as an asset on the balance sheet. At policy
      expiration, an insurer audit is conducted to adjust premiums based on
      actual, rather than estimated, annual payroll. Any premium adjustment for
      the differences between estimated and actual payroll will first be applied
      to the accrued asset and then, if needed, as an adjustment to workers'
      compensation expense at the time such adjustment is determined. The
      insurer also audits the total incurred claim amount at least annually and
      may adjust the applicable policy year collateral requirement. There is a
      reasonable expectation that the total incurred losses will be less than
      the posted collateral, and the benefit of any over-collateralization will
      inure to the





**F-10**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements




Company.
The Company insures occupational injuries and illness in New York through
participation in a self-insured group pool on a guaranteed cost insurance policy
basis, with the premium payable monthly. The insurer group contracts with an
independent third-party administrator on behalf of its members to manage the
claims, and claim expenses are paid by the insurer. For work-related injuries in
Texas, the Company provides work related injury benefits through a qualified
“Non-Subscriber Employee Retirement Income Security Act Occupational Injury and
Illness Benefit Plan.” Claim expenses are paid as incurred and estimated losses
are accrued on a monthly basis based on actual payroll. An insurance policy is
in place to cover liability losses in excess of a deductible amount. The cost of
this insurance is accrued monthly. The Company contracts with an independent
third-party administrator to manage the claims.




*
    Emeritus
      accounts for stock option awards to employees under the intrinsic
      value-based method of accounting prescribed by APB No. 25,
      “Accounting for Stock Issued to Employees”. Under this method, no
      compensation expense is recorded provided the exercise price is equal to
      or greater than the quoted market price of the stock at the grant date.
      The Company makes pro forma disclosures of net income and earnings per
      share as if the fair value-based method of accounting (the alternative
      method of accounting for stock-based compensation) had been applied as
      required by FAS No. 123, “Accounting for Stock-Based Compensation”.
      The fair value-based method requires the Company to make assumptions to
      determine expected risk-free interest rates, stock price volatility,
      dividend yield and weighted-average option life. To the extent such things
      as actual volatility or life of the options is different from estimated,
      amounts expensed will be more or less than would have been recorded
      otherwise.




*
    Emeritus
      maintains allowances for doubtful accounts for estimated losses resulting
      from the inability of its residents to make required payments. If the
      financial condition of Emeritus's residents were to deteriorate, resulting
      in an impairment of their ability to make payments, additional charges may
      be required.




*
    Emeritus
      records a valuation allowance to reduce its deferred tax assets to the
      amount that is more likely than not to be realized, which at this time
      shows a net asset valuation of zero. Emeritus has considered future
      taxable income and ongoing prudent and feasible tax planning strategies in
      assessing the need for the valuation allowance. However, in the event
      Emeritus were to determine that it would be able to realize its deferred
      tax assets in the future in excess of its net recorded amount, an
      adjustment to the deferred tax asset would increase net income in the
      period such determination was made.




*
    Emeritus
      accounts for impairment of long-lived assets, which include property and
      equipment, investments, and amortizable intangible assets, in accordance
      with the provisions of SFAS No. 144 Accounting for the Impairment or
      Disposal of Long-Lived Assets or SFAS No. 142 Goodwill and Other
      Intangible Assets, as applicable. An impairment review is performed
      whenever a change in condition occurs, which indicates that the carrying
      amounts of assets may not be recoverable. Such changes include changes in
      our business strategies and plans, changes in the quality or structure of
      the Company's relationships with its partners and deteriorating operating
      performance of individual communities. The Company uses a variety of
      factors to assess the realizable value of assets depending on their nature
      and use. Such assessments are primarily based upon the sum of expected
      future undiscounted net cash flows over the expected period the asset will
      be utilized, as well as market values and conditions. The computation of
      expected future undiscounted net cash flows can be complex and involves a
      number of subjective assumptions. Any changes in these factors or
      assumptions could impact the assessed value of an asset and result in an
      impairment charge equal to the amount by which its carrying value exceeds
      its actual or estimated fair value.





**F-11**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements









*
    Emeritus
      accounts for leases as either operating, capital, or financing leases
      depending on the underlying terms. The determination of the classification
      of leases is complex and in certain situations requires a significant
      level of judgment. Leases are generally accounted for as operating leases
      to the extent the underlying lease does not: (i) transfer ownership by the
      end of the lease term, (ii) contain a bargain purchase option, (iii)
      include a lease term equal to or greater than 75% of the economic life of
      the leased property or (iv) include minimum lease payments for which the
      present value equals or exceeds 90% of the fair value of the underlying
      leased property. Properties under operating leases are not included on the
      balance sheet and are accounted for in the statement of operations as
      facility lease expense for actual rent paid to the extent any increases in
      rent is considered to be contingent and not determinable. In cases where
      there are rent escalator provisions that have fixed or determinable
      increases, the operating leases are accounted for as the total rent for
      the term of the lease, including both base rent and fixed annual
      increases, on a straight-line basis over the lease term. This accounting
      treatment results in greater facility lease expense than the actual rent
      paid in the earlier years of the respective leases and less facility lease
      expense than the actual rent paid in the later years of the lease. Those
      leases that meet one of the criteria described above cannot be accounted
      for as operating leases but are accounted for as capital leases. For
      properties under capital lease arrangements, a liability is established on
      the balance sheet based on the present value of the rent payments not to
      exceed the fair value of the underlying leased property, including base
      rent, fixed annual increases and any other payment obligations over the
      lease term, and a corresponding long-term asset is recorded. Lease
      payments are allocated between principal and interest on the lease
      obligation and the capital lease asset is depreciated over the term of the
      lease. Typically, capital lease treatment results in greater depreciation
      and interest than actual lease payments paid in the early years of the
      leases and less depreciation and interest than actual rent paid in the
      later years of the leases. Properties that are sold and leased-back and
      for which the Company has continuing involvement are accounted for as
      financings, in which the property remains on the balance sheet and a
      financing obligation is recorded generally equal to the purchase price of
      the properties sold. The impact on the statement of operations is similar
      to a capital lease.





*Basis
of Presentation and Principles of Consolidation*





The
consolidated financial statements include the accounts of the Company and its
majority-owned subsidiaries. In addition, the accounts of limited liability
companies and partnerships are consolidated where the Company maintains
effective control over such entities’ assets and operations, notwithstanding a
lack of technical majority ownership. The Company's management contracts do not
result in control and those entities are not consolidated. All significant
inter-company balances and transactions are eliminated in
consolidation.





*Revenue
Recognition*





Operating
revenue consists of resident fee revenue, community revenue, other service fees,
and management services revenue. Resident units are rented on a month-to-month
basis and rent is recognized in the month the unit is occupied. Service fees
paid by residents for assisted living and other related services are recognized
in the period services are rendered. Management fees are comprised of revenue
from management contracts and are recognized in the month in which services are
performed in accordance with the terms of the management contract.





The
Company charges nonrefundable move-in fees at the time the resident occupies the
unit and the related services are performed. Revenue for these fees is deferred
and recognized over the average period of resident occupancy, currently 15
months.





**F-12**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


*Cash
and Cash Equivalents*





Cash and
cash equivalents consist primarily of money market investments, commercial
paper, and certificates of deposit with a maturity date at purchase of three
months or less. Cash equivalents at December 31, 2004, and 2003, were not
material.





*Property
and Equipment*





Property
and equipment are stated at cost. Depreciation and amortization are computed
using the straight-line method over the estimated useful lives of the assets as
follows: buildings and improvements, 12 to 40 years; furniture, equipment and
vehicles, five to seven years; capital lease assets and leasehold improvements,
over the shorter of the useful life or the lease term.





The
Company accounts for impairment of long-lived assets, which primarily include
property and equipment, investments, and amortizable intangible assets, in
accordance with the provisions of SFAS No. 144 Accounting for the Impairment or
Disposal of Long-Lived Assets or SFAS No. 142 Goodwill and Other Intangible
Assets, as applicable. An impairment review is performed whenever a change in
condition occurs which indicates that the carrying amounts of assets may not be
recoverable. Such changes include changes in the Company's business strategies
and plans, changes in the quality or structure of its relationships with its
partners, and deteriorating operating performance of individual communities. The
Company uses a variety of factors to assess the realizable value of assets
depending on their nature and use. Such assessments are primarily based upon the
sum of expected future undiscounted net cash flows over the expected period the
asset will be utilized, as well as market values and conditions. The computation
of expected future undiscounted net cash flows can be complex and involves a
number of subjective assumptions. Any changes in these factors or assumptions
could impact the assessed value of an asset and result in an impairment charge
equal to the amount by which its carrying value exceeds its actual or estimated
fair value.





*Investments*





Investment
securities are classified as trading and are recorded at fair value. They
represent funds for the non-qualified deferred compensation plan.





Investments
in 20% to 50% owned affiliates are accounted for under the equity method except
where a lack of voting power exists. Investments in less than 20% owned entities
are accounted for under the cost method unless the Company exercises significant
influence by means other than ownership.





*Intangible
Assets*





Intangible
assets, which are comprised of deferred financing costs (included in other
assets) and lease acquisition costs, are amortized on the straight-line method
over the term of the related debt or lease agreement.





*Income
Taxes*





Deferred
income taxes are provided based on the estimated future tax effects of loss
carryforwards and temporary differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates that
are expected to apply to taxable income in the years in which those
carryforwards and temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A valuation
allowance is recorded for deferred tax assets when it is more likely than not
that such deferred tax assets will not be realized.





**F-13**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


*Deferred
Rent*





Deferred
rent primarily represents lease incentives that are deferred and amortized using
the straight-line method over the terms of the associated leases and the effects
of straight-lining leases that contain fixed payment escalators.





*Deferred
Gain on Sales of Communities*





Deferred
gains on sales of communities consist of deferred gains on sale-leaseback
transactions. Deferred gains on sale-leaseback transactions are amortized using
the straight-line method over the terms of the associated leases where the
Company has no continued financial involvement in communities that it has sold
and leased back. Sale-leaseback transactions where the Company has continuing
financial involvement, other than normal leasebacks, are not accounted for as
sales until such involvement terminates.





*Leases
and Debt with Escalator Clauses*





Leases
and debt that contain fixed payment escalators are accounted for on a
straight-line basis as if the lease payments or interest rates were fixed over
the life of the lease or debt. In addition, certain leases contain payment
escalators based on the increase in the Consumer Price Index (CPI) not to exceed
certain fixed rates. To the extent there is a high level of certainty that the
fixed rate increase under the lease will be met, lease payments are accounted
for on a straight-line basis using the fixed rate. If the change in CPI is less
than the fixed rate, the difference is accounted for at the time the contingency
is resolved.





*Community
Operations*





Community
operations expenses represent direct costs incurred to operate the communities
and include costs such as resident activities, marketing, housekeeping, food
service, payroll and benefits, facility maintenance, utilities, taxes, and
licenses.





*Stock-Based
Compensation*





The
Company applies APB Opinion No. 25, *Accounting
for Stock Issued to Employees* and
related interpretations in measuring compensation costs for its stock option
plans. The Company discloses pro forma net loss and net loss per share as if
compensation cost had been determined consistent with Statement of Financial
Accounting Standards (SFAS) No. 123, *Accounting
for Stock-Based Compensation* .





**F-14**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements





Had
compensation costs for the Company’s stock option plan been determined pursuant
to SFAS 123, the Company’s pro forma net income (loss) and pro forma net income
(loss) per share would have been as follows (in thousands, except per share
amounts):





**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002****(In
      thousands, except per share data )**Net
      income (loss) to common shareholders:As
      reported
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )Add:
      Stock-based employee compensation expenseincluded
      in reported net income (loss)
    
    
    -
    
    
    -
    
    
    -Deduct:
      Stock-based employee compensationdetermined
      under fair value based method for all awards
    
    
    (1,028
    )
    
    (1,156
    )
    
    (773
    )Pro
      forma
    
    $
    (45,305
    )
    $
    (952
    )
    $
    (14,571
    )Net
      income (loss) per common share:As
      reported - Basic
    
    $
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )Pro
      forma - Basic
    
    $
    (4.27
    )
    $
    (0.09
    )
    $
    (1.43
    )As
      reported - Diluted
    
    $
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )Pro
      forma - Diluted
    
    $
    (4.27
    )
    $
    (0.09
    )
    $
    (1.43
    )


The
Company estimates the fair value of its options using the Black-Scholes option
value model, which is one of several methods that can be used to estimate option
values. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. Option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. The
Company's options have characteristics significantly different from those of
traded options, and changes in the subjective input assumptions can materially
affect the fair value estimates. The fair value of options granted were
estimated at the date of grant using the following weighted average assumptions:








**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002**Expected
      life from vest date (in years)
    
    
    4
    
    
    4
    
    
    4Risk-free
      interest rate
    
    
    3.04%
      - 3.58
    %
    
    1.96%
      - 2.6
    %
    
    2.9%
      - 4.3
    %Volatility
    
    
    88.4%
      - 90.8
    %
    
    89.3%
      - 90.0
    %
    
    90.4%-93.3
    %Dividend
      yield
    
    
    -
    
    
    -
    
    
    -Weighted
      average fair value (per share)
    
    $
    4.24
    
    $
    2.55
    
    $
    1.99








**F-15**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


*Income
(Loss) Per Share*




The
capital structure of Emeritus includes convertible debentures, and redeemable
and non-redeemable convertible preferred stock, common stock warrants, and stock
options. Basic net income (loss) per share is computed based on weighted average
shares outstanding and excludes any potential dilution. Diluted net income
(loss) per share is computed based on the weighted average number of shares
outstanding plus dilutive potential common shares. Options and warrants are
included under the "treasury stock method" to the extent they are dilutive.
Certain shares issuable upon the exercise of stock options and warrants and
conversion of convertible debentures and preferred stock have been excluded from
the computation because the effect of their inclusion would be anti-dilutive.
The following table summarizes those that are excluded in each period because
they are anti-dilutive (in thousands):


**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002**Convertible
      Debentures
    
    
    1,455
    
    
    1,455
    
    
    1,455Options
    
    
    1,559
    
    
    30
    
    
    1,714Warrants
      - Senior Housing Partners I, L.P.
    
    
    400
    
    
    400
    
    
    -Warrants
      - Saratoga Partners
    
    
    1,000
    
    
    -
    
    
    1,000Series
      A Preferred(1)
    
    
    -
    
    
    -
    
    
    1,374Series
      B Preferred
    
    
    5,019
    
    
    4,824
    
    
    4,6369,433
    
    
    6,709
    
    
    10,179




(1) Repurchased in July and August 2003





Dilutive
potential common shares and adjustments to net income (loss) to common
shareholders arising under the assumed conversion into common stock of the
convertible debentures, Series A redeemable convertible preferred, and Series B
convertible preferred stock are included under the "if-converted method".





The
following table summarizes the computation of basic and diluted net income
(loss) per common share amounts presented in the accompanying consolidated
statements of operations (in thousands, except per share data):


**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002**Basic:Numerator
      for basic net income (loss) per share:Net
      income (loss) to common shareholders
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )Denominator
      for basic net income per share:Weighted
      average number of common shares outstanding
    
    
    10,623
    
    
    10,255
    
    
    10,207Basic
      net income (loss) per share
    
    $
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )Diluted:Numerator
      for diluted net income (loss) per share:Net
      income (loss) to common shareholders
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )Denominator
      for diluted net income (loss) per share:Weighted
      average number of common shares outstanding
    
    
    10,623
    
    
    10,255
    
    
    10,207Assumed
      exercise of options and warrants
    
    
    -
    
    
    1,266
    
    
    -10,623
    
    
    11,521
    
    
    10,207Diluted
      net income (loss) per share
    
    $
    (4.17
    )
    $
    0.02
    
    $
    (1.35
    )








**F-16**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements





*Comprehensive
Income (Loss)*





Comprehensive
income (loss) consists of net income (loss) and other gains and losses affecting
shareholders' equity, which under accounting principles generally accepted in
the United States, are excluded from results of operations. For the Company,
these consist of unrealized gains and losses on investment securities, net of
any related tax effect.





*Recent
Accounting Pronouncements*





In
January 2003, the FASB issued Interpretation No. 46 (FIN No. 46). This
Interpretation was revised in December 2003 (FIN No. 46R) and addresses
consolidation by business enterprises of VIE's. A VIE is subject to the
consolidation provisions of FIN No. 46R if it cannot support its financial
activities without additional subordinated financial support from third parties
or its equity investors lack any one of the following characteristics: the
ability to make decisions about its activities through voting rights, the
obligation to absorb losses of the entity if they occur, or the right to receive
residual returns of the entity if they occur. FIN No. 46R requires a VIE to be
consolidated by its primary beneficiary. The primary beneficiary is the party
that holds the variable interests that expose it to a majority of the entity’s
expected losses and/or residual returns. For purposes of determining a primary
beneficiary, all related party interests must be combined with the actual
interests of the Company in the VIE. The application of this Interpretation is
immediate for VIE's created or altered after January 31, 2003, and is effective
at the end of the first quarter of 2004 for variable interest entities that
existed prior to February 1, 2003.





The
Company has evaluated the impact of FIN No. 46R on all its current related-party
management agreements, including those more fully discussed under the section
denoted as “Emeritrust Transactions”, as well as other management agreements and
other arrangements with potential VIE's. The Company does not believe it has any
VIE's that require consolidation.





In May
2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity. For public enterprises,
such as the Company, this statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. Management
has determined that no current financial instruments of the Company are covered
by this pronouncement.





In
December 2004, the FASB issued FASB Statement No. 123 Revised (R) “Share-Based
Payment”. This statement requires the Company to recognize in the income
statement expense for compensation cost related to share based payments
including stock options and employee stock purchase plans. FASB No. 123R would
eliminate the Company’s ability to account for share-based awards to employees
using APB Opinion 25, “Accounting for Stock Issued to Employees” and would
require that the transactions use a fair value method as of the grant date. FASB
123R addresses the accounting for transactions in which the Company receives
employee services in exchange for equity instruments or liabilities that are
based on the fair value of the Company’s equity instruments or that may be
settled through the issuance of such equity instruments. FASB 123R is effective
for the Company after June 15, 2005. The Company is currently evaluating the
impact of this statement on its financial statements.





*Reclassifications*





Certain
reclassifications have been made to the consolidated financial statements to
conform to the current period presentation.








**F-17**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(2)**  **Short-Term
Investments**





In 1999,
the Company wrote down its investment in the common stock of ARV Assisted
Living, Inc. (“ARV”) by $7.4 million as management concluded the decline in the
fair market value of this investment was other than temporary. Details
regarding the ARV investment, which comprised the entire investment designated
as available for sale as of December 31, are as follows (In
thousands):





****
    
    
    
    **Gross**
    
    **Fair****Amortized**
    
    **Unrealized**
    
    **Market****Cost**
    
    **Gains/(Losses)**
    
    **Value**2004
    
    $
    -
    
    $
    -
    
    $
    -2003
    
    $
    -
    
    $
    -
    
    $
    -2002
    
    $
    1,512
    
    $
    1,247
    
    $
    2,759








On April
23, 2003, ARV announced that, at a special meeting held on that date, its
shareholders voted to approve the Agreement and Plan of Merger, dated as of
January 3, 2003, between ARV and Prometheus Assisted Living LLC ("Prometheus").
ARV further announced that the merger transaction closed and trading of the ARV
stock on the American Stock Exchange ceased on April 23, 2003. Under the terms
of the merger, shares of ARV's stock held by shareholders other than Prometheus
and its affiliates were converted into the right to receive merger consideration
of $3.90 per share, without interest. On April 25, 2003, the Company received
approximately $2.9 million in exchange for its 755,884 shares of ARV common
stock in which it had a carrying value of approximately $1.5 million, thus
recognizing a gain of approximately $1.4 million, which is included in "Other,
net" in the Company's Consolidated Statements of Operations and a reduction in
"Accumulated other comprehensive gain" in the Company's Consolidated Balance
Sheets.





S hort-term
investments designated as trading securities are carried at fair value and
represent funds for
the non-qualified deferred compensation plan of $ 1.3
million and $987,000 at December 31, 2004 and 2003, respectively.





**(3)**  **Long-Term
Investments**





In
December 2003, Emeritus invested $7.7 million in a limited liability
company (LLC) that acquired Alterra Healthcare Corporation,
a national assisted living company headquartered in Milwaukee, Wisconsin, that
was the subject of a voluntary Chapter 11 bankruptcy. The
investment represents an 11% interest in the total invested capital of the LLC and includes
an excess of approximately $3.6 million over the underlying net book
value . Alterra
operates approximately 300 assisted living communities in 22 states . The
purchase price for Alterra was $76 million and the
transaction closed on December 4, 2003, following approval by the Bankruptcy
Court. The members of the LLC consist of an affiliate of Fortress Investment
Group LLC (Fortress), a New York based private equity fund, which is the
managing member, an entity controlled by Mr. Baty, and the Company. Under the
LLC agreement, distributions are first allocated to Fortress until it receives
payment on a $15.0 million loan to the LLC at 15% interest and its original
investment of $49 million together with a 15% preferred return, and then are
allocated to the three investors in proportion to percentage interests, as
defined in the agreement, which are a 50% interest for Fortress and a 25%
interest each for the Company and the entity controlled by Mr. Baty .





Through
January 31, 2004, the investment was structured as an ownership interest in an
LLC, which is a pass-through entity for tax purposes, similar to a limited
partnership. Under generally accepted accounting principles, the Company was
required to use the equity method of accounting for its LLC membership interest
and record a portion of Alterra's results of operations in its financial
statements. As a consequence, equity losses of approximately $794,000 were
recorded in the consolidated statement of operations for the





**F-18**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


year
ended December 31, 2004, under the caption “Other, net,” which represents the
Company's portion of Alterra's net loss for December 2003 and January
2004.





The LLC
made an election to be treated as a corporation for tax purposes effective
January 31, 2004, and is no longer a pass-through entity. As a result of this
election, on February 1, 2004, the Company began accounting for Alterra on
a cost basis under APB 18 “The Equity Method of Accounting for Investments in
Common Stock” until Fortress's investment falls below a certain level and/or
there is a change in structure such that the Company would have significant
influence over the operations of Alterra. If and when such an event occurs,
Emeritus will resume using the equity method of accounting for its investment in
Alterra.





**(4)**  **Other
Receivables**





Other
receivables consisted of the following at December 31 (In
thousands):





**2004**
    
    **2003**Working
      capital advances to third parties and affiliates
    
    $
    390
    
    $
    152Interest
      receivable
    
    
    1
    
    
    470Other
      receivables.
    
    
    1,879
    
    
    1,339$
    2,270
    
    $
    1,961





**(5)**  **Property
and Equipment**





Property
and equipment consist of the following at December 31 (In
thousands):








**2004**
    
    **2003**Land
      and improvements
    
    $
    13,467
    
    $
    15,835Buildings
      and improvements
    
    
    645,922
    
    
    319,147Furniture
      and equipment
    
    
    19,016
    
    
    16,962Vehicles
    
    
    5,544
    
    
    5,413Leasehold
      improvements
    
    
    10,120
    
    
    7,787694,069
    
    
    365,144Less
      accumulated depreciation and amortization
    
    
    68,057
    
    
    39,419626,012
    
    
    325,725Construction
      in progress
    
    
    1,035
    
    
    870$
    627,047
    
    $
    326,595





Included
in the above schedule are property and equipment under capital leases. Equipment
under capital leases is $709,000 and $495,000 at
December 31, 2004 and 2003, respectively, with
accumulated depreciation of $289,000 and $121,000, respectively . Vehicles
under capital leases are $1.3 million and $981,000 at
December 31, 2004 and 2003, respectively, with
accumulated depreciation of $417,000 and $186,000, respectively . Buildings
under capital leases are $521.4 million and
$187.6 million at December 31, 2004 and 2003, respectively, with
accumulated depreciation of $26.0 million and $2.7 million ,
respectively.








**F-19**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(6)**  **Notes
Receivable From and Investments in Affiliated Companies**





During
1998, the Company sold its interest in a community located in Texas to a
Baty-related entity. Pursuant to the purchase and sale agreement, the Company
advanced $1.0 million of funds to the Baty-related entity, which was
subsequently repaid in 1999, and $800,000, subject to promissory notes bearing
interest at 9% and payable in 10 years and on demand, respectively. The $1.0
million note contained additional funding provisions whereby the Company funds
20% of the losses generated by the community up to $500,000, of which $500,000
was outstanding at December 31, 2003 and 2002, which also bears interest at 9%
and is payable in 10 years. In addition, the Company has advanced the
Baty-related entity $450,000 under a repair note, bearing interest at 9% and due
June 2008. The
Baty-related entity’s aggregate obligation to the Company under these notes was
$2.6 million , including
accrued interest of $881,000 , at
December 31, 2003 . These
notes were paid off in connection with completing the first stage of a lease of
up to 24 assisted living facilities (See CPM-JEA Transactions in footnote 17 for
details)





In
January 2000, the Company purchased a 30% equity interest in Senior Healthcare
Partners, LLC, a pharmaceutical supply limited liability company. The
Company has cash funding obligations of up to $1.8 million. As of December 31,
2001, the Company had funded the entire $1.8 million . During
2004, the Company additionally funded $356,000 . The
Company recognized its share of partnership gain of $132,000, $175,000 and
$98,000 in 2004, 2003 and 2002,
respectively, which is included in "Other, net".





In
August, 2004, the Company received a note receivable for $1.3 million for the
balance of the purchase price of the Scottsdale, Arizona community sold for
approximately $1.8 million. The note has a 5-year term with interest at 5.5
percent and includes principal payments based on a 30-year amortization, with
the first principal payment due December 1, 2004.





**(7)**  **Restricted
Deposits**





Restricted
deposits consist of funds required by various REIT's to be placed on deposit
until the Company’s communities meet certain debt coverage and/or cash flow
coverage ratios, at which time the funds will be released to the
Company .











**F-20**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(8)**  **Long-term
Debt**





Long-term
debt consists of the following at December 31 (In thousands):












**2004**
    
    **2003**Notes
      payable, principal and interest at LIBOR* plus 4.15% with a floor of 6.5%
      (6.5% at December 31, 2003) payable monthly, unpaid principal and interest
      due December 2006, with an option to extend to September
    2007
    
    $
    -
    
    $
    57,042Notes
      payable, interest only at 12% plus 1.75% accrued interest (12% at December
      31, 2003) payable monthly, unpaid principal and capitalized interest due
      December 2007
    
    
    -
    
    
    16,298Note
      payable, interest only at 12.13% (12.63% at December 31, 2004) payable
      monthly with a 50 basis point increase each anniversary capped at 13%,
      principal and interest starting the second year (October 2004), and unpaid
      principal and interest due June 2007 (note was refinanced in March
      2005)
    
    
    19,634
    
    
    25,800Notes
      payable, principal & interest at LIBOR* plus 4.5% and LIBOR plus 7.75%
      (7% and 9.75% at December 31, 2003) payable monthly, unpaid principal and
      interest due March 2006
    
    
    -
    
    
    6,647Notes
      payable, interest at rates from 8.0% to 12%, payable in monthly
      installments, due through March 2013
    
    
    10,482
    
    
    11,412Notes
      payable, principal and interest at 6.98%, payable in monthly installments,
      due August 2008
    
    
    22,092
    
    
    22,639Notes
      payable, principal and interest at prime, payable in monthly installments,
      due September 2005
    
    
    631
    
    
    1,300Notes
      payable, interest at 12% in first year and 12.5% in second, payable in
      monthly installments, unpaid principal and interest due April 2006. (note
      was refinanced in March 2005)
    
    
    1,822
    
    
    -Subtotal
    
    
    54,661
    
    
    141,138Less
      current portion
    
    
    4,133
    
    
    4,750Long-term
      debt, less current portion
    
    $
    50,528
    
    $
    136,388












*
    LIBOR
      is the London Interbank Offering Rate.





Substantially
all long-term debt is secured by the Company’s property and
equipment.





On July
30, 2004, the Company completed a sale-leaseback of 11 communities. The
communities were sold to Health Care Property Investors, Inc. (HCP), an
independent third party, and leased back to the Company for a 15-year initial
lease period with two 10-year renewal options. As a part of this transaction,
HCP assumed the note payable of $57.0 million due December, 2006. In addition,
the Company paid off HCP mezzanine debt of $16.3 million that was due December
31, 2007.





**F-21**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


In
January 2003, the Company reached an agreement with General
Motors Acceptance Corporation (“GMAC”) to extend a $6.8 million note set to
mature February 1, 2003 . The original
$6.8 million note has been bifurcated into a $6.2 million Note A and a $560,000
Note B . The new
notes of $6.8 million mature March, 1, 2006, and provides for monthly principal
payments of approximately $22,000 in addition to interest at LIBOR plus 4.5% and
LIBOR plus 7.75%, respectively .





Additionally, related
to the GMAC extension, the original Seller note for $1 million was also
extended . The
original seller note principal balance for the year ended December 31, 2003, was
$921,000 with a maturity of March 1, 2003. This amendment extends the principal
maturity to March 1, 2006, and requires $12,500 monthly principal and interest
payments, with interest accruing at 12%. The Company made a $200,000 principal
paydown in February 2003 and made all scheduled principal payments in 2004.





On
November 1, 2004, the Company sold a single community located in Issaquah,
Washington, for $9.6 million. In connection with this sale the Company paid off
all GMAC related financing. In addition, the extension of the $1 million note
was also paid off.





In May
2003, in connection with the *Lease
of Eight Communities in May 2003* transaction discussed in Note 17, "Sales and Acquisitions, including Certain
Related-Party Transactions", a REIT
loaned $600,000 to the Company for general working capital purposes and for
capital and other improvements (included in the note for $10.5 million in the
table above). This loan
has a 10-year term with no extensions, bearing interest at 10% annually with
monthly interest-only payments. In addition, if the Company exercises its
purchase option at any time on any of the eight communities, the pro rata
principal portion of the loan will become due at the time the closing of the
sale of such facility occurs.





The REIT that
financed the Emeritrust II transaction held $6.8 million of the Company's
leasehold mortgage debt that matured in March 2005 and bore interest at 12% per
annum, commencing March 2002 with periodic increases up to 13% per
annum . This REIT
also provided $7.5 million in leasehold mortgage financing incurred to support
the Series A Preferred Stock repurchase in August 2003 and $11.5 million
in leasehold mortgage financing to support the purchase of the
Emeritrust II communities . On
September 30, 2003, these three financings were consolidated into a single
$25.8 million leasehold mortgage financing, secured by the 32 communities and
maturing on June 30, 2007. The debt bears interest at an initial rate of 12.13%
per annum with periodic increases up to 1 3%. The
consolidated loan requires monthly payments of interest the first year and
monthly payments of principal and interest, based on a 10-year amortization,
thereafter. Additional principal reductions may occur, at the Company's option,
through increases in the amount of the lease financing based on the portfolio
achieving certain coverage ratios. The Company made a cash principal reduction
of $6.0 million on August 2, 2004. The balance on the note as of March 2, 2005,
was approximately $19.6 million.





In March
2005, the Company closed a debt restructuring transaction that reduces the
effective interest rate by approximately 2.75% on $21.4 million of debt and
extends the maturity to February 2008





The
Company modified the existing note in full substitution with Healthcare Realty
Trust, Incorporated ("HRT"), an unrelated third party lender. Health Care REIT,
Inc. (“HCN”) sold the loan to HRT, and assigned substantially all of the
leasehold mortgages and all additional collateral securing the loan pursuant to
a certain Loan Purchase Agreement between HCN, HRT, and Emeritus. HRT and the
Company agreed to modify, amend, and restate the loan. The restated loan has a
maturity date of February 28, 2008. The initial interest accrues on the
principal amount outstanding at the rate of 10% per annum. Commencing on the
first day of the first month after the commencement date and on the first day of
each month thereafter, the Company will make monthly interest only payments
sufficient to pay all interest accrued. On the maturity date, the Company will
make a balloon payment equal to the outstanding balance of this note including
the outstanding principal balance, all accrued and unpaid interest and all
charges, expenses, and other amounts payable by the Company to HRT. The Company
will not have the privilege of prepaying on the note in whole or in part at any
time without the prior written consent of HRT, at HRT's sole discretion. In
addition,





**F-22**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


the note
contains certain subjective default clauses, which, as a remedy, HRT may declare
the loan to be immediately due and payable.





In
connection with the loan modification, HRT also extended an additional $1.8
million to the Company on the same terms as the restated loan from HRT to pay
off certain transaction cost advances that matured in March 2006 and had an
interest rate of 12.0% (increasing to 12.5% in April 2005).  Including this
modification, principal maturities of long-term debt at December 31, 2004, would
have been $3.1 million in 2005, $2.3 million in 2006, $2.8 million in 2007,
$42.8 million in 2008, $50,000 in 2009, and $3.6 million thereafter.





Certain
of the Company's wholly owned subsidiaries, established pursuant to financing
requirements, continue to hold assets, which include certain properties operated
by the Company and which also may include cash that has been swept into the
Company's deposit accounts. Notwithstanding consolidation for financial
statement purposes, it is management's intention that the assets and liabilities
of the subsidiaries are not available to pay other debts or obligations of the
consolidated Company and the consolidated Company is not liable for the
liabilities of the subsidiaries, except as
otherwise provided in connection with these financing requirements .





Certain
of the Company’s indebtedness include restrictive provisions related to cash
dividends, investments, and borrowings. As of December 31, 2004, the Company was
in violation of one or more covenants in certain of the leases, but has been
able to obtain waivers from the owners such that it was still deemed to be in
compliance and thus, was not in default.  Many of its debt instruments
contain " cross-default"
provisions pursuant to which a default under one obligation can cause a default
under one or more other obligations to the same lender. Such cross-default
provisions affect 6 owned assisted living properties .
Accordingly, any event of default could cause a material adverse effect on its
financial condition if such debts are cross-defaulted.





Principal
maturities (excluding the effect of the March, 2005 refinancing transactions) of
long-term debt at December 31, 2004, are as follows (In thousands):





2005
    
    $
    4,1332006
    
    
    5,3042007
    
    
    20,1292008
    
    
    21,4072009
    
    
    50Thereafter
    
    
    3,638Total
    
    $
    54,661








**(9)**  **Convertible
Debentures**





The
Company has $32.0 million of 6.25% convertible subordinated debentures (the
“Debentures”) that are due January 1, 2006 . The
Debentures are convertible
into common stock at the rate of $22 per share, which equates to an aggregate of
approximately 1,454,545 shares of the Company’s common stock .
Interest on the debenture is payable semiannually on January 1 and July 1 of
each year. The Debentures are unsecured and subordinated to all other
indebtedness of the Company.





The
Debentures are subject to redemption, as a whole or in part, at a redemption
price of 100% of the principal amount.





Of the
$32.0 million of debentures, $21.5 million are owned by directors and officers
or their affiliates. Saratoga Partners, two of whose representatives are
directors, own $5.0 million of the debentures. Affiliates of Daniel R. Baty, the
Company’s chief executive officer and a director, and Stanley L. Baty, a
director, own $15.8 million of the debentures and another executive officer owns
$660,000.





**F-23**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(10)**  **Redeemable
Preferred Stock**





The
Company has authorized 5,000,000 shares of preferred stock, $0.0001 par
value .
Pursuant to such authority, in October
1997, the Company sold 25,000 shares of Series A cumulative convertible,
exchangeable, redeemable preferred stock for $25,000,000 . The
holder of the Series A redeemable Preferred Stock was entitled to receive
quarterly dividends payable in cash. The
dividend rate was 9% of the stated value of $25,000,000 .
Dividends accumulate, whether or not declared or paid. If cash dividends
were not paid quarterly, the dividend rate increased to 11% (“arrearage rate”)
until the unpaid cash dividends had been fully paid . The
preferred stock had a mandatory redemption date of October 24, 2004, at a price
equal to $1,000 per share, plus any accrued but unpaid dividends . Each
share of preferred stock could be converted, at the option of the holder, into
55 shares of common stock, at the trading price at the time of
conversion . The
preferred stock was also exchangeable in whole only, at the option of the
Company, into 9% subordinated convertible notes due October 24, 2004 . The 9%
subordinated notes would have contained the same conversion rights, restrictions
and other terms as the preferred stock. For each of the years ended December 31,
2003, and 2002, the Company
accumulated dividends aggregating $1.7 million, and $2.75 million, respectively,
at the arrearage dividend rate of 11%, for a total of $7.2 million .





Since the
Company was unable to pay dividends for more than six consecutive quarters, the
Series A shareholders became entitled to elect one additional director to their
board of directors at each annual shareholders’ meeting until such time the
Company had paid the accrued dividends . The
Series A shareholders opted not to elect an additional director. In addition,
because the Company was unable to pay dividends to their Series A shareholders
for more than six consecutive quarters, beginning
in 2002, the Series A dividends were calculated on a compounded cumulative
basis, retroactively. The retroactive adjustment of Series A dividends for 2000
and 2001 were $19,000 and $275,000 ,
respectively, which were recognized in 2002. The
cumulative compounding for 2003 and 2002 was an additional $586,000 and
$622,000 ,
respectively.





*Repurchase
of Series A Preferred Stock.* In a
two-part transaction that was completed August 28, 2003, the
Company repurchased all the outstanding shares of its Series A Preferred
Stock for an aggregate purchase price of $20.5 million . The
Series A Preferred Stock had been issued originally in October 1997 for $25.0
million. As a part
of the repurchase, the holder of the Series A Preferred Stock waived
approximately $10.1 million in accrued and unpaid dividends . As a
result of the transaction, the Company recognized a gain of approximately
$14.5 million . Just
prior to the repurchase, the Series A Preferred Stock was accruing
compounded, cumulative dividends of approximately $3.7 million annually with
mandatory redemption in October 2004 at a
price of $25 million plus accrued and unpaid dividends. In completing the
repurchase, the Company avoided these future obligations. The Company obtained
the funds to complete the repurchase through three related transactions as
described in footnote (17).














**F-24**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(11)**  **Income
Taxes**





Income
taxes reported by the Company differ from the amount computed by applying the
statutory rate primarily due to limitations on utilizing net operating losses
and requirements to pay Alternative Minimum taxes.





Income
taxes of $1.2 million and $418,000 at December 31, 2004 and December 31, 2003,
respectively, are due primarily because of gains on sale-leaseback transactions
involving several communities in 2004 and 2003, which have been deferred for
accounting purposes. The Company believes that it will be required to pay an
alternative minimum income tax for 2004 on its federal income tax return and in
certain states it  will
pay income or franchise tax.





The tax
effect of temporary differences and carryforwards that give rise to significant
portions of deferred tax assets and liabilities are comprised of the following
at December 31, (In thousands):








**2004**
    
    **2003**Gross
      deferred tax liabilities:Lease
      expense
    
    $
    (15,171
    )
    $
    -Book
      basis in fixed assets in excess of tax basis
    
    
    -
    
    
    (4,933
    )Insurance
    
    
    -
    
    
    (1,131
    )Depreciation
      and amortization
    
    
    (967
    )
    
    (1,525
    )Other
    
    
    -
    
    
    (45
    )$
    (16,138
    )
    $
    (7,634
    )Gross
      deferred tax assets:Net
      operating loss carryforwards
    
    
    11,890
    
    
    25,303Deferred
      gains on sale-leasebacks
    
    
    12,828
    
    
    13,811Unearned
      rental income and deferred move-in fees
    
    
    5,332
    
    
    4,012Vacation
      accrual
    
    
    1,094
    
    
    740Health
      insurance accrual
    
    
    860
    
    
    928Insurance
      accrual
    
    
    8,807
    
    
    -Interest
      expense
    
    
    12,558
    
    
    -Depreciation
      and amortization
    
    
    132
    
    
    -Deferred
      lease payments
    
    
    -
    
    
    1,414Capital
      leases
    
    
    10,714
    
    
    1,680Federal
      alternative minimum tax credit
    
    
    945
    
    
    142Other
    
    
    1,592
    
    
    63466,752
    
    
    48,664Less
      valuation allowance
    
    
    (50,614
    )
    
    (41,030
    )Deferred
      tax assets, net
    
    
    16,138
    
    
    7,634Net
      deferred tax assets
    
    $
    -
    
    $
    -





The
increase in the valuation allowance was $9.6 million, $2.8 million, and $1.8
million for 2004, 2003, and 2002, respectively. The increases were primarily due
to the change in accounting for leases and deferred gains, for which management
does not believe that it is more likely than not that realization is
assured.





For
federal income tax purposes, the Company has net operating loss carryforwards at
December 31, 2004, available to offset future federal taxable income, if any, of
approximately $35.0 million expiring beginning in 2005.





**F-25**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(12)**  **Shareholders’ Deficit**





*Preferred
Stock*





In
December 1999, the Company sold 30,000 shares of its Series B preferred stock to
Saratoga Partners IV, L.P. ("Saratoga") and certain investors related to
Saratoga for a purchase price of $1,000 per share . Each
share of Series B Preferred Stock has voting authority, and is convertible into
the number of shares of common stock equal to the stated value of $1,000 divided
by an initial conversion price of $7.22, to be adjusted for any anti-dilutive
transactions . Additionally,
the Company issued to Saratoga a seven-year warrant ("the Warrant") to purchase
one million shares of Common Stock at an exercise price of $4.30 per share on
August 31, 2000.





The
Series B Preferred Stock is entitled to receive quarterly dividends payable in a
combination of cash and additional shares of Series B Preferred Stock. From
issuance to January 1, 2004, the dividend rate was 6% of the stated value of
$1,000, of which 2% was payable in cash and 4% was payable in Series B Preferred
Stock at the rate of one share of Series B Preferred Stock for every $1,000 of
dividend . After
January 1, 2004, the dividend rate is 7% of which 3% is payable in cash and 4%
is payable in Series B Preferred Stock .
Dividends accumulate, whether or not declared or paid. Prior to
January 1, 2007, however, if the cash portion of the dividend is not paid, the
cash dividend rate will increase to 7% ("arrearage rate"), until the unpaid cash
dividends have been fully paid, or until January 1, 2007, whichever first
occurs . Beginning
January 10, 2003, the Company can redeem all of the Series B Preferred Stock at
$1,000 per share plus unpaid dividends, if the closing price for the common
stock on the American Stock Exchange is at least 175% of the then conversion
price for 30 consecutive trading days.  In 2002,
the Company accrued $2.4 million in cash dividends at the higher arrearage rate,
and $1.3 million equivalent to 1,317 shares of Series B Preferred Stock as
in-kind dividends. In the third quarter of 2002, the Company issued 2,533 shares
of Series B Preferred Stock for the in-kind dividends accrued from 2000, 2001,
and the first two quarters of 2002. In the fourth quarter of 2002, another 331
shares of Series B Preferred Stock were issued for the third quarter
accrual.  During
2003, additional shares of Series B Preferred Stock were issued on a quarterly
basis on the first day following the quarter to which they were related. Thus,
an additional 1,357 shares, equivalent to $1.4 million, of Series B Preferred
Stock were issued as paid-in-kind dividends during 2003.  During
2004, an additional 1,412 shares, equivalent to $1.4 million Series B Preferred
Stock were issued as paid-in-kind dividends. Accordingly, the Company had a
cumulative commitment to issue 362 shares, 348 shares, and 334 shares of Series
B Preferred Stock at December 31, 2004, 2003, and 2002,
respectively.





As of
December 31, 2004, the Company has accrued its obligation to pay cash dividends
to the Series B preferred shareholders, which amounted to approximately $10.5
million, including all penalties for non-payment . Since
the Company had not paid these dividends for more than six consecutive quarters,
under the Designation of Rights and Preferences of the Series B preferred stock
in the Company's Articles of Incorporation, the Series B preferred shareholders
may designate one director in addition to the other directors that they are
entitled to designate under the shareholders' agreement. As of
January 1, 2002, the Series B preferred shareholders became entitled to
designate an additional director under the Articles, but thus far have chosen
not to do so .








*1995
Stock Incentive Plan*





The
Company has a 1995 stock incentive plan (“1995 Plan”) which combines the
features of an incentive and non-qualified stock option plan, stock appreciation
rights, and a stock award plan (including restricted stock). The 1995 Plan is a
long-term incentive compensation plan and is designed to provide a competitive
and balanced incentive and reward program for participants.





The
Company has authorized 2,400,000 shares of common stock to be reserved for
grants under the 1995 Plan  of which
264,390 were available for future awards at December 31, 2004 . Options
generally vest





**F-26**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


between
three-year to five-year periods, at the discretion of the Compensation Committee
of the Board of Directors, in cumulative increments beginning one year after the
date of the grant and expire not later than ten years from the date of grant.
The options are granted at an exercise price equal to the fair market value of
the common stock on the date of the grant.





In May
2001, the Company announced an offer to exchange options under the 1995 Plan
held by current employees, including executive officers, for new options to be
granted under the 1995 Plan and new option letter agreements. Under the offer,
employees were required to tender all or none of their options in exchange for
new options subject to the same number of shares of common stock as the options
tendered for exchange. Approximately 99% of outstanding options were exchanged.
The new options were granted on December 10, 2001, which was the first business
day that was at least six months and one day after the date tendered options
were accepted for exchange. The new options have an exercise price of $2.11 and
fully vested 30 months after the date of grant, which was June 11, 2004. In all
other respects, the terms of the new options were the same as the terms of the
options tendered for exchange.





A summary
of the activity in the Company’s stock option plans follows :





**2004**
    
    **2003**
    
    **2002****Weighted-**
    
    
    
    **Weighted-**
    
    
    
    **Weighted-****Average**
    
    
    
    **Average**
    
    
    
    **Average****Exercise**
    
    
    
    **Exercise**
    
    
    
    **Exercise****Shares**
    
    **Price**
    
    **Shares**
    
    **Price**
    
    **Shares**
    
    **Price**Outstanding
      at beginning of year
    
    
    2,151,443
    
    $
    2.89
    
    
    1,714,333
    
    $
    2.56
    
    
    1,192,552
    
    $
    2.39Granted
    
    
    45,000
    
    $
    6.42
    
    
    536,500
    
    $
    3.94
    
    
    601,000
    
    $
    2.94Exercised
    
    
    (514,082
    )
    $
    2.37
    
    
    (50,223
    )
    $
    2.44
    
    
    (7,501
    )
    $
    2.11Canceled
    
    
    (123,407
    )
    $
    4.25
    
    
    (49,167
    )
    $
    3.03
    
    
    (71,718
    )
    $
    2.96Outstanding
      at end of year
    
    
    1,558,954
    
    $
    3.06
    
    
    2,151,443
    
    $
    2.89
    
    
    1,714,333
    
    $
    2.56Options
      exercisable at year-end
    
    
    1,061,448
    
    $
    2.70
    
    
    916,941
    
    $
    2.57
    
    
    420,110
    
    $
    2.82Weighted-average
      fair value of optionsgranted
      during the year
    
    
    
    
    $
    4.24
    
    
    
    
    $
    2.55
    
    
    
    
    $
    1.99







The following
is a summary of stock options outstanding at December 31, 2004 :


**Options
      Outstanding**
    
    **Options
      Exercisable****Weighted-****Average**
    
    **Weighted-**
    
    
    
    **Weighted-****Remaining**
    
    **Average**
    
    
    
    **Average****Range
      of**
    
    **Number**
    
    **Contractual**
    
    **Exercise**
    
    **Number**
    
    **Exercise****Exercise
      Prices**
    
    **Outstanding**
    
    **Life**
    
    **Price**
    
    **Exercisable**
    
    **Price**$
    1.60
    
    
    -
    
    $
    2.11
    
    
    644,390
    
    
    6.95
    
    $
    2.10
    
    
    644,390
    
    $
    2.10$
    2.56
    
    
    -
    
    $
    4.06
    
    
    854,814
    
    
    7.66
    
    $
    3.47
    
    
    394,808
    
    $
    3.30$
    6.30
    
    
    -
    
    $
    7.95
    
    
    50,750
    
    
    8.95
    
    $
    6.44
    
    
    13,250
    
    $
    6.84$
    9.63
    
    
    -
    
    $
    9.63
    
    
    500
    
    
    3.88
    
    $
    9.63
    
    
    500
    
    $
    9.63$
    10.25
    
    
    -
    
    $
    15.25
    
    
    8,500
    
    
    2.64
    
    $
    13.09
    
    
    8,500
    
    $
    13.091,558,954
    
    
    7.38
    
    $
    3.06
    
    
    1,061,448
    
    $
    2.70










*Employee
Stock Purchase Plan*





In July
1998, the Company adopted an Employee Stock Purchase Plan (the "Plan") to
provide substantially all employees who have completed six months of service an
opportunity to purchase shares of its common stock through payroll deductions,
at a price equal to 85% of the fair market value . A total
of 400,000 shares are available for purchase under the Plan . Periodically,
participant account balances are used to purchase





**F-27**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements





shares of
stock on the open market at the lesser of the fair market value of shares on the
first or last day of the participation period .
Employees may not exceed $25,000 in annual purchases or 15% of eligible
compensation . The Plan
expires in May 2008. In 2004, 2003, and 2002, employees purchased, net of open
market repurchases; zero; zero; and 43,695 common shares ,
respectively, through the Plan, for an
aggregate total of 175,975 since inception of the Plan .





**(13)
Comprehensive Income (Loss)**





Comprehensive
income (loss) consists of the following for the years ended December 31, 2004,
2003, and 2002, respectively (In thousands):





**2004**
    
    **2003**
    
    **2002**Net
      income (loss) to common shareholders
    
    $
    (44,277
    )
    $
    204
    
    $
    (13,798
    )Other
      comprehensive income (loss):Unrealized
      holding gainson
      investment securities
    
    
    -
    
    
    144
    
    
    1,383Realized
      gains on investment securities
    
    
    -
    
    
    (1,391
    )
    
    -Comprehensive loss
    
    $
    (44,277
    )
    $
    (1,043
    )
    $
    (12,415
    )





**(14)**  **Financial Instruments**





The
Company has financial instruments other than investment securities consisting of
cash and cash equivalents, trade accounts receivable, other receivables, notes
receivable from affiliates, short-term borrowings, accounts payable, convertible
debentures, redeemable preferred stock, and long-term debt. The fair value of
the Company’s financial instruments, based on their short-term nature or current
market indicators such as prevailing interest rates, approximates their carrying
value with the exception of the following: long-term debt had an estimated fair
value, based on the Company’s incremental borrowing rate of 9.5%, of $53.4
million, which approximates the carrying value of $54.7 million; and the
convertible debentures have an estimated fair value, based on the Company’s
incremental borrowing rate, of $31.7 million versus a book value of $32.0
million at December 31, 2004.





**(15)**  **Related-Party Management Agreements**





During
1995, the Company’s two most senior executive officers, its Chief Executive
Officer, and its then President, who is now its Chief Financial Officer, formed
a New York general partnership (the “Partnership”) to facilitate the operation
of assisted living communities in the state of New York, which generally
requires that natural persons be designated as the licensed operators of
assisted living communities. The Partnership operates ten leased communities in
New York. The Company has agreements with the Partnership and the partners under
which all of the Partnership’s profits have been assigned to the Company and the
Company has indemnified the partners against losses. As the Company has
unilateral and perpetual control over the Partnership’s assets and operations,
the results of operations of the Partnership are consolidated with those of the
Company.





The
Company has management agreements with a number of entities directly owned or
controlled by Mr. Baty relating to 8 communities at December 31, 2004. The
agreements have terms ranging from two to four years, with options to renew, and
provide for management fees ranging from 4% to 7% of gross operating revenues.
Management fee revenue earned under these and previous agreements was
approximately $2.2 million, $4.4 million, and $4.3 million in 2004, 2003, and
2002, respectively.





Mr. Baty
is a principal shareholder, director, and Chairman of the Board of Holiday
Retirement Corporation, and is the principal owner of Columbia-Pacific Group,
Inc. Substantially all of the independent living





**F-28**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


facilities
operated by Holiday are owned by partnerships that are controlled by Mr. Baty
and Holiday. Mr. Baty’s varying financial interests and responsibilities include
the acquisition, financing, and refinancing of independent living facilities and
the development and construction of, and capital raising activities to finance
new facilities. Columbia-Pacific and affiliated partnerships operate assisted
living communities and independent living facilities, many of which the Company
manages under various management agreements. The financial interests and
management and financing responsibilities of Mr. Baty with respect to Holiday
and Columbia-Pacific and their affiliated partnerships could present conflicts
of interest with the Company, including potential competition for residents in
markets where both companies operate and competing demands for the time and
efforts of Mr. Baty.





**(16)**  **Leases**





At
December 31, 2004, the Company leased office space and 158 assisted living
communities. The office lease expires in 2006 and contains two five-year renewal
options. The community leases, which are triple-net leases, expire from 2005 to
2018 and contain various extension options, ranging from five to 15
years.





Minimum
lease payments under noncancelable operating leases at December 31, 2004, are as
follows (In thousands):





2005
    
    $
    36,9982006
    
    
    37,5092007
    
    
    38,0082008
    
    
    38,5142009
    
    
    39,021Thereafter
    
    
    131,862Total
    
    $
    321,912





Facility
lease expense under noncancelable operating leases was approximately $38.4
million, $33.8 million, and $27.2 million for 2004, 2003, and 2002,
respectively, which included non-cash expense of approximately $652,000,
$550,000, and $344,000, respectively, related to straight-lining lease expense
based on fixed inflators. A number of operating leases provide for additional
lease payments after 24 months computed at 5% of additional revenues of the
community. Additional facility lease expense under these provisions was
approximately $920,000, $628,000, and $599,000 in 2004, 2003, and 2002,
respectively. Additional lease payment after 13 months computed at rates ranging
from 7% to 8.5% of gross revenues in excess of a specified threshold are related
to a 24 community lease acquisition from the fourth quarter of 2002 and resulted
in additional lease expense of $67,000 and zero in 2004 and 2003, respectively.





Facility
lease expense under noncancelable operating leases with entities in which Mr.
Baty has a financial interest was approximately $5.9 million, $5.8 million and
$1.5 million, for 2004, 2003, and 2002, respectively.





**F-29**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements





Minimum
lease payments under noncancelable capital leases and financing obligations at
December 31, 2004, are as follows (In thousands):





2005
    
    $
    57,2242006
    
    
    59,0882007
    
    
    60,9742008
    
    
    62,8492009
    
    
    64,642Thereafter
    
    
    729,729Subtotal
    
    
    1,034,506Less
      imputed interest at rates ranging between 6.0% and 9.5%
    
    
    404,981Capital
      lease and financing obligations
    
    
    629,525Less
      current portion
    
    
    15,479Capital
      lease and financing obligations, less current portion
    
    $
    614,046





Facility
interest expense under noncancelable capital leases and financing obligations
was approximately $28.7 million, $6.1 million, and $2.4 million for 2004, 2003,
and 2002, respectively. Depreciation was approximately $25.0 million, $5.1
million, and $2.1 million for 2004, 2003, and 2002, respectively.


Many
of the Company's leases contain "cross-default" provisions pursuant to which a
default under one obligation can cause a default under one or more other
obligations to the same lessor. Such cross-default provisions affect 154
assisted living properties operated under leases. Accordingly, any event of
default could cause a material adverse effect on the Company's financial
condition if such leases are cross-defaulted. Defaults can include certain
financial covenants, which generally relate to lease coverage and cash flow. In
addition, the Company is required to maintain the leased properties in a
reasonable and prudent manner. For the year ended December 31, 2003, the Company
expected to be in compliance at least through 2004 and for the foreseeable
future. However, in 2004, the Company was in violation of one or more covenants
in certain of the leases, but has been able to obtain waivers from the owners
such that it was still deemed to be in compliance and thus, was not in default.





**(17)**  **Sales,
Leases and Acquisitions, including Certain Related-Party
Transactions**





*Emeritrust
Transactions*





Beginning
in 1999, the Company managed 46 communities under arrangements with several
related investor groups that involved (i) payment of management fees to the
Company (ii) options for Emeritus to purchase the communities at a price
determined by a formula, and (iii) obligations to fund operating losses of
certain communities.





*Emeritrust I
Communities Management* . During
2004, 2003, and 2002, the Company managed the Emeritrust I communities,
which included 25 of the 46 communities. Through March 31, 2004 the management
agreement provided for a base fee of 3% of gross revenues generated by the
communities and an additional management fee of 4% of gross revenues, payable to
the extent of 50% of cash flow from the communities. The management agreement
also required the Company to fund cash operating losses of the communities. In
each of April and August 2003, the Emeritrust I owners disposed of a
community, reducing the number of managed communities to 23. In March 2004, the
Emeritrust I owners disposed of a community, reducing the number of communities
that the Company managed to 22. In June 2004, the Emeritrust I owners sold a
community located in Grand Terrace, California, to an entity controlled by Mr.
Baty. This entity, in turn, leased the community to the Company, reducing the
number of communities that





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 **NOTES
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Table of Contents
  Index to Consolidated Financial
Statements


the
Company managed to 21. On September 30, 2004, 16 of the original 21
Emeritrust I Communities were acquired by a third party REIT and leased as
described under Emeritrust I Communities Lease. The five remaining communities
continue to be managed by the Company. Under this arrangement, the Company
received management fees (net of its funding obligations) of approximately $1.9
million, $2.7 million, and $1.8 million in 2004, 2003, and 2002, respectively.
This management agreement, as extended several times, expired at the end of
2003. On January 2, 2004, the Company and the Emeritrust I investors
entered into a new management agreement providing for management fees computed
on the same basis and (i) terminating all options to purchase the communities,
(ii) terminating any further funding obligation, and (iii) providing for a term
expiring September 30, 2005, provided that either party may terminate the
agreement on 90 days notice. Effective April 1, 2004, the Emeritrust I owners
extended the underlying financing on the Emeritrust I communities. In connection
with the financing extension, the management agreement was amended to provide
for a flat management fee of 5% of gross revenues and amended the term to March
31, 2005, with a one-year extension to March 31, 2006, available under certain
circumstances, subject to termination by either party on short notice.





*Emeritrust
I Communities Lease.* In
connection with these communities and others, the following transaction took
place that eliminated the majority of the Emeritrust I communities as managed
communities, converting them to leased communities: As of September 30,
2004, 16 of the remaining 21 Emeritrust I Communities were acquired by a
third party REIT and leased to the Company and their operating results are
included in the Company's consolidated financial statements beginning October 1,
2004. Emeritus still manages 5 communities on behalf of the Emeritrust I group;
the Emeritrust I group had previously disposed of 4 communities, including 1
which continues to be leased by the Company.





On
September 30, 2004, the Company completed the first phase of a transaction to
lease up to 20 assisted living communities in 12 states, with 1,824 units. These
communities, which were owned by entities in which Mr. Baty had financial
interests, have been acquired by an independent REIT for an approximate $170.8
million investment and are being leased to the Company. The Company completed
the lease on the first 18 communities on September 30, 2004, and anticipates the
remaining two communities will close during the second quarter of 2005. Sixteen
of the communities included in this lease were part of the group of 21 owned by
AL Investors and have been referred to in past filings with the Securities and
Exchange Commission as the “Emeritrust I communities.” The Company managed these
communities under a master management agreement entered into in 1999, which has
been amended from time to time since then. The Company will continue to manage
the five remaining Emeritrust I communities under the amended master management
agreement for a fee based on a fixed percentage of revenue as described above
under Emeritrust I Communities Management. Of the other four communities
included in the lease, two were previously managed by the Company, one was
leased by the Company and one is new to the Company’s portfolio.





The 18
communities are leased by the Company from the REIT pursuant to a new master
lease with a 15-year term, with one 15-year renewal option. Due to certain
subjective default provisions and default remedies, the leases are accounted for
as capital leases. For the leases completed on September 30, 2004 this resulted
in additions to property and equipment and capital lease and financing
obligations totaling approximately $156 million. Approximately an additional
$35.3 million in property and equipment and financing obligations will be
recorded pursuant to the future closing of the two remaining facilities. The
initial lease payment for the facilities that have closed is approximately $12.2
million per year, with inflators to the extent the change in the consumer price
index exceeds 0%, not to exceed 40 basis points during years two through four
and 30 basis points thereafter as calculated with respect to the REIT's
investment basis in the properties. The initial lease payment is expected to
increase by $2.5 million when the remaining two facilities close. The Company is
responsible for all operating costs, including repairs, property taxes, and
insurance. The new master lease is cross-defaulted and cross-collateralized with
all of the Company’s other leases and loans relating to other communities owned
by the REIT and contains certain financial and other covenants. The Company has
the right of first refusal to purchase these leased communities and Mr. Baty is
personally guaranteeing the obligations of the Company under the lease. As
compensation, Mr. Baty will receive 50% of the positive cash flow of the 20
communities and will be responsible for 50% of any negative





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 **NOTES
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  Index to Consolidated Financial
Statements


cash
flow. In 2004, Mr. Baty received $200,000 as consideration.  The Company
has the right to purchase Mr. Baty’s 50% interest in the cash flow of the 20
communities for 50% of the lesser of 6 times cash flow or the fair market value
of that cash flow. For purposes of this transaction, cash flow is defined as
actual cash flow after management fees of 5% of revenues payable to the Company
and actual capital expenditures and certain other agreed adjustments.





All 20
communities provide assisted and/or memory loss related services to seniors. The
facilities are located in California, Delaware, Florida, Kansas, Montana,
Nevada, South Carolina, Ohio, Utah, Texas, Virginia, and Washington.





*Emeritrust II
Communities Management.* Through
September 30, 2003, Emeritus managed the Emeritrust II communities,
which included 21 of the 46 communities, under management agreements providing
for a base management fee of 5% of gross revenue generated by the communities
and an additional management fee of 2%, payable if the Company met certain cash
flow standards. The management agreement for five of the communities also
required the Company to fund cash operating losses of those communities. Under
this arrangement, the Company received management fees (net of its funding
obligations) of approximately $2.0 million for the year ended December 31, 2003
and approximately $2.6 million for the year ended December 31, 2002.





*Emeritrust II
Communities Lease.* On
September 30, 2003, an independent REIT acquired the 21 Emeritrust II
communities for a cash purchase price of $118.6 million and leased them to the
Company. A master lease covers the Emeritrust II communities and four other
communities originally leased under a capital lease arrangement from the REIT in
March 2002. Due to certain subjective default provisions and default remedies
which allow for acceleration of all unpaid lease payments, the leases are
accounted for as capital leases, which resulted in additions to property and
equipment and capital lease and financing obligations totaling approximately
$164.1 million. The lease is for an initial 15-year period, with one 15-year
renewal, and grants the Company a right of first opportunity to purchase any of
the Emeritrust II communities if the REIT decides to sell. The lease is a
triple-net lease, with annual base rent of $14.7 million (of which
$10.5 million is attributable to the Emeritrust II communities), and
periodic escalators of the lesser of three times the change in the consumer
price index or 28.67 basis points as calculated with respect to the REIT's
investment basis in the properties. The REIT also provided $11.5 million of debt
financing secured by the Company's leasehold interests in the Emeritrust II
communities. This debt was consolidated with other debt held by the REIT. As
part of the transaction, the Company also agreed to issue to the
Emeritrust II investors warrants to purchase 500,000 shares of its common
stock, of which 400,000 shares have been issued. The warrants expire September
30, 2008, and have an exercise price of $7.60 (subject to certain adjustments).
The holders have limited registration rights. The Company included the fair
value of these warrants, totaling approximately $2.5 million, as lease
acquisition costs and will amortize them over the life of the
lease.





*Lease
of Eight Communities in May 2003.* In May
2003, the Company entered into a lease with a REIT covering eight assisted
living communities in four states containing an aggregate of 489 units. The
lease is for an initial 10-year period with three 5-year extensions and includes
an option to acquire the communities during the second year for a price of $42.2
million and during the third year at the same price plus a 3% premium. The
Company believes this option exercise price is currently well above fair value
based on current operations. Under the lease Emeritus has a right of first
opportunity to purchase any of the properties if the owner decides to sell. The
lease is a triple-net lease, with annual base rental of $3.5 million, and rent
adjustments at the end of the first and second lease years based on a percentage
of any increase in operating revenues, with an aggregate annual limit of
$275,000, and adjustments each year thereafter based on increases in the
consumer price index. The REIT has agreed to fund up to $500,000 for capital
expenditures, with amounts added to the lease base and option price, and has
provided the Company with a 10-year working capital loan for $600,000, with
interest at 10% per annum payable monthly.





*Transactions
in Connection with the Repurchase of the Series A Preferred
Stock.* In July
2003, the first transaction involved three communities that Emeritus leased.
Prior to this transaction, the Company also held notes receivable in the
aggregate amount of $4.4 million that were secured by the same three





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  Index to Consolidated Financial
Statements


communities
and under which it received interest of approximately $144,000 annually. In the
transaction, the communities were transferred to a REIT, which became the new
owner and lessor, and the Company received net proceeds of $10.2 million in
repayment of the notes the Company held and in exchange for its related security
and other property interests in the communities. The transfer of the communities
was subject to the Company's leases, the terms of which did not change. Because
Emeritus disposed of its notes, the Company will no longer receive the interest
it formerly did. The Company recognized a deferred gain of approximately $8.5
million, which is being amortized over the remaining life of the
leases.





On
September 20, 2003, the second transaction, with the same REIT, involved the
sale-leaseback of four communities, three of which Emeritus owned and one of
which it held a 50% joint venture interest, resulting in net proceeds of
$6.6 million. The lease is for a 15-year term with a 15-year extension, is
a triple-net lease requiring the Company to pay all expenses associated with the
communities, and provides for a base annual rent of approximately
$3.5 million, with periodic escalators of the lesser of three times the
change in the consumer price index or 25 basis points as calculated with respect
to the REIT's investment basis in the properties. Prior to this transaction, the
communities secured mortgage financing of $24.6 million, with annual
interest payments of approximately $2.4 million, which was assumed by the
REIT in the sale. As a part of the assumption, the Company provided a letter of
credit against the default of the underlying debt and continued a security
interest in community receivables and limited guarantees in favor of the debt
holder. These features of the transaction constitute continuing involvement for
accounting purposes and preclude sale-leaseback accounting and require the
Company to use finance accounting. As a result, although the transaction
resulted in the legal sale of the communities to the REIT and their subsequent
leasing by the Company, the Company's consolidated financial statements continue
to reflect the communities as owned and the Company has established a financing
obligation equal to the purchase price of approximately $34.6 million.





The third
transaction, again with the same REIT, was a mortgage loan for $7.5 million
secured by the Company’s leasehold interest in the seven communities involved in
the first two transactions discussed above. The debt matures in August 2006 and
requires monthly interest-only payments at an initial rate of 12% per annum,
with periodic increases. This mortgage debt was subsequently consolidated with
other debt held by the REIT, as discussed in Note 8, "Long-term
Debt".





*Lease
of Eight Communities from Baty.* In April
2002, the Company entered into agreements to acquire the ownership interest of
one community and the leasehold interest of seven communities through the
assumption of their respective mortgage debt and lease obligations. The eight
communities, comprising 617 units in Louisiana and Texas, had been previously
operated by Horizon Bay Management L.L.C. In May 2002, the Company assigned its
rights under these agreements to entities wholly owned by Mr. Baty and entered
into five-year management agreements with the Baty entities expiring
April 30, 2007, and providing for a management fee of 5% of gross revenue.
As a part of these agreements, the Company had the right to reacquire the one
community and seven leased communities at any time prior to April 30, 2007,
by assuming the mortgage debt and lease obligations and paying the Baty entities
the amount of any cash investment in the communities, plus 9% per annum. In the
original agreements of acquisition with the Baty entities, Horizon Bay agreed to
fund operating losses of the communities to the extent of $2.3 million in the
first twelve months and $1.1 million in the second twelve months following the
closing. Under the management agreements with the Baty entities, the Company
agreed to fund any operating losses in excess of these limits over the five-year
management term. In late 2002, the Baty entities and Horizon Bay altered their
agreement relating to operating losses whereby (i) Horizon Bay paid the Baty
entities $2 million and (ii) the Baty entities waived any further funding
by Horizon of operating losses of the communities.





On
September 30, 2003, Emeritus entered into an agreement to lease the eight
Horizon Bay communities. ** Under the
agreement, the Baty entities assigned, and the Company assumed, the existing
leases relating to seven of the facilities, which were leased from two different
lessors. In lieu of acquiring the remaining community, which was owned by a Baty
entity subject to mortgage financing, the Company leased the community for a
term of 10 years, with rent equal to the debt service on the mortgage
indebtedness





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  Index to Consolidated Financial
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(including
interest and principal) plus 25% of cash flow (after accounting for assumed
management fees and capital expenditures). As of April 1, 2004, this Horizon Bay
community became a capital lease under the CPM-JEA transactions described below.
The debt that is secured by this community may be cross-collateralized by Mr.
Baty with an Emeritrust I community that he may acquire and lease to the
Company, as described below. Annual rent relating to the eight communities is
estimated at $4.6 million, with annual adjustments based upon changes in the
consumer price lindex. The Company paid the Baty Entities approximately $70,000,
which represents their cash investment plus 9% per annum, as provided in the
original agreement related to the management of these communities between the
Baty Entities and the Company. Although this transaction closed
December 31, 2003, the economic and financial terms were effective
June 30, 2003. Four of these facilities are capital leases resulting in
additions to property and equipment and capital lease and financing obligations
on our consolidated balance sheets totaling approximately $23.6 million.





*Fretus
Lease.* On
October 1, 2002, the Company entered into an operating lease agreement with
Fretus Investors LLC ("Fretus"), for 24 assisted living communities (the
"Properties") in six states containing an aggregate of approximately 1,650
units. Fretus acquired the Properties from Marriott Senior Living Services, a
subsidiary of Marriott International. Fretus is a private investment joint
venture between Fremont Realty Capital ("Fremont"), which holds a 65% stake,
with the remaining 35% minority stake held by an entity controlled by Mr. Baty
and in which he holds an indirect 36% interest. Mr. Baty is also guarantor
of a portion of the debt and the Baty-related entity is the administrative
member of Fretus . Fretus,
in turn, leased the Properties to the Company. The Company has no obligation
with respect to the properties other than its responsibilities under the lease,
which includes the option to purchase solely at the discretion of the
Company.





The
Fretus lease is for an initial 10-year period with two 5-year extensions and
includes an opportunity for the Company to acquire the Properties during the
third, fourth, or fifth year and the right under certain circumstances for the
lease to be cancelled as to one or more properties upon the payment of a
termination fee to Emeritus. The lease is a triple-net lease, with base rental
equal to (i) the debt service on the outstanding senior mortgage  granted
by Fretus , and
(ii) an amount necessary to provide a 12% annual return on equity to Fretus. The
initial senior mortgage debt is for $45.0 million and interest is accrued at
LIBOR plus 3.5%, subject to a floor of 6.25%. The Fretus equity is approximately
$25.0 million but may increase as a result of additional capital contributions
for specified purposes and will decrease as a result of cash distributions to
investors. Based on the initial senior mortgage terms and Fretus equity, current
rent payments are approximately $500,000 per month. In addition to the base
rental, the lease also provides for percentage rental equal to a percentage
(ranging from 7% to 8.5%) of gross revenues in excess of a specified threshold,
commencing with the thirteenth month of the lease. The Properties in this lease
transaction are all purpose-built assisted living communities in which the
Company offers both assisted and memory loss services in selected communities.
Rent expense under the Fretus lease was $5.9 million, $5.8 million, and
$1.5 million for the years ended December 31, 2004, 2003, and 2002,
respectively.





*March
2002 Lease of Four Communities.* In March
2002, the Company entered into a 15-year master lease arrangement with HC REIT,
Inc. for four communities, two of which Emeritus previously held an ownership
interest in and two of which it previously leased from another lessor. A
Baty-related entity held a 50% economic interest in one of the communities in
which the Company had an interest. Preceding the HC REIT transaction, Emeritus
purchased the Baty-related entity's economic interest for Baty’s investment
basis of $2.1 million plus a 9% return, a $2.95 million total payment. The other
community in which the Company had an interest was 50% owned by an outside
investor. Also preceding the HC REIT transaction, the Company purchased the
remaining 50% interest in this community for $2.65 million. Subsequent to the
two purchase transactions, Emeritus entered into a master lease arrangement with
the REIT for all four communities and recognized a net loss of approximately
$530,000, which is recorded in “Other, net” in the consolidated statements of
operations. The loss is primarily comprised of write-offs of existing loan fees
and lease acquisition costs for the four buildings. Additionally, the Company
has a deferred gain on sale associated with the transaction that approximates
$1.8 million and new lease acquisition costs of $1.0





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  Index to Consolidated Financial
Statements


million,
that are being amortized over the lease period of 15 years. These leases were
accounted for as capital leases in which the Company established on its balance
sheet a capital lease obligation of $42.8 million and corresponding long-term
assets of the same amount. The statement of operations includes charges for
depreciation and interest based on this asset and liability.





*Alterra
Transactions* . On
December 31, 2003, independent of the LLC arrangement as described in footnote
“(6) Long-Term Investments”, the Company acquired five assisted living
communities, containing an aggregate of 355 units, from Alterra for the
assumption of $22.6 million of mortgage debt, which bears interest at 6.98% per
annum, provides for monthly payments of $178,000, including principal and
interest, and matures August 2008.





*CPM-JEA
Transactions* On April
1, 2004, the Company completed the first stage of a lease of up to 24 assisted
living facilities in 13 states, including up to 10 stand-alone dementia care
facilities. The facilities were acquired by an independent REIT for an
approximate $190.7 million investment, inclusive of transaction fees and leased
to the Company. On October 1, 2004, the Company completed the lease of another
facility located in Joliet, Illinois, and on October 22, 2004, the Company
entered into a lease for one community located in Cape May, New Jersey. Due to
certain subjective default clauses in the lease and remedies which allow for
acceleration of all unpaid rents in the event of default, these leases have been
accounted for as capital leases, which resulted in additions to property and
equipment and capital lease and financing obligations totaling approximately
$174.1 million. The Company has leased 20 of the 24 senior housing and long-term
care properties, which the REIT acquired for a total investment of about $168.3
million, inclusive of transaction fees. Ten of the communities, all of which the
Company managed in 2003, were owned by entities that Mr. Baty controls and in
which he has financial interests (CPM stands for Columbia Pacific Management and
the entities are collectively referred to as the “Baty Entities”). The remainder
of the communities were owned by entities in which Mr. Baty had an indirect
ownership interest (the “JEA Entities”). With respect to the communities
formerly owned by the JEA Entities, the Company entered into a management
agreement with JEA Senior Living (“JEA”), a partner in the JEA Entities that is
not affiliated with Mr. Baty, to provide certain management services to the
communities for a period of three years. Under the terms of this management
agreement, JEA is entitled to a monthly management fee of 5% of the gross
revenues of the communities and to a termination payment of $100,000 per year
for a period of ten years after the termination of the management agreement. The
Company also agreed to an earn-out payment to the JEA Entities of up to $2.0
million based on the improvement in the net operating income of the communities
during the three-year period after the closing. Lease acquisition costs include
$2.7 million in cash and $1.0 million by the execution and delivery by the
Company of its promissory notes to two of the Baty Entities, which provide for
interest at the rate of 8% and a maturity date of April 1, 2007. In connection
with the transaction, the Company received payment on a $2.7 million note
receivable from a separate CPM entity. The communities are leased under four
master leases with the independent REIT, each with a maturity date of March 31,
2019, with three 5-year renewal options. The lease rate is 9% with fixed
inflators of the lesser of four times the change in the consumer price index or
3%. The base rent as of December 31, 2004, is approximately $1.2 million per
month. Of the balance of $22.4 million of the REIT’s investment, $14.8 million
representing two communities closed in the first quarter of 2005, and the
remaining amount of $7.6 million representing one community that will not be
acquired.





On
October 1, 2004, the Company entered into a lease for one community located in
Corona, California. The Corona community, which had been owned by Alterra
Healthcare Corporation, was not a lease that was anticipated at the time of the
original transaction. The facility was acquired by an independent REIT for an
approximate $3.2 million investment, inclusive of transaction fees and leased to
the Company, which resulted in additions to property and equipment and capital
lease and financing obligations totaling approximately $3.7
million.





In March
2005, the Company entered into agreements covering the final two communities of
lease transactions announced in March, 2004. One community had been previously
managed by the Company and is located in Richland, Washington. This community
offers assisted living services and was part of the CPM





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  Index to Consolidated Financial
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group.
The second Community located in Lubbock, Texas, offers memory loss services and
is a part of the JEA managed group of communities. It is new to the Company’s
portfolio.





*HCP
Transaction* . On July
30, 2004, the Company completed a sale-leaseback of 11 communities. The
communities were sold to Health Care Property Investors, Inc. (HCP), an
independent third party, and leased back to the Company for a 15-year initial
lease period with two 10-year renewal options. These properties are included in
an existing master lease covering 25 communities. As part of this agreement,
maturities for leases and debt that HCP holds on 9 existing communities will
also be extended 5 years. The lease basis is set at $83.5 million with an
initial rate of 9.25 percent. Annual lease escalators are based on the Consumer
Price Index and capped at 3 percent. Certain features of the transaction,
including a guarantee of the lease payments by Mr. Baty and a potential put
option under certain defaults, constitute continuing involvement for accounting
purposes and preclude sale-leaseback accounting, requiring the Company to use
finance accounting. As a result, although the transaction resulted in the legal
sale of the communities to HCP and their subsequent leasing by the Company, the
Company's consolidated financial statements continue to reflect the communities
as owned and establish a financing obligation equal to the purchase price of
$83.5 million. The communities provide assisted and dementia related services to
seniors, containing 1,150 units located in 8 states.





*Other
Transactions.* Effective July 1, 2003, the Company ceased managing 10 Regent Assisted Living
communities. On August 1, 2003, the Company ceased managing an additional Regent
Assisted Living community. Effective October 1, 2003, the Company ceased
managing three additional communities.





On
November 1, 2003, the Company entered into an operating lease agreement for an
Alzheimer's community located in Silverdale, Washington, containing an aggregate
of 46 units. The lease is for an initial 10-year period with two 10-year
extension options. The lease is a triple-net lease, with base rental
approximating $235,000 annually with fixed escalators after the second year and
variable escalators at the end of the sixth lease year based on a percentage of
increases in the consumer price index. This lease, after the end of third lease
year, also includes an option to terminate. The property in this acquisition is
a purpose-built Alzheimer's community in which the Company operates as
such.





On August
9, 2004, the Company sold a single community located in Scottsdale, Arizona, for
$1,775,000. The buyer paid approximately $444,000 in cash and the Company is
carrying a note receivable for the remaining $1.3 million. The note has a 5-year
term with interest at 5.5 percent and includes principal payments based on a
30-year amortization, with the first principal payment due December 1, 2004. The
Company recorded a gain related to this sale in discontinued operations of
$700,000 in the third quarter 2004 financial statements as it has no continuing
involvement in the community. The community provided independent living services
to seniors. The operations and related gain on the sale of the community are
reflected as discontinued operations in the consolidated statements of
operations.





On August
12, 2004, the Company sold undeveloped land located in Grand Terrace, California
for a cash purchase price of $518,000.  The Company previously carried the
land on its books at a basis of $235,000. The Company recorded a gain, net of
closing costs, of $265,000 in Other, net in the consolidated statements of
operations for the year ended December 31, 2004.





On
November 1, 2004, the Company sold a single community located in Issaquah,
Washington, for cash of $9.6 million. Since the Company had a continuing
involvement in the community until such time as the buyer was granted a license
on January 7, 2005, to operate the community, the Company deferred the proceeds
and associated gain of $1.3 million until that point and recorded the related
assets at December 31, 2004 as held for sale.





In March
2005, the Company closed on the final two communities of lease transactions
announced in March, 2004. One community had been previously managed by the
Company and is located in Richland, WA. This





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community
offers assisted living services. The second Community offers memory loss
services and is located in Lubbock, TX. It is new to the Company
portfolio.





*Five
Community Mortgage Assumption.* On
December 31, 2003, independent of the LLC transaction in Note 3, "Long-term
Investments", the Company acquired five assisted living communities (the "Five
Properties"), containing an aggregate of 355 units, from Alterra for the
assumption of $22.6 million of mortgage debt, which bears interest at 6.98% per
annum, provides for monthly payments of $178,000, including principal and
interest, and matures August 2008. The Five Properties in this acquisition are
purpose-built assisted living communities in which the Company offers both
assisted and memory loss services to select communities.





The
initial allocations of purchase cost at fair value were based upon available
information for the acquired business ( *Five
Community Mortgage Assumption)* and were
finalized when any contingent purchase price amounts were resolved. The final
allocations did not differ materially from the initial allocations. Aggregate
purchase cost allocations were as follows (In thousands):


**December
      31,****2003**Land
    
    $
    3,588Buildings
    
    $
    18,477Furniture
      and fixtures
    
    $
    579Loan
      fees
    
    $
    411Liabilities
      assumed
    
    $
    22,639





The
following summary, prepared on a pro forma basis, combines the results of
operations as if the *Five
Community Mortgage Assumption* acquisition had been consummated as of the beginning of 2003 (In thousands,
except per share data).


**Year
      ended****December
      31,****2003**(unaudited)Net
      revenues
    
    $
    215,377Net
      loss
    
    
    (8,276
    )Preferred
      dividends
    
    
    (6,238
    )Gain
      on repurchase of Series A preferred stock
    
    
    14,523Net
      income (loss) to common shareholders
    
    $
    9Income
      (loss) per common share:Basic
      and diluted
    
    $
    -Weighted
      average common shares outstanding:Basic
      and diluted
    
    
    10,255





These
unaudited pro forma results are not necessarily indicative of what actually
would have occurred if the acquisition had been completed as of the beginning of
2003. In addition, they are not intended to be a projection of future results
and do not reflect all of the synergies, additional revenue-generating services
or reductions in direct community operating expenses that might be achieved from
combined operations.











**F-37**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(18)**  **Commitments
and Contingencies**





In
February 2005, a San Antonio, Texas, jury found one of our assisted living
communities negligent in the care of a resident. The jury awarded a verdict
against the Company in the amount of $1.5 million in compensatory damages and
$18 million in punitive damages. The verdict was in connection with an action
that alleged negligence brought by the relatives of a resident at one of the
Company’s assisted living facilities. The Company believes that there are
substantial grounds for an appeal and that the damage award was not justified by
the facts or the law in the case presented by the plaintiff. The Company is
appealing the verdict based on significant legal errors the Company believes
occurred at the trial. The Company has posted funds in the amount of $1.7
million in order to stay the proceedings while the appellate process runs its
course, which could be anywhere from 18 months to three years. The Company will
not be required to pay additional amounts until the appeal and further
litigation is completed or the case is settled. The Company has recorded a
reserve of $18.7 million on its consolidated balance sheet for the judgment
against the Company with a corresponding charge on its consolidated statements
of operations in 2004.  This reserve was recorded  in
accordance with our self-insured pool agreement as discussed under "*Summary
of Significant Accounting Policies and Use of Estimates*."





In
February 2004, the California Public Interest Research Group brought an action
against owners and operators of assisted living communities and senior housing
facilities including us. The action seeks, on behalf of residents of these
facilities located in California, to recover move-in or preadmission fees that
have been paid over the past three years as well as certain penalties. The
Company is defending this action vigorously and has entered into a joint defense
agreement with other operators in California. Emeritus believes recent court
rulings in the case have significantly eroded the viability of the plaintiff’s
action.





The
Company is involved in legal proceedings, claims, and litigation arising in the
ordinary course of business. In the opinion of management, the outcome of these
matters will not have a material effect, except as noted above, on the Company’s
results of operations or financial position.





The
Company is self-insured for certain employee health benefits. The Company’s
policy is to accrue amounts equal to the actuarial liabilities that are based on
historical information along with certain assumptions about future events.
Changes in assumptions for such matters as health care costs and actual
experience could cause these estimates to change.





**(19)**  **Liquidity**





The
Company has incurred significant operating losses since its inception and has a
working capital deficit of $71.9 million, although $14.7
million represents
deferred revenue and unearned revenue and $10.5 million of preferred dividends
is due only if declared by the Company's board of directors, who are currently
discussing paying out the earned dividends of the Series B preferred stock to
the extent financing is available. No agreement has been reached. Additionally
due to the adverse judgment against the Company as described under “(18)
Commitments and Contingencies” an additional reserve was recorded for $18.7
million in accordance with our self-insured pool agreement as discussed under
"*Summary of Significant Accounting Policies and Use of Estimates*."
 The Company believes there is substantial grounds for an appeal and that
the damage award was not justified by the facts or the law in the case
presented. The Company is appealing the verdict and on March 16, 2005, has
posted funds in the amount of $1.7 million in order to stay the proceedings
while the appellate process runs its course, which could be anywhere from 18
months to three years. The Company will not be required to pay additional
amounts until the appeal and further litigation is completed or the case is
settled. Also, the Company has $32.0 million of 6.25% convertible subordinated
debentures that will come due January 1, 2006. Of the $32.0 million, $21.5
million is owned by directors and officers or their affiliates (see Note
“(9) **** Convertible
Debentures”). In 2004, 2003, and 2002, the Company reported positive net cash
from operating activities in its consolidated statements of cash flows. At times
in the past, however, the Company has been dependent upon third party financing
or disposition of assets to fund operations and the Company cannot guarantee
that, if necessary in the future, such transactions will be available timely or
at all, or on terms attractive to the Company.





**F-38**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


In March
2005, the Company closed a debt restructuring transaction that reduces the
effective interest rate by approximately 2.75% on $21.4 million of debt and
extends the maturity to February 2008.





On
September 30, 2003, the Company consolidated three previous financings with
Health Care REIT, Inc. (“HCN”) into a single $25.8 million leasehold mortgage
financing, secured by 32 communities and maturing on June 30, 2007 . The debt
had interest at an initial rate of 12.13% per annum with periodic increases up
to 13%. The consolidated loan required monthly payments of interest during the
first year and monthly payments of principal and interest, based on a 10-year
amortization, thereafter.  The
Company made a cash principal reduction of $6.0 million on August 2,
2004 . The
balance on the note as of March 2, 2005, was approximately $19.5
million.





The
Company modified the existing note in full substitution with Healthcare Realty
Trust, Incorporated ("HRT"), an unrelated third party lender. HCN sold the loan
to HRT, and assigned substantially all of the leasehold mortgages and all
additional collateral securing the loan pursuant to a certain Loan Purchase
Agreement between HCN, HRT, and Emeritus. HRT and the Company agreed to modify,
amend, and restate the loan. The restated loan has a maturity date of February
28, 2008. Interest accrues on the principal amount outstanding at the fixed rate
of 10% per annum. Commencing on the first day of the first month after the
commencement date and on the first day of each month thereafter, the Company
will make monthly interest only payments sufficient to pay all interest accrued.
On the maturity date, the Company will make a balloon payment equal to the
outstanding balance of this note including the outstanding principal balance,
all accrued and unpaid interest and all charges, expenses, and other amounts
payable by the Company to HRT. The Company will not have the privilege of
prepaying on the note in whole or in part at any time without the prior written
consent of HRT, at HRT's sole discretion. In addition, the note contains certain
subjective default clauses, which, as a remedy, HRT may declare the loan to be
immediately due and payable.





In
connection with the loan modification, HRT also extended an additional $1.8
million to the Company on the same terms as the restated loan from HRT to pay
off certain transaction cost advances that matured in March 2006 and had an
interest rate of 12.0% (increasing to 12.5% in April 2005).





In 2002
and continuing in the first quarter of 2003, the Company refinanced
substantially all of its debt obligations, extending the maturities of such
financings to dates in 2005 or thereafter, at which time the Company will need
to refinance or otherwise repay the obligations. Many of the Company's debt
instruments and leases contain "cross-default" provisions pursuant to which a
default under one obligation can cause a default under one or more other
obligations to the same lender or lessor. Such cross-default provisions affect 6
owned assisted living properties and 154 operated under leases. Accordingly, any
event of default could cause a material adverse effect on the Company's
financial condition if such debt or leases are cross-defaulted. For the year
ended December 31, 2003, Management believed the Company would be in compliance
at least through 2004. However, in 2004, the Company was in violation of one or
more covenants in certain of the leases, but has been able to obtain waivers
from the owners such that it was still deemed to be in compliance and thus, was
not in default.





Management
believes that the Company will be able to sustain positive operating cash flow
at least through 2005 and for the foreseeable future and will have adequate cash
from operations for all necessary investing and financing activities including
required debt service and capital expenditures.








**F-39**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**


Table of Contents
  Index to Consolidated Financial
Statements


**(20)**  **Quarterly
Results (Unaudited)**





**(In
      thousands, except per share data)****2004**
    
    **Q1**
    
    **Q2**
    
    **Q3**
    
    **Q4**Total
      operating revenue
    
    $
    65,571
    
    $
    77,721
    
    $
    80,561
    
    $
    94,082Income
      (loss) from operations**(a)**
    
    
    2,556
    
    
    5,517
    
    
    4,940
    
    
    (13,093
    )Other
      income and expense
    
    
    (7,636
    )
    
    (9,252
    )
    
    (10,462
    )
    
    (12,913
    )Loss
      from continuing operations before income taxes
    
    
    (5,080
    )
    
    (3,735
    )
    
    (5,522
    )
    
    (26,006
    )Provision
      for income taxes**(b)**
    
    
    -
    
    
    -
    
    
    (915
    )
    
    (273
    )Loss
      from continuing operations
    
    
    (5,080
    )
    
    (3,735
    )
    
    (6,437
    )
    
    (26,279
    )Income
      (loss) from discontinued operations
    
    
    58
    
    
    117
    
    
    851
    
    
    (35
    )Preferred
      dividends
    
    
    (920
    )
    
    (930
    )
    
    (938
    )
    
    (949
    )Net
      loss to common shareholders
    
    $
    (5,942
    )
    $
    (4,548
    )
    $
    (6,524
    )
    $
    (27,263
    )Income
      (loss) per common share - basic and diluted:Continuing
      operations
    
    $
    (0.59
    )
    $
    (0.44
    )
    $
    (0.69
    )
    $
    (2.52
    )Discontinued
      operations
    
    
    0.01
    
    
    0.01
    
    
    0.08
    
    
    -$
    (0.58
    )
    $
    (0.43
    )
    $
    (0.61
    )
    $
    (2.52
    )**2003**
    
    
    **Q1**
    
    
    **Q2**
    
    
    **Q3**
    
    
    **Q4**Total
      operating revenue
    
    $
    46,261
    
    $
    48,493
    
    $
    49,295
    
    $
    58,900Income
      (loss) from operations
    
    
    2,759
    
    
    2,743
    
    
    1,435
    
    
    2,385Other
      income and expense
    
    
    (3,733
    )
    
    (2,332
    )
    
    (4,052
    )
    
    (5,972
    )Income
      (loss) from continuing operations before income taxes
    
    
    (974
    )
    
    411
    
    
    (2,617
    )
    
    (3,587
    )Provision
      for income taxes**(b)**
    
    
    -
    
    
    -
    
    
    (576
    )
    
    158Income
      (loss) from continuing operations
    
    
    (974
    )
    
    411
    
    
    (3,193
    )
    
    (3,429
    )Income
      (loss) from discontinued operations
    
    
    (10
    )
    
    1
    
    
    (954
    )
    
    67Preferred
      dividends
    
    
    (1,871
    )
    
    (1,905
    )
    
    (1,464
    )
    
    (998
    )Gain
      on repurchase of Series A preferred stock
    
    
    -
    
    
    -
    
    
    14,465
    
    
    58Net
      income (loss) to common shareholders
    
    $
    (2,855
    )
    $
    (1,493
    )
    $
    8,854
    
    $
    (4,302
    )Basic
      income (loss) per common share:Continuing
      operations
    
    $
    (0.28
    )
    $
    (0.15
    )
    $
    0.95
    
    $
    (0.43
    )Discontinued
      operations
    
    
    -
    
    
    -
    
    
    (0.09
    )
    
    0.01$
    (0.28
    )
    $
    (0.15
    )
    $
    0.86
    
    $
    (0.42
    )Diluted
      income (loss) per common share:Continuing
      operations
    
    $
    (0.28
    )
    $
    (0.15
    )
    $
    0.63
    
    $
    (0.43
    )Discontinued
      operations
    
    
    -
    
    
    -
    
    
    (0.05
    )
    
    0.01$
    (0.28
    )
    $
    (0.15
    )
    $
    0.58
    
    $
    (0.42
    )The
      sum of quarterly per share data may not equal the per share total reported
      for the year.(a)
      Income (loss) from operations in the fourth quarter of 2004 contains an
      additional insurance accrual of $18.7 million (see Note
    18).(b)
      Tax provision in 2004 and 2003 relates to alternative minimum tax
      liability from sale-leaseback transactions.










**F-40**
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED**
 Table of Contents
  Index to Consolidated Financial
Statements











**(21)**  **Discontinued
Operations**





On August
9, 2004, the Company sold an owned facility (“Scottsdale Royale”) to an
unrelated third party. Due to certain legal requirements of resident
notification, the Company leased the property back from the third party through
August 31, 2004. In addition, on September 30, 2004, the Company committed to
sell another owned facility (“Hearthside of Issaquah”); which under FASB
Statement No. 144 “Accounting for the Impairment or Disposal of Long-Lived
Assets”, qualifies as an asset held for sale. A current asset of $7.9 million
was recorded on the Company's financial statements and the Company discontinued
depreciating the asset as of September 30, 2004. Hearthside of Issaquah was sold
on November 1, 2004. Since the Company had a continuing involvement in the
community until such time as the buyer was granted a license on January 7, 2005,
to operate the community, the Company deferred the gain of $1.3 million until
that point. Both transactions qualify for discontinued operations treatment
under FASB Statement No. 144 and the results of discontinued operations is
reported as a separate line item in the condensed consolidated statement of
operations.





The
following table shows the revenues and net income (loss) for the discontinued
operations (in thousands):








**Year
      ended December 31,****2004**
    
    **2003**
    
    **2002****Total
      revenue:**Hearthside
      of Issaquah
    
    $
    2,936
    
    $
    3,302
    
    $
    3,188Scottsdale
      Royale
    
    
    305
    
    
    406
    
    
    545Total
    
    $
    3,241
    
    $
    3,708
    
    $
    3,733**Income
      (loss):**Hearthside
      of Issaquah
    
    $
    313
    
    $
    196
    
    $
    324Scottsdale
      Royale
    
    
    678
    
    
    (1,092
    )
    
    (76
    )Total
    
    $
    991
    
    $
    (896
    )
    $
    248











**(22)**  **Impairment
of Long-lived Assets**





In August
2003, based on operating losses and clarification of certain zoning issues, the
Company determined that an owned facility (“Scottsdale Royale”) was
impaired. The
Company recorded an impairment loss of $950,000 for this facility, which was
reflected in the loss from discontinued operations in its consolidated
statements of operations for the year ended December 31, 2003.





In
December 2004, the Company concluded that it is unlikely that parcels of land
located in Arizona, Illinois, and South Carolina would be developed in the
foreseeable future due to various factors (such as cash availability to complete
the project, project start-up losses, and other market conditions) that are not
conducive to continuation of development at this time. The Company has
determined the fair value of the assets and has concluded that an impairment
exists on the land located in Arizona and Illinois. The Company recorded an
impairment loss of approximately $447,000, which is reflected in Other, net in
its consolidated statements of operations for the year ended December 31,
2004.



















**F-41**


Table of Contents
  Index to Consolidated Financial
Statements


**REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING****FIRM**


**ON
FINANCIAL STATEMENT SCHEDULE**





The Board
of Directors and Shareholders


Emeritus
Corporation:





Under
date of March 29, 2005, we reported on the consolidated balance sheets of
Emeritus Corporation and subsidiaries as of December 31, 2004 and 2003, and the
related consolidated statements of operations, shareholders’ deficit and
comprehensive operations , and cash flows for each of the years in the
three-year period ended December 31, 2004, which are included in the Form 10-K.
In connection with our audits of the aforementioned consolidated financial
statements, we also audited the related consolidated financial statement
schedule for each of the years in the three-year period ended December 31, 2004
in the Form 10-K. The financial statement schedule is the responsibility of the
Company’s management. Our responsibility is to express an opinion on the
financial statement schedule based on our audits.





In our
opinion, such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.





/s/    KPMG
LLP





Seattle,
Washington


March 29,
2005








**S-1**
 ****


Table of Contents
  Index to Consolidated Financial
Statements





**Emeritus Corporation****Valuation
      and Qualifying Accounts****Years
      Ended December 31, 2004, 2003, and 2002****(in
      thousands)****Column
      A**
    
    **Column
      B**
    
    **Column
      C**
    
    **Column
      D**
    
    **Column
      E****Balance**
    
    **Charged****at**
    
    **to**
    
    
    
    **Balance****Beginning**
    
    **Other
      Costs**
    
    
    
    **at
      End****of
      Year**
    
    **and
      Expenses**
    
    **Deductions**
    
    **of
      Year****Description**Year
      ended December 31, 2004:Valuation
      accounts deducted from assets:Allowance
      for doubtful receivables
    
    $
    358
    
    $
    996
    
    $
    (513
    )
    $
    841Year
      ended December 31, 2003:Valuation
      accounts deducted from assets:Allowance
      for doubtful receivables
    
    $
    327
    
    $
    234
    
    $
    (203
    )
    $
    358Year
      ended December 31, 2002:Valuation
      accounts deducted from assets:Allowance
      for doubtful receivables
    
    $
    398
    
    $
    346
    
    $
    (417
    )
    $
    327








**S-2**
 ****