**UNITED STATES**


**SECURITIES AND EXCHANGE COMMISSION**


**Washington, D.C. 20549**







**FORM 10-K/A**


**(AMENDMENT NO. 1)**




**(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, 2003.**





**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, 2003**





|**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, 2003, was $24,497,029.


Aggregate market value of common voting stock held by non-affiliates of the registrant as of February 29, 2004, was $51,252,977.


As of February 29, 2004, 10,303,035 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 filed on April 29, 2004.













Explanatory Note





This amendment on Form 10-K/A to Form 10-K of Emeritus Corporation, for the year ended December 31, 2003, incorporates certain revisions to historical financial data and related descriptions but is not intended to update other information presented in this report as originally filed, except where specifically noted. This amendment includes a restatement, which changes Items 2, 6, 7, and 8 of Part I. See the Note (2) to our Consolidated Financial Statements for further discussion of this matter. We are not required to and we have not updated any forward-looking statements previously included in the Form 10-K filed on March 30, 2004.





We concluded that the restatement was necessary when we determined that (i) certain leases that had been accounted for as operating leases should have instead been accounted for as capital leases, (ii) certain other operating leases with rent escalator clauses required straight-line treatment of the base rent and estimated rent escalators, and (iii) a transaction that was accounted for under sale-leaseback accounting should have been accounted for as a financing. In addition, we are making certain other adjustments in these periods as described in Note (2) to our Consolidated Financial Statements.














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**EMERITUS CORPORATION**




******TABLE OF CONTENTS******


****

**Page No.******PART I****ITEM 1.
DESCRIPTION OF BUSINESS
1ITEM 2.
DESCRIPTION OF PROPERTY
8ITEM 3.
LEGAL PROCEEDINGS
14ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
15EXECUTIVE OFFICERS OF EMERITUS
15**PART II**ITEM 5.
MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
17ITEM 6.
SELECTED CONSOLIDATED FINANCIAL DATA
18ITEM 7.
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
49ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
50ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
50ITEM 9A.
CONTROLS AND PROCEDURES
50**PART III**ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
52ITEM 11.
EXECUTIVE COMPENSATION
52ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND EQUITY COMPENSATION PLAN INFORMATION
52ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
53ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
53**PART IV**ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
54








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. DESCRIPTION OF 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, 2003, we operated, or had an interest in, 175 assisted living communities, consisting of approximately 14,845 units with a capacity for 18,208 residents, located in 32 states. These include 19 communities that we own, 109 communities that we lease, and 47 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.


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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 is expected to start increasing again in 2004, although at a slower pace than during the 1990's.




*  *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.




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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 175 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, 2003, the average cost per unit of our owned and leased communities was approximately $68,200. We believe that these costs are less than the current 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 32 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.* Mr. Baty has more than 31 years of experience in the long-term care industry, ranging from independent living to skilled nursing care. We believe that his experience and the relationships that he 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 Columbia-Pacific Group, Inc., an operator of independent living facilities and assisted living communities. In addition, our operating vice presidents have an average of 17 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.




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*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 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 industry averages. This rate strategy has led to increased rates across most of our portfolio. We believe that continued focus on both rates and occupancy 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 95 in 2002. With changes in the capital markets and opportunities to own or lease communities, the number of managed communities has declined to 47 in 2003 (most of those making up the decline became leased communities in our consolidated portfolio) and we expect it to decline further in 2004. 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. We particularly expect to favor the acquisition of communities that provide more complete coverage of our existing markets and intend to focus on acquisitions of communities that have been originally designed as assisted living facilities with a favorable current operating structure, and communities that provide immediate positive cash flow opportunities with minimal impact to existing operations. In 2002 and 2003, as the opportunities arose, we acquired additional communities that satisfy our criteria. We intend to continue to be selective and measured in our acquisition strategy in the future.

****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. We think that these markets are receptive to the development of new assisted living communities and the expansion of existing communities.




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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.                                                                                                          

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*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 10% of our total revenues.





*Management Activities*





At December 31, 2003, we managed and provided administrative services to 47 assisted living communities under management agreements that typically provide for management fees ranging from 3% 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 $10.2 million for 2003, although we expect that to be substantially less in 2004 because (i) we have acquired or leased a number of communities that we formerly managed in 2003, (ii) we expect to acquire or lease more of the managed communities in 2004 and, (iii) in July 2003, we ceased managing 12 communities for a third party. We have various categories of management agreements, including:




*
a management agreement covering 23 communities that is a continuing component of the Emeritrust I transaction referred to in "Item 7. Management's Discussion and Analysis, Significant 2003 and 2002 Transactions, Emeritrust Transactions, Emeritrust I Communities Management". This management agreement, which may be terminated by either party on 90 days notice, provides 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.  *
management agreements covering 19 communities owned by entities controlled by Mr. Baty. We generally receive fees ranging from 4% to 6% of the gross revenues generated by the communities. We have announced that we have agreed to lease up to 13 of these communities and will operate them pursuant to the lease, which is scheduled for as early as March 31, 2004, and as late as the end of the second quarter 2004.  *
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 ranging from 4% to 7% of gross revenues, or similar arrangements based on occupied capacity.  *
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.


Upon completion of the transaction to lease up to 13 previously managed communities from Mr. Baty, we will continue to manage 34 communities, of which 23 are the Emeritrust I Communities under a management agreement that may be terminated by either party on 90 days notice. 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.





*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


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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 2004. 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 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, 2003, we had approximately 7,500 employees, including 5,521 full-time employees, of which approximately 119 were employed at our headquarters. Of this total, approximately 2,156 were employed in our managed communities, including 1,594 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.  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,


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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. DESCRIPTION OF PROPERTY******


*Communities*





Our assisted living communities generally consist of one-story to three-story buildings and include common dining and social areas. Seventeen 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, 2003.








|                            |                  | **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      |  | Lease        
|La Villita *                | Phoenix          | Jun-1994       | 92        |  | 92       |  | Option/Manage
|Loyalton of Flagstaff       | Flagstaff        | Jun-1999       | 61        |  | 67       |  | Lease (5)    
|Loyalton of Phoenix         | Phoenix          | Jan-1999       | 101       |  | 111      |  | Lease (5)    
|Scottsdale Royale ~         | Scottsdale       | Aug-1994       | 63        |  | 63       |  | Own          
|Village Oaks at Chandler *  | Chandler         | Oct-2002       | 66        |  | 105      |  | Lease        
|Village Oaks at Glendale *  | Glendale         | Oct-2002       | 66        |  | 105      |  | Lease        
|Village Oaks at Mesa *      | Mesa             | Oct-2002       | 66        |  | 105      |  | Lease        
|                            |                  |                |           |  |          |  |              
|**California**              |                  |                |           |  |          |  |              
|Creston Village *           | Paso Robles      | Feb-1998       | 100       |  | 110      |  | Lease (5)    
|Emerald Hills               | Auburn           | Jun-1998       | 89        |  | 98       |  | Lease        
|Fulton Villa                | Stockton         | Mar-1995       | 80        |  | 80       |  | Own (2)      
|Loyalton of Folsom *        | Folsom           | Jan-2002       | 98        |  | 113      |  | Manage       
|Loyalton of Rancho Solano * | Fairfield        | Mar-1998       | 172       |  | 189      |  | Lease (5)    
|The Palms at Loma Linda     | Loma Linda       | Dec-2003       | 140       |  | 220      |  | Own (4)      
|The Springs at Oceanside *  | Oceanside        | Dec-2003       | 113       |  | 236      |  | Own (4)      
|The Terrace *               | Grand Terrace    | Mar-1996       | 87        |  | 87       |  | Option/Manage
|Villa Del Rey               | Escondido        | Mar-1997       | 84        |  | 84       |  | Own (2)      
|                            |                  |                |           |  |          |  |              
|**Colorado**                |                  |                |           |  |          |  |              
|Loyalton of Broadmoor       | Colorado Springs | Dec-2003       | 37        |  | 45       |  | Own (4)      
|                            |                  |                |           |  |          |  |              
|**Connecticut**             |                  |                |           |  |          |  |              
|Cold Spring Commons *       | Rocky Hill       | Apr-1997       | 80        |  | 88       |  | Lease        



**8**  Table of Contents  **Emeritus****Operations**
**Units**

**Beds****Community**
**Location**
**Commenced**
**(a)**

**(b)**

**Interest**


**Delaware**Gardens at Whitechapel
Newark
Oct-1995
100

110

Option/ManageGreen Meadows at Dover *
Dover
Jul-1998
52

63

Lease**Florida**Barrington Place *
Lecanto
May-1996
79

120

Option/ManageBeneva 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

Own (2)Madison Glen
Clearwater
May-1996
135

154

Option/ManagePark Club of Brandon
Brandon
Jul-1995
88

88

Lease (5)Park Club of Fort Myers *
Ft. Myers
Jul-1995
77

82

Lease (5)Park Club of Oakbridge *
Lakeland
Jul-1995
88

88

Lease (5)River Oaks *
Englewood
May-1997
155

200

Own (2)Springtree *
Sunrise
May-1996
179

246

Option/ManageStanford Centre *
Altamonte Springs
May-1997
118

180

Own (2)The Colonial Park Club *
Sarasota
Aug-1996
88

90

Lease (5)The Lakes *
Ft. Myers
Jun-2000
154

190

ManageThe Lodge at Mainlands *
Pinellas Park
Aug-1996
154

162

Option/ManageThe Pavillion at Crossing Pointe ~ *
Orlando
Jul-1995
174

190

Option/ManageVillage 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**Idaho**Highland Hills
Pocatello
Oct-1996
49

55

Lease (5)Juniper Meadows
Lewiston
Nov-1997
82

90

Own (2)Loyalton of Coeur d'Alene ~
Coeur d' Alene
Mar-1996
108

114

Lease (5)Ridge Wind
Chubbuck
Aug-1996
80

106

Lease (5)Summer Wind
Boise
Sep-1995
49

53

Lease**Illinois**Canterbury Ridge *
Urbana
Nov-1998
101

111

Lease (5)Loyalton of Rockford *
Rockford
Jun-2000
100

110

Manage**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

Own (2)**Kansas**Elm Grove Estates *
Hutchinson
Apr-1997
121

133

Option/ManageLiberal Springs
Liberal
Dec-2003
44

56

Own (4)The Fairways of Augusta
Augusta
Dec-2003
21

27

Own (4)  
 **9**
  Table of Contents
 **Emeritus****Operations**
**Units**

**Beds****Community**
**Location**
**Commenced**
**(a)**

**(b)**

**Interest**
 **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
80

80

Lease**Maryland**Emerald Estates *
Baltimore
Oct-1999
120

134

ManageLoyalton of Hagerstown
Hagerstown
Jul-1999
100

110

Lease (5)**Massachusetts**Canterbury Woods *
Attleboro
Jun-2000
130

130

ManageMeadow Lodge at Drum Hill
Chelmsford
Aug-1997
80

88

Lease (3)The Lodge at Eddy Pond
Auburn
Jan-2000
108

110

Own (2)The Pines at Tewksbury *
Tewksbury
Jan-1996
49

65

Lease (5)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 (5)Ridgeland Pointe *
Ridgeland
Aug-1997
79

87

Lease (3)Silverleaf Manor
Meridian
Jul-1998
101

111

ManageTrace Point *
Clinton
Oct-1999
100

110

Manage**Missouri**Autumn Ridge ~
Herculaneum
Jun-1997
94

94

Manage**Montana**Springmeadows Residence
Bozeman
Apr-1997
74

81

Own (2)**Nevada**Concorde
Las Vegas
Nov-1996
116

128

Own (2)Village Oaks at Las Vegas
Las Vegas
Oct-2002
66

105

LeaseThe Seasons *
Reno
Feb-2002
94

109

Manage**New Jersey**Laurel Lake Estates *
Voorhees
Jul-1995
117

119

LeaseLoyalton of Cape May
Cape May
May-2001
100

110

Manage**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 (5)  
 **10**
  Table of Contents
 **Emeritus****Operations**
**Units**

**Beds****Community**
**Location**
**Commenced**
**(a)**

**(b)**

**Interest**
 
 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
78

80

LeaseWest Side Manor - Rochester (1)
Rochester
Nov-1996
72

72

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

Manage**Ohio**Brookside Estates *
Middleberg Heights
Sep-1998
99

101

Option/ManageLoyalton 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 (5)**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 (5)Anderson Place - Nursing Home
Anderson
Oct-1996
22

44

Lease (5)Anderson Place - Summer House #
Anderson
Oct-1996
30

40

Lease (5)Bellaire Place
Greenville
May-1997
81

89

Option/ManageCountryside 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

LeaseThe Willows at York *
York
Sep-1999
82

164

Manage**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

Manage  
 **11**
  Table of Contents
 **Emeritus****Operations**
**Units**

**Beds****Community**
**Location**
**Commenced**
**(a)**

**(b)**

**Interest**
 
 Cambria Lodge *
El Paso
Sep-1996
79

87

LeaseChampion Oaks
Houston
Oct-2002
48

84

LeaseCollin Oaks *
Plano
Oct-2002
78

112

LeaseDowlen Oaks
Beaumont
Dec-1996
79

87

Option/ManageEastman Estates
Longview
Jun-1997
70

77

Option/ManageElmbrook Estates
Lubbock
Dec-1996
79

87

Lease (5)Hamilton House *
San Antonio
Sep-2002
111

123

LeaseKingsley Place at Henderson *
Henderson
May-2002
57

101

Lease (5)Kingsley Place at Oakwell Farms *
San Antonio
May-2002
80

160

Lease (5)Kingsley Place at Stonebridge Ranch *
McKinney
May-2002
80

166

Lease (5)Kingsley Place at the Medical Center *
San Antonio
May-2002
80

160

Lease (5)Lakeridge Place *
Wichita Falls
Jun-1997
79

87

Option/ManageLoyalton of Austin *
Austin
Oct-2002
76

111

LeaseLoyalton of Lake Highlands *
Dallas
Oct-2002
78

112

LeaseMeadowlands Terrace
Waco
Jun-1997
71

78

Option/ManageMemorial Oaks *
Houston
Oct-2002
68

105

LeaseMyrtlewood Estates *
San Angelo
May-1997
79

87

Option/ManageRedwood Springs
San Marcos
Apr-1997
90

90

LeaseSaddleridge Lodge
Midland
Dec-1996
79

87

Option/ManageSeville Estates *
Amarillo
Mar-1997
50

55

Option/ManageSherwood Place
Odessa
Sep-1996
79

87

LeaseSugar 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

Option/Manage**Virginia**Cobblestones at Fairmont
Manassas
Sep-1996
75

82

Lease (3)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 (5)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 (5)Fairhaven Estates
Bellingham
Oct-1996
50

55

Lease (5)Garrison Creek Lodge
Walla Walla
Jun-1996
80

88

LeaseHarbour Pointe Shores
Ocean Shores
Feb-1997
50

55

Option/ManageHearthside of Issaquah *
Issaquah
Feb-2000
98

98

Own  
 **12**
 Table of Contents
 **Emeritus****Operations**
**Units**

**Beds****Community**
**Location**
**Commenced**
**(a)**

**(b)**

**Interest**


Kirkland Lodge at Lakeside
Kirkland
Mar-1996
74

84

Lease (3)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

Own (2)The Hearthstone
Moses Lake
Nov-1996
84

92

Lease (5)**West Virginia**Charleston Gardens *
Charleston
Aug-2001
100

132

ManageTotal Operating Communities
175

14,845

18,208





| | ~ | 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) | As part of a refinancing agreement, we transferred all long-term assets and liabilities related to these properties to Emeritus Realty Corporation, a wholly owned subsidiary of Emeritus included in the consolidated financial statements. Notwithstanding consolidation for financial statement purposes, it is management's intention that Emeritus Realty Corporation be a separate legal entity wherein the assets and liabilities are not available to pay other debts or obligations of the consolidated Company and the consolidated Company is not liable for the liabilities of Emeritus Realty Corporation,except as otherwise provided in connection with the financing agreement.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

(3)
These four 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. See Note (2) to our consolidated financial statements for additional discussion.




|(4) | Due to financing requirements, these assets continue to be 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.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(5) | Leases for these communities are accounted for as capital leases. For communities under capital leases 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. See Note (2) to our consolidated financial statements for additional discussion.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




*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.


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******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, 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 2004, the California Public Interest Research Group announced that it intended to bring an action against operators of assisted living communities (including us) and other senior housing facilities. The announced 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. While we have not yet been served, we intend to defend the action vigorously and have entered into a joint defense agreement with other operators in California.













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******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, 2003.








******Executive Officers of Emeritus******


The following table presents certain information about our executive officers. There are no family relationships between any of the directors or executive officers.











|Name                   |  | Age |  | Position                                          
|---------------------- |  | --- |  | --------------------------------------------------
|                       |  |     |  |                                                   
|Daniel R. Baty         |  | 60  |  | Chairman of the Board and Chief Executive Officer 
|Raymond R. Brandstrom  |  | 51  |  | Vice President of Finance, Secretary,             
|                       |  |     |  | and Chief Financial Officer                       
|Gary S. Becker         |  | 56  |  | Senior Vice President of Operations               
|Martin D. Roffe        |  | 56  |  | Vice President, Financial Planning                
|Suzette McCanless      |  | 55  |  | Vice President, Operations -- Eastern Division    
|Russell G. Kubik       |  | 50  |  | Vice President, Operations -- Central Division    
|P. Kacy Kang           |  | 36  |  | Vice President, Operations -- Western Division    
|Christopher M. Belford |  | 42  |  | Vice President, Operations -- Great Lakes Division
|Susan A. Scherr        |  | 55  |  | 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.





*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.





*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.


|
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|
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*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.





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******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** |  
|-------------- |  | -------- | ---- | ------- | -
|               |  |          |      |         |  
|**2003**       |  |          |      |         |  
|First Quarter  |  | $        | 5.78 |         | $
|Second Quarter |  | $        | 4.49 |         | $
|Third Quarter  |  | $        | 8.09 |         | $
|Fourth Quarter |  | $        | 8.50 |         | $
|               |  |          |      |         |  
|**2002**       |  |          |      |         |  
|First Quarter  |  | $        | 5.22 |         | $
|Second Quarter |  | $        | 5.00 |         | $
|Third Quarter  |  | $        | 4.50 |         | $
|Fourth Quarter |  | $        | 5.68 |         | $






As of February 29, 2004, we had 131 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. Therefore, we do not anticipate paying any cash dividends on our Common Stock in the foreseeable future.







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******ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA******


The selected data presented below under the captions "Consolidated Statements of Operations Data" as restated and "Consolidated Balance Sheet Data" as restated for, and as of the end of, each of the years in the five-year period ended December 31, 2003, are derived from the consolidated financial statements of Emeritus Corporation. The restated consolidated financial statements as of December 31, 2003 and 2002, and for each of the years in the three-year period ended December 31, 2003, are included elsewhere in this document. This selected financial data contains certain financial information that has been restated. See Note (2) to our consolidated financial statements for further discussion of this matter. However, Note (2) does not address the changes in the statements of operations data for 2000 and 1999, nor the balance sheet data for 2001, 2000, and 1999. The restatement for those periods resulted in decreased operating revenues of $535,000 in 2000 and increased operating revenues of $226,000 in 1999. Facility lease expense and total operating expenses increased by $489,000 and $518,000, in 2000 and 1999, respectively. Net loss increased by $1.0 million and $293,000 in 2000 and 1999, respectively. The restatement also resulted in an increase in deferred revenue of $1.5 million, $1.2 million, and $686,000, in 2001, 2000, and 1999, respectively; an increase in deferred rent of $3.0 million, $2.5 million, and $2.0 million in 2001, 2000, and 1999, respectively; and an increase in accumulated deficit of $4.5 million, $3.7 million, and $2.7 million in 2001, 2000, and 1999, respectively. The opening balance sheet has been adjusted for the effect of all adjustments prior to 1999, which included an increase in deferred revenue of $912,000, an increase in deferred rent of $1.5 million, and an increase in accumulated deficit of $2.4 million.





|                                                      |  | **Year Ended December 31,**               |        
|----------------------------------------------------- |  | ----------------------------------------- | -------
|                                                      |  | **2003**                                  |        
|X                                                     |  | **As restated**                          
|**Consolidated Statements of Operations Data:**       |  | **(In thousands, except per share data)**
|Total operating revenues                              |  | $                                         | 206,657
|Total operating expenses                              |  |                                           | 197,612
|Income (loss) from operations                         |  |                                           | 9,045  
|Net other expense                                     |  |                                           | (16,708
|Loss before income taxes                              |  |                                           | (7,663 
|Provision for income taxes                            |  |                                           | (418   
|Net loss                                              |  |                                           | (8,081 
|Preferred stock dividends                             |  |                                           | (6,238 
|Gain on repurchase of Series A preferred stock        |  |                                           | 14,523 
|Net income (loss) to common shareholders              |  | $                                         | 204    
|                                                      |  |                                           |        
|Net income (loss) per common share:                   |  |                                           |        
|Basic                                                 |  | $                                         | 0.02   
|Diluted                                               |  | $                                         | 0.02   
|                                                      |  |                                           |        
|Weighted average number of common shares outstanding: |  |                                           |        
|Basic                                                 |  |                                           | 10,255 
|Diluted                                               |  |                                           | 11,521 
|                                                      |  |                                           |        
|**Consolidated Operating Data:**                      |  |                                           |        
|Communities in which we have an interest              |  |                                           | 175    
|Number of units                                       |  |                                           | 14,845 



**18**


**December 31,****2003**

**2002**

**2001**

**2000**

**1999****As restated****Consolidated Balance Sheet Data:**

**(In thousands)**Cash and cash equivalents

$
6,368

$
7,301

$
10,194

$
7,496

$
12,860Working capital (deficit)


(38,285
)

(27,197
)

(13,627
)

(82,389
)

6,142Total assets


389,794


204,241


168,811


178,079


198,370Long-term debt, less current portion


136,388


119,887


131,070


60,499


128,319Capital lease and financing obligations, less current portion


215,324


40,949


-


-


-Convertible debentures


32,000


32,000


32,000


32,000


32,000Redeemable preferred stock


-


25,000


25,000


25,000


25,000Shareholders' deficit


(86,927
)

(89,834
)

(78,677
)

(69,551
)

(40,014
)







**19**


Table of Contents


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


The Management's Discussion and Analysis of Financial Condition and Results of Operations presented below reflects certain restatements to our previously reported results of operations for these periods. See Note (2) to the consolidated financial statements for a discussion of this matter.





**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 operating efficiencies and cost controls as well as implementing a systematic rate enhancement program.





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 two years and have, and are continuing, to convert managed communities to owned or lease communities where opportunities are available. In 2000 and 2001, we continued to operate approximately 130 communities, but in 2002 and 2003, we increased that to 180 and 175 communities, respectively, primarily through the lease of 24 communities formerly operated by Marriott and through other selected leases and acquisitions. From the end of 2000 to the end of 2003, the communities we manage decreased from 69 to 47 and the owned and leased communities increased from 61 to 128, reflecting both our increasing confidence in the assisted living industry and the availability of capital.





In 2004 we expect to continue reviewing acquisition opportunities and seeking to take ownership or lease positions in communities that we manage. To this end, we have announced a proposed lease of up to 13 communities that we formerly managed, a second lease of nine memory loss facilities, and a lease of two other communities.





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


**As of December 31,**
****
**As of December 31,**
****
**As of December 31******
**2003**
****
**2002**
****
**2001******
**Buildings**
****
**Units**
****
**Buildings**
****
**Units**
****
**Buildings**
****
**Units**Owned (1)(2)
19

1,813

17

1,687

16

1,579Leased (1) (2)
109

8,303

67

5,279

42

3,444Managed/Admin Services (3) (4)
46

4,589

94

8,577

70

6,620Joint Venture/Partnership (5)
1

140

2

219

5

605Operated Portfolio
175

14,845

180

15,762

133

12,248Percentage increase (decrease)
(2.8%)

(5.8%)

35.3%

28.7%

(1.5%)

(1.3%) --------


(1) Included in our consolidated portfolio of communities.


(2) Of the leased communities at the end of 2003, 76 are accounted for as operating leases, in which the assets and liabilities of the communities are not included in our consolidated balance sheet and 29 are accounted for as capital leases, in which a long-term asset and corresponding liability is established on our balance sheet. The remaining four 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. See Note (2) to our consolidated financial statements for additional discussion. There were 63 operating and 4 capital leases at the end of 2002. All leased communities at the end of 2001 were operating leases.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Table of Contents


(3) Buildings managed decreased in 2003 due to termination of 13 Regent management contracts, the 21 Emeritrust II communities, which were leased as of September 30, 2003, and the 8 Horizon Bay communities, which were leased as               December 31, 2003.


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


(5) In 2003, 2002, and 2001, we managed 1, 1, and 2 of these communities, respectively.





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 an average occupancy rate, computed by dividing the average units available, determined on a monthly basis, during a particular period by the average number of units occupied, determined on a monthly basis, during the period. In October 2002, we leased 24 buildings (with approximately 1,650 units) and in March 2003, we leased eight buildings (with approximately 489 units). At the time these groups of communities were leased, they had different rate and occupancy characteristics and, therefore, have a distorting effect on the rate and occupancy comparisons between 2002 and 2003. As a consequence, the comparison including and excluding these communities is presented below. 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 $2,400 in 2001 to $2,577 in 2002 and to $2,767 in 2003. These changes represented increases of 7.4% for both of the two years. Excluding the acquisition communities referred to above, the corresponding changes were 6.3% for 2002 and 5.6% for 2003. We believe that these improvements were a consequence of a carefully designed rate enhancement program that we began implementing in 2000.





In our consolidated portfolio, our average occupancy rate was 84.1% in 2001, decreasing to 80.9% in 2002 and further decreasing to 77.4% in 2003. Excluding the acquisition communities referred to above, our average occupancy rate was 81.8% in 2002 compared to 81.6% in 2003. We believe that these occupancy rates reflect industry-wide factors, such as the supply of available units, which have tended to keep pressure on occupancy levels, as well as, our own actions and policies. At the time the acquisition communities were added to our consolidated portfolio, their occupancy rates were lower (average rate for 2003 was 65.4%) and their average revenue per occupied unit was higher ($3,012 for 2003) than the balance of our portfolio. We also believe that our rate enhancement program has affected occupancy growth and we continue to evaluate the factors of rate and occupancy to find the optimum balance.





Since our inception in 1993, we have incurred operating losses and as of December 31, 2003, we had an accumulated deficit of approximately $159.8 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 2003 and 2002 Transactions**





In 2003 we substantially increased the number of communities we lease, reduced the number of communities we manage, repurchased all of our outstanding Series A Preferred Stock 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.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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*Emeritrust Transactions*





Since 1999, we have managed 46 communities under arrangements with several related investor groups 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 2003, 2002 and 2001, we managed the Emeritrust I communities, which included 25 of the 46 communities, under a management agreement providing 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. Under this arrangement, we received management fees (net of our funding obligations) of approximately $2.7 million, $1.8 million, and $2.8 million in 2003, 2002 and 2001, respectively. This management agreement, as extended several times, expired at the end of 2003. On January 2, 2004, we 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. In March 2004, this management agreement was amended to provide for a management fee of 5% of gross revenues. In 2004, we do not expect to receive management fees for the Emeritrust I communities at the same level as we did in 2003. The interest rate on the mortgage financing of the communities was increased effective June 30, 2003, and may be increased further in 2004, which will have the effect of reducing cash flow from the communities and, correspondingly, reducing our additional management fee that is payable to the extent of 50% of cash flow. We also expect that additional communities could be sold, thereby reducing the number of communities subject to the management agreement. Because this management agreement can be terminated by either party on short notice, there can be no guaranty that the management arrangement will continue for its full term.





*Emeritrust II Communities Management.* During 2003 (through September 30), 2002, and 2001, we 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 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 in 2003 (through September 30), and approximately $2.6 million in each of the years 2002 and 2001.





*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 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 on our consolidated balance sheet totaling approximately $121.3 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 trust decides to sell. The lease is a triple-net lease, with annual base rent of $14.6 million (of which $10.5 million is attributable to the Emeritrust II communities), and periodic escalators. 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 described below under "Debt Consolidation." 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.





*Additional Information.* The history and additional detail relating to transactions involving the Emeritrust communities is contained in our Form 8-K filed with the Securities and Exchange Commission on October 14, 2003. Mr. Baty held financial interests in the Emeritrust investor groups and had certain obligations under the Emeritrust financing arrangements and in the transactions completed in 2003. These are also described in detail in this Form 8-K.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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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 we will amortize 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 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. 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 matured 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, as discussed below under "Debt Consolidation".





*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 $3.45 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 us a 10-year working capital loan for $600,000, with interest at 10% per annum payable monthly.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------

*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 for the assumption of the mortgage debt relating to the owned community and the lease obligations relating to the leased communities. 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 expiring April 30, 2007, with the Baty entities 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). 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 level index. We will pay 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, and an entity controlled by Mr. Baty and in which he holds an indirect 36% interest, which holds a 35% minority stake. 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.





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 $24.8 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 plan to offer both assisted and memory loss services in selected communities. Rent expense under the Fretus lease was $5.8 million and $1.5 million for the years ended December 31, 2003 and 2002, respectively.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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*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 our 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 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 will both be 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 a corresponding long-term assets under property and equipment of the same amount. The statement of operations includes charges for depreciation and interest, as well as principal payments, based on this asset and liability.





*Debt Consolidation*





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.





*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 304 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.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Table of Contents 
 The following table summarizes the transactions described above:
 
 **Owned**

**Leased**


**Managed**December 31, 2002


18


67




95Emeritrust I Communities Management


-


-




(2Sale-leaseback in connection withrepurchase of the Series A Preferred Stock


(4
)

4

*


-Emeritrust II Communities Lease


-


21

***


(21Lease of Eight Communities in May


-


8




-Lease of Eight Communities from Baty


-


8

****


(8Five Community Mortgage Assumption


5


-




-Other Transactions


-


1




(17

**December 31, 2003


19


109




47





* These four leased communities are reflected in our restated 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. See Note (2) to our consolidated financial statements for additional discussion.





** includes two communities not elsewhere discussed





*** These 21 leases are accounted for as capital leases in our restated consolidated financial statements.





**** Four of these eight communities are reflected in our restated consolidated financial statements as capital leases.











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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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**Restatement**





During November 2004, we determined that the accounting treatment for a number of our leases was incorrect and that the necessary corrections would require restatement of our financial statements. At December 31, 2003, we leased 109 communities. The accounting corrections are as follows:

(a) In the past, substantially all of our leases have been accounted for as operating leases. Leases for 25 communities, however, contain provisions that permit the landlord to claim a default of the lease based on a subjective standard (such as a material adverse change) and that, upon any default, provide for immediate payment of all rents for the full term in the lease. Under accounting principles generally accepted in the United States, this combination of provisions causes the leases to fail the quantitative test for treatment as operating leases. Accordingly, these leases have been accounted for as capital leases in the restated financial statements. Under capital lease accounting, we establish on our balance sheet a liability based on the present value of 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. Based on these assets and liabilities, the statement of operations includes charges for depreciation and interest in lieu of the rent payable under the lease. Typically, capital lease treatments results in greater property-related expense than actual lease payments paid in the early years of the leases and less property-related expense than actual rent paid in the later years of the leases. The effect of these provisions results in an increase in property and equipment of $161.3 million and $40.7 million at December 31, 2003 and 2002, respectively; an increase in capital lease and financing obligations of $163.1 million and $42.1 million at December 31, 2003 and 2002, respectively; an increase in deferred gain of $2.7 million and zero at December 31, 2003 and 2002, respectively; an increase in depreciation and amortization of $4.9 million, $2.1 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; a decrease in facility lease expense of $6.9 million, $3.1 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; an increase in interest expense of $5.1 million, $2.4 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; and an increase in other, net income of $45,000, zero, and zero for the years ended December 31, 2003, 2002, and 2001, respectively.

(b) In the past, our statements of operations have included the actual rent paid under operating leases as facility lease expense. However, leases for 17 of our communities that continue to be treated as operating leases in the restated financial statements contain rent escalation provisions, which require annual increases in rent based on the lesser of a fixed amount or various formulae related to the consumer price index. Under accounting principles generally accepted in the United States, to the extent there is a high level of certainty that the fixed increase under the lease will be met, we are required to account for 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 lease and less facility lease expense than actual rent paid in the later years of the lease. In addition, leases for 4 communities are being accounted for as capital leases because the inclusion of fixed annual increases in lease payments causes the leases to fail the quantitative test for operating leases. The effect of straight lining the total rent resulted in an increase in deferred rent of $3.8 million and $3.2 million at December 31, 2003 and 2002, respectively and net increase in facility lease expense of $550,000, $344,000, and $483,000 for the years ended December 31, 2003, 2002, and 2001, respectively. The capital lease transaction for the 4 communities discussed above was consummated on December 31, 2003, and has resulted in an increase in property and equipment of $23.6 million and related financing obligation of $23.6 million, an increase in deferred gain of $119,000 and $127,000 at December 31, 2003 and 2002, respectively; and an increase in other, net income of $9,000 and $6,000 for the years ended December 31, 2003 and 2002, respectively.





(c)  A September 2003 transaction that we had accounted for under sale-leaseback accounting should have been accounted for as a financing. The transaction consisted of a sale of four communities to a REIT, which assumed the existing debt related to the communities and in turn leased the communities to us for an initial term of 15 years with one 15-year option to renew. As a part of the transaction, we provided a letter of credit against the default of the underlying debt and continued to provide a security interest in community receivables and limited guarantees in favor of the debt holder. These transaction features constitute continuing involvement in the communities and preclude sale-leaseback accounting under accounting principles, generally accepted in the United States. As a result, we are required to account for this transaction as a financing. Under finance accounting, our balance sheet will continue to reflect the communities as assets and establish a financing obligation as a liability equal to the debt assumed by the REIT and cash received from the REIT, notwithstanding the legal sale of the communities. Our statement of operations will include depreciation of the communities and interest on the financing obligation as expenses. Operating lease expense and amortization of deferred gains related to the sale of the communities has been eliminated in the restated financial statements. The effect of these provisions results in a change in our balance sheet at December 31, 2003 and our statement of operations for the year ending December 31, 2003, only. There was an increase in property and equipment of $24.2 million, an increase in capital lease and financing obligations of $34.4 million, a decrease in deferred gain of $9.7 million, an increase in depreciation and amortization of $221,000, a decrease in facility lease expense of $884,000, an increase in interest expense of $1.0 million, and an increase in other, net expense of $165,000.




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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------




(d)  In 2001 and prior years, we recognized nonrefundable move-in fees at the time the resident occupied the unit and the related services were performed. In 2002, we began charging significantly higher fees for move-ins than were previously charged. Therefore, in June 2002, we instituted a policy consistent with SEC Staff Accounting Bulletin 101 Revenue Recognition, to defer such fees and recognize them over the average period of occupancy, approximately 16 months, and made a cumulative adjustment to defer revenues in the amount of $1.8 million. As part of the restatement, we have adjusted the deferred revenues for periods prior to 2002 to be in conformance with SEC Staff Accounting Bulletin 101. This resulted in revenues increasing by $1.5 million for the year ended December 31 2002, and decreasing by $305,000 for the year ended December 31, 2001. The restatement had no effect on revenues for the year ended December 31, 2003.





(e) We are also correcting three other items that occurred in the restatement periods. We are restating the value of warrants issued as additional lease acquisition costs in connection with the lease of 21 communities effective September 30, 2003, from $1.3 million to $2.5 million. The original valuation under the Black-Scholes option value model had an error in its computation. We are also restating the accounting for $650,000 of termination fees associated with certain debt, which is required to be accrued over the term of the debt, starting from December 2002. Finally, we are restating the accounting for a deferred compensation plan that had been accounted for on a net basis. The adjustment results in the recording of a long-term deferred compensation liability and a corresponding investment representing trading securities held for this plan. These items were originally discovered and corrected in the Companys Form 10-Q as of and for the six months ended June 30, 2004. The effect of these provisions results in an increase in short-term investments of $987,000 and $421,000 at December 31, 2003 and 2002, respectively; an increase in lease acquisition costs of $1.1 million at December 31, 2003; an increase in other accrued liabilities of $176,000 and $14,000 at December 31, 2003 and 2002, respectively; an increase in long-term liabilities of $987,000 and $421,000 at December 31, 2003 and 2002, respectively; and increase in additional paid-in capital of $1.2 million at December 31, 2003; an increase in depreciation and amortization of $20,000 for the year ended December 31, 2003; and an increase in interest expense of $163,000 and $14,000 for the years ended December 31, 2003 and 2002, respectively.


A summary of the significant effect of the restatement is as follows (in thousands except per share data):


**December 31,**

**December 31,**

**December 31,**

**December 31,****2003**

**2003**

**2002**

**2002****Balance Sheets**

**As originally reported**

**As restated**

**As originally reported**

**As restated**Short-term investments

$
-

$
987

$
2,759

$
3,180Total current assets

$
17,761

$
18,748

$
20,569

$
20,990Property and equipment, net

$
117,546

$
326,595

$
119,583

$
160,244Lease acquisition costs, net

$
19,052

$
20,223


N/C


N/CTotal assets

$
178,587

$
389,794

$
163,159

$
204,241Current portion of capital lease and financing obligations

$
-

$
5,735

$
-

$
1,119Other accrued expenses

$
7,941

$
8,117

$
9,080

$
9,094Total current liabilities

$
51,122

$
57,033

$
47,054

$
48,187Capital lease and financing obligations

$
-

$
215,324

$
-

$
40,949Deferred gain on sale of communities

$
37,389

$
30,438

$
20,324

$
20,451Deferred rent

$
263

$
4,032

$
2,508

$
5,728Other long-term liabilities

$
519

$
1,506

$
894

$
1,315Total liabilities

$
257,681

$
476,721

$
222,667

$
268,517Additional paid-in capital

$
71,703

$
72,894


N/C


N/CAccumulated deficit

$
(150,798
)
$
(159,822
)
$
(155,258
)
$
(160,026
)Total shareholders' deficit

$
(79,094
)
$
(86,927
)
$
(85,066
)
$
(89,834
)Total liabilities and shareholders' deficit

$
178,587

$
389,794

$
163,159

$
204,241Note: N/C means there was no change between what was originally reported and as restated




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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------




|                                                                                         |  | ****     |                            | **Year Ended December 31,** |  
|---------------------------------------------------------------------------------------- |  | -------- | -------------------------- | --------------------------- | -
|                                                                                         |  | **2003** |                            | **2003**                    |  
|**Statements of Operations**                                                             |  |          | **As originally reported** |                             |  
|Community revenue                                                                        |  |          | N/C                        |                             |  
|Total operating revenues                                                                 |  |          | N/C                        |                             |  
|Depreciation and amortization                                                            |  | $        | 7,336                      |                             | $
|Facility lease expense                                                                   |  | $        | 41,043                     |                             | $
|Total operating expenses                                                                 |  | $        | 199,710                    |                             | $
|Income from operations                                                                   |  | $        | 6,947                      |                             | $
|Interest expense                                                                         |  | $        | (13,144                    | )                           | $
|Other, net                                                                               |  | $        | 2,124                      |                             | $
|Net other expense                                                                        |  | $        | (10,354                    | )                           | $
|Loss before income taxes                                                                 |  | $        | (3,407                     | )                           | $
|Net loss                                                                                 |  | $        | (3,825                     | )                           | $
|Net income (loss) to common shareholders                                                 |  | $        | 4,460                      |                             | $
|                                                                                         |  |          |                            |                             |  
|Income (loss) per common share:                                                          |  |          |                            |                             |  
|Basic                                                                                    |  | $        | 0.43                       |                             | $
|                                                                                         |  |          |                            |                             |  
|Diluted                                                                                  |  | $        | 0.39                       |                             | $
|Note: N/C means there was no change between what was originally reported and as restated |  |          |                            |                             |  





**Year Ended December 31****2003**

**2003**

**2002**

**2002**

**2001**

**2001****Cash Flows**

**As originally reported**

**As restated**

**As originally reported**

**As restated**

**As originally reported**

**As restated**Cash flows from operating activities:Net loss

$
(3,825
)
$
(8,081
)
$
(6,223
)
$
(6,455
)
$
(4,234
)
$
(5,022
)Depreciation and amortization

$
7,336

$
12,450

$
7,223

$
9,363


N/C


N/CAmortization of deferred gain

$
(1,073
)
$
(962
)
$
(320
)
$
(327
)

N/C


N/CGain on refinancings and sale of properties, net


N/C


N/C

$
(4,544
)
$
(4,410
)

N/C


N/CWrite down of loan fees and amortization

$
896

$
1,363

$
381

$
395


N/C


N/CDeferred revenue


N/C


N/C

$
2,884

$
1,357

$
-

$
305Deferred rent

$
(26
)
$
524

$
104

$
314

$
272

$
755Net cash provided by operating activities

$
6,372

$
8,358

$
3,840

$
4,572


N/C


N/CCash flows from investing activities:Sale of property and equipment

$
44,800

$
11,346


N/C


N/C


N/C


N/CNet cash provided by (used in) investing activities

$
23,004

$
(10,450
)

N/C


N/C


N/C


N/CCash flows from financing activities:Proceeds from long-term borrowings and financings

$
19,600

$
28,763


N/C


N/C


N/C


N/CRepayment of long-term borrowings

$
(24,350
)
$
(59
)

N/C


N/C


N/C


N/CRepayment of capital lease and financing obligations

$
-

$
(1,986
)
$
-

$
(732
)

N/C


N/CNet cash provided by (used in) financing activities

$
(30,309
)
$
1,159

$
(9,930
)
$
(10,662
)

N/C


N/CSupplemental disclosure of cash flow information -cash paid during the period for interest

$
12,992

$
19,235

$
12,852

$
15,260


N/C


N/CCommon stock warrants issued

$
1,358

$
2,549


N/C


N/C


N/C


N/CCapital Lease and financing obligations

$
-

$
222,221

$
-

$
42,800


N/C


N/CNote: N/C means there was no change between what was originally reported and as restated


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------




|                                                                                         |  |   |        |  |   |         |  |   |        |  |   |        | 
|---------------------------------------------------------------------------------------- |  | - | ------ |  | - | ------- |  | - | ------ |  | - | ------ | 
|Supplemental disclosure of cash flow information -                                       |  |   |        |  |   |         |  |   |        |  |   |        | 
|cash paid during the period for interest                                                 |  | $ | 12,992 |  | $ | 19,235  |  | $ | 12,852 |  | $ | 15,260 | 
|Common stock warrants issued                                                             |  | $ | 1,358  |  | $ | 2,549   |  |   | N/C    |  |   | N/C    | 
|Capital Lease and financing obligations                                                  |  | $ | -      |  | $ | 222,221 |  | $ | -      |  | $ | 42,800 | 
|Note: N/C means there was no change between what was originally reported and as restated |  |   |        |  |   |         |  |   |       




|                                        |  | **Three Months Ended December 31,** |                           
|--------------------------------------- |  | ----------------------------------- | --------------------------
|                                        |  | **2003**                            |                           
|**Same Community Results**              |  |                                     | **As originally reported**
|                                        |  |                                     |                           
|Depreciation & amortization             |  | $                                   | (1,347                    
|Facility lease expense                  |  | $                                   | (7,956                    
|Operating income                        |  | $                                   | 4,749                     
|Interest expense, net                   |  | $                                   | (2,209                    
|Operating income after interest expense |  | $                                   | 2,540                     




|                                        |  | **Year Ended December 31,** |                           
|--------------------------------------- |  | --------------------------- | --------------------------
|                                        |  | **2003**                    |                           
|**Same Community Results**              |  |                             | **As originally reported**
|                                        |  |                             |                           
|Depreciation & amortization             |  | $                           | (5,943                    
|Facility lease expense                  |  | $                           | (28,844                   
|Operating income                        |  | $                           | 19,293                    
|Interest expense, net                   |  | $                           | (9,755                    
|Operating income after interest expense |  | $                           | 9,538                     








**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 under different assumptions or conditions.








**30**





Table of Contents





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, we use a captive insurance structure essentially to self-fund our primary layer of insurance. This policy is claims-made based and covers losses and liabilities associated with general and professional liability. The primary layer has per occurrence and aggregate limits. Within that primary layer is a self-insured retention, which also has a per occurrence and aggregate limit. We also have an excess policy, which applies to claims in excess of the primary layer on a per occurrence basis. Losses within the primary layer, which include the self-insured retention, are accrued based upon actuarial estimates of the aggregate liability for claims incurred, which will vary based on actual versus expected experience.




*  For health insurance, we self-insure up to a certain level for each occurrence above which 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.




*  For workers' compensation insurance for insured states (excluding Texas and compulsory State Funds), we are on an incurred loss, retrospective insurance policy, retroactively adjusted, upward or downward, based upon total incurred loss experience. The premium charged by the insurance underwriter is based upon a standard rate determined by the underwriter to cover, amongst other things, estimated losses and other fixed costs. The difference between the premium charged and the actuarial based estimate of costs, which is expensed on a monthly basis, is carried as an asset on the balance sheet. After the end of the policy year, the insurance company conducts an audit and adjusts the total premium based upon the actual payroll and actual incurred loss for the policy year. Any premium adjustment for the differences between estimated and actual payroll and estimated and actual losses will first be applied to the accrued asset and then as an adjustment to workers' compensation expense at the time such adjustment is determined. There is a reasonable expectation that the incurred loss adjustment will be downward, resulting in a premium refund. The incurred loss adjustment is limited to 50% of the standard premium with the initial adjustment six months after policy expiration on December 31, 2003, and annually thereafter. For work-related injuries in Texas, we are a non-subscriber, meaning that work-related losses are covered under a defined benefit program outside of the Texas Workers' Compensation system. Losses are paid as incurred and estimated losses are accrued on a monthly basis.




*  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




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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------

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 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 annually or 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 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 to us, (ii) contain a bargain purchase option, (iii) include a lease term of 75% or more of the economic life of the leased property, or (iv) include minimum lease payments for which the present value 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 and cannot be accounted for as operating leases are generally 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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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------




Table of Contents


**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 as restated.













**Year-to-Year****Percentage of Revenues**

**Percentage Increase****Years Ended December 31,**

**(Decrease)****2003**

**2002**

**2001**

**2003-2002**

**2002-2001****As restated**Revenues:


100.0
%

100.0
%

100.0
%

33.6
%

10.3
%Expenses:Community operations


61.6


60.7


57.6


35.7


16.1General and administrative


11.6


13.7


12.7


13.9


18.2Depreciation and amortization


6.0


6.1


5.2


33.0


29.0Facility lease expense


16.4


17.6


19.7


24.4


(1.5
)Total operating expenses


95.6


98.1


95.2


30.4


13.4Income from operations


4.4


1.9


4.8


185.7


(52.8
)Other income (expense)Interest income


0.3


0.3


0.7


65.3


(58.9
)Interest expense


(9.4
)

(9.1
)

(9.5
)

37.2


6.3Other, net


1.0


2.7


0.4


(51.0
)

607.6Net other expense


(8.1
)

(6.1
)

(8.4
)

73.7


(18.0
)Loss before income taxes


(3.7
)

(4.2
)

(3.6
)

18.7


28.5Provision for income taxes


(0.2
)

-


-


N/A


N/ANet loss


(3.9
%)

(4.2
%)

(3.6
%)

25.2
%

28.5
%




**33** **MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**  Table of Contents


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 $206.7 million from $154.7 million in 2002, or 33.6%. 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. Average monthly revenue per unit (excluding the impact of additional leased communities, which was favorable by $68) was $2,699 for 2003 compared to $2,577 for 2002, an increase of approximately 5.6%. 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. However, the occupancy rate excluding the impact of additional leased communities, which was unfavorable by 4.2 percentage points, decreased 0.2 percentage points from the prior year. 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 95 as of December 31, 2002, a decline of 48 managed communities. Of the 48 previously managed communities, 29 are currently leased and included in our consolidated portfolio at December 31, 2003.





*Community Operations:* Community operating expenses for the year ended December 31, 2003, increased $33.5 million to $127.3 million from $93.8 million for 2002, or 35.7%. 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 61.6% in 2003 from 60.7% 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 additional operating communities and health and workers compensation insurance. As a percentage of total operating revenues, G&A expenses decreased to 11.6% for 2003, compared to 13.7% for 2002, primarily as a result of increased revenue due to additional communities in our consolidated portfolio. Since approximately 25% of the communities we operate are 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 6.0% for 2003 and 2002, respectively.





*Depreciation and Amortization:* Depreciation and amortization for the year ended December 31, 2003, and 2002, were approximately $12.5 million and $9.4 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 in "Significant 2003 and 2002 Transactions". In 2003, this represents 6.0% of total operating revenues compared to 6.1% for 2002.





*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 an 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


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Table of Contentspercentage of revenues was 16.4% and 17.6% for the years ended December 31, 2003 and 2002, respectively.




*Interest Income:* Interest income for the year ended December 31, 2003, was $666,000 versus $403,000 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 $19.4 million compared to $14.1 million for the year ended December 31, 2002. This increase of $5.3 million, or 37.2%, 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 2003 and 2002 Transactions". As a percentage of total operating revenues, interest expense increased to 9.3% from 9.1% for the year ended December 31, 2003 and 2002, respectively, reflecting increased revenues in conjunction with lower interest rates.





*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 in 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 believe that we will be 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 will pay income or franchise tax.





*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, 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 $1.7 million and $2.1 million for 2003 and 2002, respectively.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Table of Contents


Comparison of the Years Ended December 31, 2002 and 2001





*Total Operating Revenues:* Total operating revenues for the year ended December 31, 2002, increased by $14.4 million to $154.7 million from $140.3 million in 2001, or 10.3%. Approximately $9.7 million of the increase reflects revenue from 24 communities that we began leasing in late 2002. 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 additional managed communities throughout 2002 compared to 2001. Average monthly revenue per unit was $2,577 for 2002 compared to $2,405 for 2001, an increase of approximately 7.2%. Management fees increased by $2.2 million in the year ended December 31, 2002, compared to 2001. This is primarily due to the addition of 24 managed communities in 2002 compared to 2001, as well as, increases in contingent management fees from certain existing managed communities. These increases were partially offset by a decrease in the occupancy rate of 3.2 percentage points to 80.9% for 2002 from 84.1% for 2001. Exclusive of the 24 communities acquisition, occupancy decreased to 81.8% in 2002.





*Community Operations:* Community operating expenses for the year ended December 31, 2002, increased $13.0 million to $93.8 million from $80.8 million for 2001, or 16.1%. Approximately $9.7 million of the increase reflects operating expense from 24 communities that we began leasing in October 2002. The balance of this change was due to increases in personnel costs and above average increases in liability, health, and workers compensation insurance premiums. Community operating expenses as a percentage of total operating revenue increased to 60.7% in 2002 from 57.6% in 2001, primarily as a result of these increased expenses.





*General and Administrative:* General and administrative (G&A) expenses for the year ended December 31, 2002, increased $3.2 million to $21.1 million from $17.9 million for 2001, or 18.2%. 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 increased to 13.7% for 2002, compared to 12.7% for 2001, primarily as a result of higher expenses due to additional communities in our consolidated portfolio. Since more than half 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 6.0% and 6.6% for 2002 and 2001, respectively.





*Depreciation and Amortization:* Depreciation and amortization for the year ended December 31, 2002, and 2001, were approximately $9.4 million and $7.3 million, respectively. The increase was primarily the result of additional depreciation resulting from capital lease treatment of the March 2002 lease of four communities described under Significant 2003 and 2002 Transactions. In 2002, this represents 6.1% of total operating revenues compared to 5.2% for 2001. The decrease as a percentage of revenues is due to increased revenues from leased communities.


*Facility Lease Expense* : Facility lease expense for the year ended December 31, 2002, was $27.2 million compared to $27.6 million for the year ended December 31, 2001, representing a decrease of $413,000, or 1.5%. Facility lease expense increased by approximately $1.5 million from 24 communities that we began leasing in October 2002 and by approximately $700,000 as a result of rent escalators. These increases were offset by the disposition of one leased community and by the change of two communities, which were previously operating leases, that were converted to capital leases with the March 2002 lease of four communities described under Significant 2003 and 2002 Transactions. We had 63 communities under operating leases as of December 31, 2002, compared to 42 communities as of December 31, 2001. Facility lease expense as a percentage of revenues decreased to 17.6% from 19.7% for the years ended December 31, 2002, and 2001, respectively.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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*Interest Income:* Interest income for the year ended December 31, 2002, was $403,000 versus $980,000 for the year ended December 31, 2001. This was primarily attributable to declining interest rates.





*Interest Expense:* Interest expense for the year ended December 31, 2002, was $14.1 million compared to $13.3 million for the year ended December 31, 2001. This increase of $839,000, or 6.3%, is primarily attributable to the effects of capital lease treatment of the March 2002 lease of four communities described under Significant 2003 and 2002 Transactions offset by the effect of a reduced amount of outstanding debt in 2002 compared to 2001. As a percentage of total operating revenues, interest expense decreased to 9.1% from 9.5% for the year ended December 31, 2002 and 2001, respectively, reflecting increased revenues in conjunction with lower interest rates.





*Other, net:* Other, net increased by $3.5 million to $4.1 million in income for the year ended December 31, 2002, from $581,000 income for the year ended December 31, 2001. The amount for the year 2002 includes a $5.1 million gain related to discounts we received upon the payoff of existing financing, offset by 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. The amount for the year 2001 included a deficit-funding obligation of $335,000 arising from our management of the Emeritrust communities, losses of $313,000 associated with our investment in Senior Healthcare Partners, LLC, and a net gain of $1.1 million on sale of two communities.





*Preferred dividends:* For the year ended December 31, 2002 and 2001, the preferred dividends were approximately $7.3 million and $6.4 million, respectively. As of December 31, 2002, for the previous ten quarters, we had not declared cash dividends on our preferred stock but had 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 $2.1 million for both 2002 and 2001. In addition, because the board of directors did not declare dividends on our Series A preferred stock for more than six quarters, effective January 1, 2002, such dividends were calculated on a compounded cumulative basis, retroactive to our last payment, until they are paid current. Had we been required to pay the higher rate for the Series A preferred stock, both our preferred dividends and net loss to common shareholders would have increased $275,000 and $19,000 for 2001 and 2000, respectively. This combined amount of $294,000 was recognized in 2002 as well as an additional cumulative compounded dividend of $622,000 for 2002.





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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Table of Contents


*Same Community Comparison*





Three months ended December 31, 2003, and 2002:







We operated 59 owned or leased communities on a comparable basis during both the three months ended December 31, 2003 and 2002. The following table sets forth a comparison of same community restated results of operations, excluding general and administrative expenses, for the three months ended December 31, 2003 and 2002.




**Three Months ended December 31,**
********
****
**(In thousands)**
********
****
**2003**
****
**2002**
****
**Dollar**
****
**% Change**
********
****
**As restated**
****
**Change**
****
****
**Fav / (Unfav**
**)**Revenue

$
34,494

$
33,516

$
978


2.9
%Community operating expenses


(20,442
)

(21,674
)

1,232


5.7Community operating income


14,052


11,842


2,210


18.7Depreciation & amortization


(2,281
)

(2,285
)

4


0.2Facility lease expense


(6,142
)

(5,815
)

(327
)

(5.6
)Operating income


5,629


3,742


1,887


50.4Interest expense, net


(3,704
)

(3,170
)

(534
)

(16.8
)Operating income after interest expense

$
1,925

$
572

$
1,353


236.5
%


The same communities represented $34.5 million or 57.6% of our total revenue of $59.9 million for the fourth quarter of 2003. Same community revenues increased by $978,000 or 2.9% for the quarter ended December 31, 2003, from the comparable period in 2002. This was primarily due to rate increases, which increased revenue per unit by 4.4%, partially offset by a decrease in average occupancy to 81.6% in the fourth quarter of 2003 from 82.3% in the fourth quarter of 2002. Facility lease expense for the fourth quarter of 2003 increased primarily due to various rent escalators related to certain leased facilities. For the quarter ended December 31, 2003, our operating income after interest expense increased to $1.9 million from $572,000 for the comparable period of 2002, primarily as a result of a combination of increased rates and decreased community operating expenses mainly due to improvements in personnel and related costs; taxes, licenses, and fees; insurance; and other operating expenses in 2003 compared to 2002.


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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Year ended December 31, 2003, and 2002:




We operated 59 owned or leased communities on a comparable basis during both the twelve months ended December 31, 2003 and 2002. The following table sets forth a comparison of same community restated results of operations, excluding general and administrative expenses, for 2003 and 2002.





|                                        |      | **Year Ended December 31,** | ****   
|--------------------------------------- | ---- | --------------------------- | -------
|****                                    | **** | **(In thousands)**          | ****   
|****                                    | **** | **2003**                    | ****   
|****                                    | **** | **As restated**             | ****   
|Revenue                                 |      | $                           | 136,213
|Community operating expenses            |      |                             | (82,133
|Community operating income              |      |                             | 54,080 
|Depreciation & amortization             |      |                             | (9,018 
|Facility lease expense                  |      |                             | (24,064
|Operating income                        |      |                             | 20,998 
|Interest expense, net                   |      |                             | (14,046
|Operating income after interest expense |      | $                           | 6,952  





The same communities represented $136.2 million or 65.9% of our total revenue of $206.7 million for the year ended December 31, 2003. Same community revenues increased by $5.3 million or 4.0% for the year ended December 31, 2003, from the year ended December 31, 2002. The increase in revenue is attributable to our rate enhancement program, which resulted in an increase in same community average monthly revenue per unit to $2,715 for 2003, from $2,585 for 2002. This is an increase of $130 or 5.0%. These results were partially offset by a decrease in occupancy to 81.8% in 2003 from 81.9% in 2002. Facility lease expense for the year ended December 31, 2003, increased primarily due to variable rent escalators related to certain leased communities. For the year ended December 31, 2003, our operating income after interest expense increased to $7.0 million from $3.3 million for 2002, primarily as a result of a combination of increased rates and decreased community operating expenses mainly due to improvements in taxes, licenses, and fees; insurance; and other operating expenses in 2003 compared to 2002.








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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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**Liquidity and Capital Resources**





For the year ended December 31, 2003, net cash provided by operating activities was $8.4 million compared to $4.6 million for the prior year. Increases in current liabilities provided cash of approximately $4.7 million primarily due to an increase in accounts payable of $2.9 million and an increase in deferred revenue of $3.2 million, partially offset by decreases in other current liabilities of $1.4 million. Net cash used by increases in current assets were approximately $952,000, primarily from increases in prepaid expenses.
 
 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. Net cash provided by investing activities amounted to $3.2 million for the year ended December 31, 2002, and was comprised primarily of proceeds from sale of property and equipment related to refinancing of four communities through sale-leaseback transactions, which was partially offset by the acquisition of property, equipment, new leases, and lease improvements.
 
 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, long-term debt repayments of $59,000, repayment of capital lease and financing obligations of $2.0 million, short-term debt repayments of $2.8 million, and an increase in restricted deposits of $1.6 million, partially offset by proceeds from long-term borrowings and financings of $28.8 million. For the year ended December 31, 2002, net cash used in financing activities was $10.7 million primarily from short-term and long-term debt repayments, and financing and debt issuance costs.
 
 We have incurred significant operating losses since our inception and have a working capital deficit of $38.3 million, although $6.1 million represents deferred revenue and $8.2 million of preferred dividends is due only if declared by our board of directors. In 2003, 2002, and 2001, 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 2002, 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 acquisitions in 2003, our long-term debt has increased from $123.5 million at December 31, 2002, to $141.1 million at December 31, 2003, our obligations under operating leases have decreased from $391.4 million to $358.3 million, and our capital lease and financing obligations have increased from $42.1 million to $221.1 million. In particular, the number of communities we lease increased from 67 at December 31, 2002 to 109 at December 31, 2003. 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 17 owned assisted living properties and 104 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. At the time of the original filing of our Form 10-K 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 did become in violation of one or more covenants in certain of its leases, but were 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 2004 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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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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The following table summarizes our contractual obligations at December 31, 2003, (In thousands):





|                                                                  |  | **Principal Payments Due by Period (as restated)** |          
|----------------------------------------------------------------- |  | -------------------------------------------------- | ---------
|                                                                  |  |                                                    |          
|**Contractual Obligations**                                       |  |                                                    | **Total**
|Long-term debt, including current portion                         |  | $                                                  | 141,138  
|Capital lease and financing obligations including current portion |  | $                                                  | 221,059  
|Operating leases                                                  |  | $                                                  | 358,348  
|Convertible debentures                                            |  | $                                                  | 32,000   




The following table summarizes interest on our contractual obligations at December 31, 2003, (In thousands):
  **Interest Due by Period (as restated)****Less than**





**After 5****Contractual Obligations**

**Total**

**1 year**

**1-3 years**

**4-5 years**

**years**Long-term debt

$
33,593

$
10,034

$
18,807

$
4,493

$
259Capital lease and financing obligations

$
142,964

$
15,537

$
29,678

$
27,263

$
70,486Convertible debentures

$
5,000

$
2,000

$
3,000

$
-

$
-




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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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**Recent Accounting Pronouncements**





In June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires us to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. We also record a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. We adopted SFAS No. 143 on January 1, 2003. However, adoption of SFAS No. 143 did not have an impact on our financial condition and results of operations.





In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. The provisions of the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 in the fourth quarter of 2002 had no effect on our consolidated financial statements.





In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Adoption of Interpretation No. 45 did not have an impact on our financial condition and results of operations.





In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46), Consolidation of Variable Interest Entities. This Interpretation was revised in December 2003 and addresses consolidation by business enterprises of VIE's. A VIE is subject to the consolidation provisions of FIN No. 46 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. 46 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 VIE's that existed prior to February 1, 2003.





We have evaluated the impact of FIN No. 46 on all its current related party management agreements including those more fully discussed under Item 13 "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS," under sections denoted as "Emeritrust Transactions" and "Baty Transactions" as well as other management agreements and other arrangements with potential VIE's. We doe not believe we have any VIE's that will 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.





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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
|---------------------------------------------------------------------------------------------------------

**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.





**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 2003, 2002, and 2001, we recorded net losses before preferred dividends of $8.1 million, $6.5 million, and $5.0 million, respectively. 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, 2003, we had total debt of $141.1 million, with minimum principal payments of about $4.8 million due in 2004. At December 31, 2003, we were obligated under both operating and capital long-term leases requiring minimum annual cash lease payments of which $57.7 million is payable in 2004. In addition, we will have approximately $6.4 million and $68.9 million in principal amount of debt repayment obligations that become due in 2005 and 2006, respectively. 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


**43**


**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**


Table of Contents


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




*Because we are highly leveraged, we may not be able to respond to changing business and economic conditions or continue with selected acquisitions.* A substantial portion of our future cash flow will be devoted to debt service and lease payments. In the past, we have frequently been dependent on third party financing and disposition of assets to fund these obligations in full and we may be required to do so in the future. In addition, we are periodically required to refinance these obligations as they mature. As a consequence of acquisitions of communities, we have substantially increased our leverage in 2003. Our long-term debt has increased from $123.5 million at December 31, 2002, to $141.1 million at December 31, 2003, our obligations under long-term leases, both capital and operating, have increased from $433.5 million to $579.4 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. During the last three years, occupancy levels declined, although last year 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 that we occasionally will face such suits because of the nature of our business. We currently maintain insurance policies with coverage and self-insured retention (with respect to general and professional liability) and deductibles (with respect to auto liability and property damage claims) we deem appropriate based on the nature and risks of our business, historical experience, industry standards, and the availability of insurance. We could incur liability in excess of our insurance coverage or experience claims not covered by our insurance, including punitive damages. 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. Our liability insurance policies must be renewed annually, and we may not be able to obtain liability insurance coverage in the future or, if available, on acceptable terms. During the past several years, retained losses relating to high self-insured retention and annual premiums have increased significantly, which have substantially compounded our costs associated with insurance and claims defense.





*We face risks associated with selective acquisitions.* We intend to continue to seek selective acquisition opportunities. However, we may not succeed in identifying any future acquisition opportunities or completing any identified acquisitions. The acquisition of communities presents a number of risks. Existing residences 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 residences 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


**44**


**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**


Table of Contents  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.





*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 and we may suffer losses that could cause the value of your investment in our stock to 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 residences. If we are unable to attract or retain qualified residence 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  **45** **MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**  Table of Contents 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.





*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 interest 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.* Our recent transactions to lease an additional 24 communities and our agreements to manage 24 communities involve limited guarantees by Mr. Baty and rely on his direct and indirect ownership of the communities involved. We believe that  **46** **MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**  Table of Contents 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. 
 *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.





*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


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|**MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
**AND RESULTS OF OPERATIONS (continued)**
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*  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 29, 2004, Mr. Baty controls about 39% of our outstanding common stock. Together, our directors and executive officers own, directly and indirectly, over 61% 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.










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******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, 2003. For our debt obligations with variable interest rates, the rates presented reflect the current rates in effect at the end of 2003. These rates are based on LIBOR plus margins ranging from 4.15% to 7.75%.





|                |      | **Expected maturity date (In thousands, as restated)** | ****     | **** | ****
|--------------- | ---- | ------------------------------------------------------ | -------- | ---- | ----
|****            | **** | ****                                                   | **2004** | **** | ****
|Long-term debt: |      |                                                        |          |      |     
|Fixed rate      |      | $                                                      | 8,602    |      | $   
|Variable rate   |      | $                                                      | 1,883    |      | $   







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, 2003, our variable rate borrowings totaled approximately $65.0 million. Currently, all our variable rate borrowings are based upon LIBOR, subject to a LIBOR floor ranging from 2.0% to 2.5%. As of December 31, 2003, the LIBOR rates were below the floor. If LIBOR interest rates were to average 2% more, our annual facility lease expense and net loss would increase by approximately $167,000 for the Fretus lease.  Our annual interest expense and net loss would increase approximately $483,000 with respect to our variable rate borrowings. This amount is determined by considering the impact of hypothetical interest rates on our outstanding variable rate borrowings as of December 31, 2003, and does not consider changes in the actual level of borrowings that may occur subsequent to December 31, 2003. If LIBOR rates should increase above the floor, we will be exposed to higher interest expense costs. 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.





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


The financial statements and the Independent Auditors report 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, 2003, 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, 2003.





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, 2003. The evaluation has revealed no evidence of any fraud, intentional misconduct or concealment on the part of Company personnel.





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;
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| | · | 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;
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| | · | Establishing clear responsibilities for our real estate personnel and accounting personnel and increasing the formal interaction, responsibility and coordination between such personnel;
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| | · | Documenting the review, analysis and related conclusions with respect to complex leasing transactions;
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| | · | Requiring senior accounting personnel and the chief accounting officer to review such transactions in order to evaluate, document and approve their accounting treatment.
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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 Amendment No. 1 on Form 10-K/A. 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 2003 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.





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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/A and in our definitive Proxy Statement relating to our 2004 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 EQUITY****COMPENSATION PLAN INFORMATION************


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, 2003, 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, 2003, consolidated financial statements.




|                             |  |  |                         |  |   |                               |  |  |                              
|---------------------------- |  |  | ----------------------- |  | - | ----------------------------- |  |  | -----------------------------
|                             |  |  |                         |  |   |                               |  |  | Number of shares remaining   
|                             |  |  | Number of shares to be  |  |   |                               |  |  | available for future issuance
|                             |  |  | issued upon exercise of |  |   | Weighted-average exercise     |  |  | under equity compensation    
|                             |  |  | outstanding options,    |  |   | price of outstanding options, |  |  | plans (excluding shares      
|                             |  |  | warrants and rights     |  |   | warrants and rights           |  |  | reflected in column (a)) (1) 
|Plan Category                |  |  | (a)                     |  |   | (b)                           |  |  | (c)                          
|                             |  |  |                         |  |   |                               |  |  |                              
|Equity compensation plans    |  |  |                         |  |   |                               |  |  |                              
|approved by shareholders     |  |  | 2,151,443               |  | $ | 2.89                          |  |  | 410,008                      
|                             |  |  |                         |  |   |                               |  |  |                              
|Equity compensation plans    |  |  |                         |  |   |                               |  |  |                              
|not approved by shareholders |  |  | -                       |  |   | -                             |  |  | -                            
|                             |  |  |                         |  |   |                               |  |  |                              
|Total                        |  |  | 2,151,443               |  | $ | 2.89                          |  |  | 410,008                      








__________________




(1) Represents 224,025 shares available for purchase under the Employee Stock Purchase Plan and 185,983 shares available for grant under the 1995 Stock Incentive Plan, which includes director stock options.


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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.










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





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





(1)  *FINANCIAL STATEMENTS* . The following restated 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/A:





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




(2)  *FINANCIAL STATEMENT SCHEDULES.*





|Report of Independent Registered Public Accounting Firm on Financial Statement Schedule | S-1
|--------------------------------------------------------------------------------------- | ---
|Schedule 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.





(b)  *REPORTS ON FORM 8-K.*


|1. | A report on Form 8-K (Item 2) dated October 13, 2003, was filed on October 14, 2003, related to the acquisition of 21 communities.
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|2. | A report on Form 8-K (Item 5 and 7) dated October 15, 2003, was filed on October 16, 2003, related to a press release about an update to the Alterra transaction.
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|3. | A report on Form 8-K (Item 12) dated November 7, 2003, was furnished on November 7, 2003, related to a press release announcing the results of operations for the third quarter of 2003.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------






(c) *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)  
 **54**
 
 Table of Contents
 **Footnote****Number**

**Description**

**Number**
 
 **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)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)  
 **55**
 
 Table of Contents
 **Footnote****Number**

**Description**

**Number**
 
 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.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  
 **56**
 
  Table of Contents
 
 **Footnote****Number**

**Description**

**Number**
 
 ("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,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)  
 **57**
 
  Table of Contents
 **Footnote****Number**

**Description**

**Number**
 
 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)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)  
 **58**
 
 Table of Contents
 **Footnote****Number**

**Description**

**Number**
 
 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..(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)  
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 Table of Contents
 **Footnote****Number**

**Description**

**Number**
 
 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 theregistrant 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)**10.53**

**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).

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  Table of Contents
  **Footnote****Number**

**Description**

**Number**
 
 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)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)**10.54**

**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)  
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  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").

(37)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").

(37)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).

(37)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).

(37)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).

(37)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)10.6

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,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)  
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  Table of Contents
  **Footnote****Number**

**Description**

**Number**
 
 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,(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)  
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  Table of Contents
 
 **Footnote****Number**

**Description**

**Number**
 
 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., EmeritusProperties 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)  
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  Table of Contents
 
 **Footnote****Number**

**Description**

**Number**
 
 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.("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)  
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  Table of Contents
  **Footnote****Number**

**Description**

**Number**
 
 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)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)  
 **66**
 
  Table of Contents
  **Footnote****Number**

**Description**

**Number**
 
 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.

(37)10.76.2
Guaranty given by Emeritus Corporation ("Guarantor"), in favor of WASHINGTON LESSOR - SILVERDALE,INC., ("Lessor") dated August 15, 2003.

(37)**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)  
 **67**
 
  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)21.1


Subsidiaries of the registrant.

(36)23.1


Consent of Independent registered public accounting firm.

(36)31.1


Certification of Periodic Reports31.1.1Certification 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 January 27, 2005

(37)31.1.2Certification 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 January 27, 2005

(37)32.1


Certification of Periodic Reports32.1.1Certification 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 January 27, 2005

(37)32.1.2Certification 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 January 27, 2005

(37)99.1


Press Releases99.1.1Press Release dated March 26, 2004, reports on fourth quarter and year 2003 results.

(35)







(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 on November 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) on August 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) on October 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.






**68**   Table of Contents


(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 herewith.









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****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: January 27, 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**      









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******Index to Consolidated Financial Statements******


|****                                                                                                                                          | **Page No.**
|--------------------------------------------------------------------------------------------------------------------------------------------- | ------------
|Report of Independent Registered Public Accounting Firm                                                                                       | F-2         
|                                                                                                                                              |             
|Consolidated Balance Sheets as of December 31, 2003 and 2002 - Restated                                                                       | F-3         
|                                                                                                                                              |             
|Consolidated Statements of Operations for the years ended December 31, 2003, 2002, and 2001 - Restated                                        | F-4         
|                                                                                                                                              |             
|Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002, and 2001- Restated                                         | F-5         
|                                                                                                                                              |             
|Consolidated Statements of Shareholders Deficit and Comprehensive Operations for the years ended December 31, 2003, 2002, and 2001- Restated | F-7         
|                                                                                                                                              |             
|Notes to Consolidated Financial Statements - Restated                                                                                         | F-8         
|                                                                                                                                              |             
|Report of Independent Registered Public Accounting Firm on Financial Statement Schedule                                                       | S-1         
|                                                                                                                                              |             
|Schedule II--Valuation and Qualifying Accounts                                                                                                | S-2         
|                                                                                                                                              |             







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******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, 2003 and 2002, 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, 2003. 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, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.




As discussed in Note (2) to the accompanying consolidated financial statements, the Company has restated its consolidated balance sheets as of December 31, 2003 and 2002, 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, 2003.














/s/KPMG LLP




Seattle, Washington


March 5, 2004, except as to footnote 2, which is as of January 21, 2005







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****EMERITUS CORPORATION******CONSOLIDATED BALANCE SHEETS****(In thousands, except share data)****ASSETS****December 31,**

**December 31,****2003**

**2002**Current Assets:

**As restated**Cash and cash equivalents

$
6,368

$
7,301Short-term investments


987


3,180Trade accounts receivable, net


2,769


1,647Other receivables


1,961


3,645Prepaid expenses and other current assets


6,663


5,217Total current assets


18,748


20,990Long-term investments


7,678


-Property and equipment, net


326,595


160,244Property held for development


1,254


1,254Notes receivable from and investments in affiliates


2,409


6,358Restricted deposits


7,306


5,555Lease acquisition costs, net


20,223


6,081Other assets, net


5,581


3,759Total assets

$
389,794

$
204,241**LIABILITIES AND SHAREHOLDERS' DEFICIT**Current Liabilities:Current portion of long-term debt

$
4,750

$
3,604Current portion of capital lease and financing obligations


5,735


1,119Trade accounts payable


6,774


3,108Accrued employee compensation and benefits


5,885


5,355Accrued interest


1,888


1,737Accrued real estate taxes


2,702


2,463Accrued dividends on preferred stock


8,228


13,457Other accrued expenses


8,117


9,094Deferred revenue


6,075


2,884Other current liabilities


6,879


5,366Total current liabilities


57,033


48,187Long-term debt, less current portion


136,388


119,887Capital lease and financing obligations, less current portion


215,324


40,949Convertible debentures


32,000


32,000Deferred gain on sale of communities


30,438


20,451Deferred rent


4,032


5,728Other long-term liabilities


1,506


1,315Total liabilities


476,721


268,517Minority interests


-


558Redeemable preferred stock


-


25,000Commitments and contingenciesShareholders' Deficit:Preferred stock, $.0001 par value. Authorized 5,000,000 shares.Series B, Authorized 70,000 shares; issued and outstanding 34,830 and 33,473 atDecember 31, 2003, and December 31, 2002, respectively


-


-Common stock, $.0001 par value. Authorized 40,000,000 shares; issued and outstanding10,297,449 and 10,247,226 shares at December 31, 2003, and December 31, 2002, respectively


1


1Additional paid-in capital


72,894


68,944Accumulated other comprehensive income


-


1,247Accumulated deficit


(159,822
)

(160,026
)Total shareholders' deficit


(86,927
)

(89,834
)Total liabilities and shareholders' deficit

$
389,794

$
204,241







See accompanying notes to consolidated financial statements.


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Table of Contents Index to Consolidated Financial Statements    ******EMERITUS CORPORATION********CONSOLIDATED STATEMENTS OF OPERATIONS****(In thousands, except per share data)****Year Ended December 31,****2003**

**2002**

**2001**Revenues:

**As restated**Community revenue

$
191,979

$
139,189

$
129,256Other service fees


4,435


4,575


2,291Management fees


10,243


10,892


8,725Total operating revenues


206,657


154,656


140,272Expenses:Community operations


127,290


93,822


80,829General and administrative


24,041


21,112


17,864Depreciation and amortization


12,450


9,363


7,260Facility lease expense


33,831


27,193


27,606Total operating expenses


197,612


151,490


133,559Income from operations


9,045


3,166


6,713Other income (expense):Interest income


666


403


980Interest expense


(19,387
)

(14,135
)

(13,296
)Other, net


2,013


4,111


581Net other income (expense)


(16,708
)

(9,621
)

(11,735
)Loss before income taxes


(7,663
)

(6,455
)

(5,022
)Provision for income taxes


(418
)

-


-Net loss


(8,081
)

(6,455
)

(5,022
)Preferred stock dividends


(6,238
)

(7,343
)

(6,368
)Gain on repurchase of Series A preferred stock


14,523


-


-Net income (loss) to common shareholders

$
204

$
(13,798
)
$
(11,390
)Income (loss) per common share:Basic

$
0.02

$
(1.35
)
$
(1.12
)Diluted

$
0.02

$
(1.35
)
$
(1.12
)Weighted average common shares outstanding:Basic


10,255


10,207


10,162Diluted


11,521


10,207


10,162


See accompanying notes to consolidated financial statements.








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**EMERITUS CORPORATION****CONSOLIDATED STATEMENTS OF CASH FLOWS****(In thousands)****Year Ended December 31****2003**

**2002**

**2001**Cash flows from operating activities:

**As restated**Net loss

$
(8,081
)
$
(6,455
)
$
(5,022
)Adjustments to reconcile net loss to net cash provided by operating activities:Depreciation and amortization


12,450


9,363


7,260Amortization of deferred gain


(962
)

(327
)

(221
)Gain on refinancings and sale of properties, net


-


(4,410
)

(1,392
)Impairment of long-lived asset


950


-


-Gain on sale of investment securities


(1,437
)

-


-Write down of lease acquisition costs


25


262


835Write down of loan fees and amortization


1,363


395


-Write off of deferred gain


-


265


-Provision for doubtful accounts


(30
)

(71
)

466Other


345


364


894Changes in operating assets and liabilities, net of acquisitions:Trade accounts receivable


(456
)

(404
)

179Other receivables


559


(404
)

-Prepaid expenses and other current assets


(1,055
)

(2,545
)

265Trade accounts payable


2,890


1,003


(1,038
)Accrued employee compensation and benefits


(772
)

2,054


852Accrued interest


173


(1,259
)

(130
)Accrued real estate taxes


(866
)

1,048


(391
)Other accrued expenses


928


(33
)

(531
)Deferred revenue


3,171


1,357


305Other current liabilities


(808
)

3,428


867Security deposits and other long-term liabilities


(553
)

627


14Deferred rent


524


314


755Net cash provided by operating activities


8,358


4,572


3,967Cash flows from investing activities:Acquisition of property and equipment


(2,738
)

(11,698
)

(1,429
)Purchase of minority partner interest


(2,500
)

(3,070
)

-Sale of property and equipment


11,346


25,010


2,350Construction expenditures - leased properties


(382
)

(1,154
)

(694
)Proceeds from sale of investment securities


2,949


-


-Management and lease acquisition costs


(12,587
)

(2,229
)

(416
)Advances to affiliates and other managed communities


1,469


(941
)

2,699Proceeds from sales of interest in affiliates


-


750


-Investment in Alterra


(7,678
)

-


-Investment in affiliates


(79
)

(2,971
)

-Distributions to minority partners


(250
)

(500
)

-Net cash provided by (used in) investing activities


(10,450
)

3,197


2,510Cash flows from financing activities:Decrease (increase) in restricted deposits


(1,636
)

(35
)

748Repayment of short-term borrowings


(2,791
)

(2,210
)

(1,650
)Debt issue and other financing costs


(578
)

(3,374
)

-Repurchase of Series A preferred stock


(20,524
)

-


-Proceeds from long-term borrowings and financings


28,763


120,838


145Repayment of long-term borrowings


(59
)

(125,092
)

(3,067
)Repayment of capital lease and financing obligations


(1,986
)

(732
)

-Other


(30
)

(57
)

45Net cash provided by (used in) financing activities


1,159


(10,662
)

(3,779
)Net increase (decrease) in cash and cash equivalents


(933
)

(2,893
)

2,698Cash and cash equivalents at the beginning of the period


7,301


10,194


7,496Cash and cash equivalents at the end of the period

$
6,368

$
7,301

$
10,194








See accompanying notes to consolidated financial statements


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|**EMERITUS CORPORATION**                                              | 
|--------------------------------------------------------------------- | 
|**CONSOLIDATED STATEMENTS OF CASH FLOWS**                             | 
|**(In thousands)**                                                    | 
|                                                                      | 
|                                                                      | 
|                                                                      | 
|Supplemental disclosure of cash flow information -                    | 
|cash paid during the period for interest                              | 
|                                                                      | 
|Noncash investing and financing activities:                           | 
|Transfer of property held for sale to property and equipment          | 
|Transfer of property and equipment from property held for development | 
|Notes receivable from buyer in sales                                  | 
|Assumption of debt by buyer in sale                                   | 
|Unrealized holding gains in investment securities                     | 
|Accrued and in-kind preferred stock dividends                         | 
|Gain on repurchase of Series A preferred stock                        | 
|Common stock warrants issued                                          | 
|Note from affiliates                                                  | 
|Debt assumed for acquisition of property and equipment                | 
|Capital Lease and financing obligations                               | 
|                                                                      | 










See accompanying notes to consolidated financial statements.




|
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******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, 2000,














**As restated**





**As restated**


**As restated**as previously reported


30,609

$
-


10,120,045

$
1

$
66,373

$
(1,087
)
$
(131,090
)
$
(65,803
)Adjustments for periods prior to 2000


-


-


-


-


-


-


(3,748
)

(3,748
)Balances at December 31, 2000,as restated


30,609


-


10,120,045


1


66,373


(1,087
)

(134,838
)

(69,551
)Unrealized gain on investmentsecurities


-


-


-


-


-


951


-


951Issuances of shares underEmployee Stock Purchase Plan


-


-


75,985


-


45


-


-


45Preferred stock dividends


-


-


-


-


1,268


-


(6,368
)

(5,100
)Net loss for the year endedDecember 31, 2001, as restated


-


-


-


-


-


-


(5,022
)

(5,022
)Balances at December 31, 2001,as restated


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, as restated


-


-


-


-


-


-


(6,455
)

(6,455
)Balances at December 31, 2002,as restated


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, as restated


-


-


-


-


-


-


(8,081
)

(8,081
)Balances at December 31, 2003,as restated


34,830

$
-


10,297,449

$
1

$
72,894

$
-

$
(159,822
)
$
(86,927
)


See accompanying notes to consolidated financial statements.




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Table of ContentsIndex to Consolidated Financial Statements
 ****
 ****EMERITUS CORPORATION**** **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS** **AS RESTATED**
 
 **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.
 
 **(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. The Company owns 19 communities and leases 109 communities. These 128 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 for an additional 47 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, 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 of 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, this management agreement was amended to provide for a management fee of 5% of gross revenues. In the third quarter of 2003, the Company executed a short-term extension of the management agreement for the 23 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
 
 **F-8**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 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.
 
 *  **Emeritrust II:** 21 communities that the Company began managing 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 are now included in the Company's consolidated results. 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 19 communities owned by entities controlled by Mr. Baty. The Company generally receives fees ranging from 4% 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 ranging from 4% to 7% of gross revenues, or similar arrangement based on 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.
  
 *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
 
 **F-9**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
 
 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, Emeritus uses a captive insurance structure essentially to self-fund its primary layer of insurance. This policy is claims-made based and covers losses and liabilities associated with general and professional liability. The primary layer has per occurrence and aggregate limits. Within that primary layer is a self-insured retention, which also has a per occurrence and aggregate limit. The Company also has an excess policy, which applies to claims in excess of the primary layer on a per occurrence basis. Losses within the primary layer, which include the self-insured retention, are accrued based upon actuarial estimates of the aggregate liability for claims incurred, which will vary based on actual versus expected experience.
  *
For health insurance, Emeritus self-insures up to a certain level for each occurrence above which 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.
  *
For workers' compensation insurance for insured states (excluding Texas and compulsory State Funds), the Company is on an incurred loss, retrospective insurance policy, retroactively adjusted, upward or downward, based upon total incurred loss experience. The premium charged by the insurance underwriter is based upon a standard rate determined by the underwriter to cover, amongst other things, estimated losses and other fixed costs. The difference between the premium charged and the actuarial based estimate of costs, which is expensed on a monthly basis, is carried as an asset on the balance sheet. After the end of the policy year, the insurance company conducts an audit and adjusts the total premium based upon the actual payroll and actual incurred loss for the policy year. Any premium adjustment for the differences between estimated and actual payroll and estimated and actual losses will first be applied to the accrued asset and then as an adjustment to workers' compensation expense at the time such adjustment is determined. There is a reasonable expectation that the incurred loss adjustment will be downward, resulting in a premium refund. The incurred loss adjustment is limited to 50% of the standard premium with the initial adjustment six months after policy expiration on December 31, 2003, and annually thereafter. For work-related injuries in Texas, the Company is a non-subscriber, meaning that work-related losses are covered under a defined benefit program outside of the Texas Workers' Compensation system. Losses are paid as incurred and estimated losses are accrued on a monthly basis.
  *
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.
 
 **F-10**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 
 Table of Contents
 Index to Consolidated Financial Statements
 *
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 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 annually or 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.
  *
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 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
 
 **F-11**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 
 Table of Contents
 Index to Consolidated Financial Statements
 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.
 
 
 *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, 2003, and 2002, 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, 25 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
 
 **F-12**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 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 available-for-sale and are recorded at fair value. Unrealized holding gains and losses, net of any related tax effect, are excluded from results of operations and are reported as a component of other comprehensive income (loss).
 
 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.
 
 *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 and deferred gains on sale 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 and sale 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.
 
 **F-13**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 *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* .
 
 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,****2003**

**2002**

**2001****As restated**Net income (loss) to common shareholders:As reported

$
204

$
(13,798
)
$
(11,390
)Add: Stock-based employee compensation expenseincluded in reported net income (loss)


-


-


-Deduct: Stock-based employee compensationdetermined under fair value based method for all awards


(1,156
)

(773
)

(1,074
)Pro forma

$
(952
)
$
(14,571
)
$
(12,464
)Net income (loss) per common share:As reported - basic and diluted

$
0.02

$
(1.35
)
$
(1.12
)Pro forma - basic and diluted

$
(0.09
)
$
(1.43
)
$
(1.23
)
 
 
 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 and employee purchase plan shares were estimated at the date of grant using the following weighted average assumptions:
 
 **Year ended December 31,****2003**

**2002**

**2001**Expected life from vest date (in years)


4


4


4Risk-free interest rate


1.96% - 2.6
%

2.9% - 4.3
%

4.12% - 4.39
%Volatility


89.3% - 90.0
%

90.4%-93.3
%

80.7% - 82.1
%Dividend yield


-


-


-Weighted average fair value (per share)

$
2.55

$
1.99

$
1.31
 
 **F-14**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - 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,****2003**

**2002**

**2001**Convertible Debentures


1,455


1,455


1,455Options


30


1,714


1,193Warrants - Senior Housing Partners I, L.P.


400


-


-Warrants - Saratoga Partners


-


1,000


1,000Series A Preferred(1)


-


1,374


1,374Series B Preferred


4,824


4,636


4,2396,709


10,179


9,261
 (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,****2003**

**2002**

**2001****As restated**Basic:Numerator for basic net income (loss) per share:Net income (loss) to common shareholders

$
204

$
(13,798
)
$
(11,390
)Denominator for basic net income (loss) per share:Weighted average number of common shares outstanding


10,255


10,207


10,162Basic net income (loss) per share

$
0.02

$
(1.35
)
$
(1.12
)Diluted:Numerator for diluted net income (loss) per share:Net income (loss) to common shareholders

$
204

$
(13,798
)
$
(11,390
)Denominator for diluted net income (loss) per share:Weighted average number of common shares outstanding


10,255


10,207


10,162Assumed exercise of options and warrants


1,266


-


-11,521


10,207


10,162Diluted net income (loss) per share

$
0.02

$
(1.35
)
$
(1.12
)
 
 **F-15**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - 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 June 2001, FASB issued SFAS No. 143, Accounting for Asset Retirement Obligations. SFAS No. 143 requires the Company to record the fair value of an asset retirement obligation as a liability in the period in which it incurs a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. The Company also records a corresponding asset that is depreciated over the life of the asset. Subsequent to the initial measurement of the asset retirement obligation, the obligation will be adjusted at the end of each period to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. The Company adopted SFAS No. 143 on January 1, 2003. Adoption did not have an impact on the Companys financial condition and results of operations.
 
 In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 amends existing guidance on reporting gains and losses on the extinguishment of debt to prohibit the classification of the gain or loss as extraordinary, as the use of such extinguishments have become part of the risk management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to require sale-leaseback accounting for certain lease modifications that have economic effects similar to sale-leaseback transactions. The provisions of the Statement related to the rescission of Statement No. 4 are applied in fiscal years beginning after May 15, 2002. The provisions of the Statement related to Statement No. 13 were effective for transactions occurring after May 15, 2002, with early application encouraged. The adoption of SFAS No. 145 in the fourth quarter of 2002 had no effect on the Company's consolidated financial statements.
 
 In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others, an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34. This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under guarantees issued. The Interpretation also clarifies that a guarantor is required to recognize, at inception of a guarantee, a liability for the fair value of the obligation undertaken. The initial recognition and measurement provisions of the Interpretation are applicable to guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. Adoption did not have an impact on the Companys financial condition and results of operations.
 
 In January 2003, the FASB issued Interpretation No. 46 (FIN No. 46), Consolidation of Variable Interest Entities. This Interpretation was revised on December 2003 and addresses consolidation by business enterprises of VIE's. A VIE is subject to the consolidation provisions of FIN No. 46 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. 46 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 VIE's that existed prior to February 1, 2003.
 
 **F-16**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 The Company has evaluated the impact of FIN No. 46 on all its current related party management agreements including those more fully discussed under Item 13 "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS," under sections denoted as "Emeritrust Transactions" and "Baty 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 will 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.
 
 
 **(2)**  **Restatement**
 
 During November 2004, the Company determined that the accounting treatment for a number of its leases was incorrect and that the necessary corrections would require restatement of its financial statements. At December 31, 2003 the Company leased 109 communities. The below items also affect footnotes 1, 3, 6, 12, 14, 17, 18, 20, and 21. The accounting corrections are as follows:

(a) In the past, substantially all of the Company's leases have been accounted for as operating leases. Leases for 25 communities, however, contain provisions that permit the landlord to claim a default of the lease based on a subjective standard (such as a material adverse change) and that, upon any default, provide for immediate payment of all rents for the full term in the lease. Under accounting principles generally accepted in the United States, this combination of provisions causes the leases to fail the quantitative test for treatment as operating leases. Accordingly, these leases have been accounted for as capital leases in the restated financial statements. Under capital lease accounting, the Company establishes on its balance sheet a liability based on the present value of 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. Based on these assets and liabilities, the statement of operations includes charges for depreciation and interest in lieu of the rent payable under the lease. Typically, capital lease treatments results in greater property-related expense than actual lease payments paid in the early years of the leases and less property-related expense than actual rent paid in the later years of the leases. The effect of these provisions results in an increase in property and equipment of $161.3 million and $40.7 million at December 31, 2003 and 2002, respectively; an increase in capital lease and financing obligations of $163.1 million and $42.1 million at December 31, 2003 and 2002, respectively; an increase in deferred gain of $2.7 million and zero at December 31, 2003 and 2002, respectively; an increase in depreciation and amortization of $4.9 million, $2.1 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; a decrease in facility lease expense of $6.9 million, $3.1 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; an increase in interest expense of $5.1 million, $2.4 million, and zero for the years ended December 31, 2003, 2002, and 2001, respectively; and an increase in other, net income of $45,000, zero and zero for the years ended December 31, 2003, 2002, and 2001, respectively.

(b) In the past the Company's statements of operations have included the actual rent paid under operating leases as facility lease expense. However, leases for 17 of the Company communities that continue to be treated as operating leases in the restated financial statements contain rent escalation provisions, which require annual increases in rent based on the lesser of a fixed amount or various formulae related to the consumer price index. Under accounting principles generally accepted in the United States, to the extent there is a high level of certainty that the fixed increase under the lease will be met, the Company is required to account for 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 lease and less facility lease expense than actual rent paid in the later years of the lease. In addition, leases for 4 communities are being accounted for as capital leases because the inclusion of fixed annual increases in lease payments causes the leases to fail the quantitative test for operating leases. The effect of straight lining the total rent resulted in an increase in deferred rent of $3.8 million and $3.2 million at December 31, 2003 and 2002, respectively; a net increase in facility lease expense of $550,000, $344,000, and $483,000 for the years ended December 31, 2003, 2002, and 2001, respectively. The capital lease transaction for the 4 communities discussed above was
 
 **F-17**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 consummated on December 31, 2003, and has resulted in an increase in property and equipment of $23.6 million and related financing obligation of $23.6 million; an increase in deferred gain of $119,000 and $127,000 at December 31, 2003 and 2002, respectively; and an increase in other, net income of $9,000 and $6,000 for the years ended December 31, 2003 and 2002, respectively.
(c) A September 2003 transaction that the Company had accounted for under sale-leaseback accounting should have been accounted for as a financing. The transaction consisted of a sale of four communities to a REIT, which assumed the existing debt related to the communities and in turn leased the communities to the Company for an initial term of 15 years with one 15-year option to renew. As a part of the transaction, the Company provided a letter of credit against the default of the underlying debt and continued to provide a security interest in community receivables and limited guarantees in favor of the debt holder. These transaction features constitute continuing involvement in the communities and preclude sale-leaseback accounting under accounting principles, generally accepted in the United States. As a result, the Company is required to account for this transaction as a financing. Under finance accounting the Company's balance sheet will continue to reflect the communities as assets and establish a financing obligation as a liability equal to the debt assumed by the REIT and cash received from the REIT, notwithstanding the legal sale of the communities. The Companys statement of operations will include depreciation of the communities and interest on the financing obligation as expenses. Operating lease expense and amortization of deferred gains related to the sale of the communities has been eliminated in the restated financial statements. The effect of these provisions results in a change in our balance sheet at December 31, 2003 and our statement of operations for the year ending December 31, 2003, only. There was an increase in property and equipment of $24.2 million, an increase in capital lease and financing obligations of $34.4 million, a decrease in deferred gain of $9.7 million, an increase in depreciation and amortization of $221,000, a decrease in facility lease expense of $884,000, an increase in interest expense of $1.0 million, and an increase in other, net expense of $165,000.
 
 (d)  In 2001 and prior years, the Company recognized nonrefundable move-in fees at the time the resident occupied the unit and the related services were performed. In 2002, the Company began charging significantly higher fees for move-ins than were previously charged. Therefore, in June 2002, the Company instituted a policy consistent with SEC Staff Accounting Bulletin 101 Revenue Recognition, to defer such fees and recognize them over the average period of occupancy, approximately 16 months, and made a cumulative adjustment to defer revenues in the amount of $1.8 million. As part of the restatement, the Company has adjusted the deferred revenues for periods prior to 2002 to be in conformance with SEC Staff Accounting Bulletin 101. This resulted in revenues increasing by $1.5 million for the year ended December 31 2002, and decreasing by $305,000 for the year ended December 31, 2001. The restatement had no effect on revenues for the year ended December 31, 2003.
 
 (e)  The Company is also correcting three other items that occurred in the restatement periods. The Company is restating the value of warrants issued as additional lease acquisition costs in connection with the lease of 21 communities effective September 30, 2003, from $1.3 million to $2.5 million. The original valuation under the Black-Scholes option value model had an error in its computation. The Company is also restating the accounting for $650,000 of termination fees associated with certain debt, which is required to be accrued over the term of the debt, starting from December 2002. Finally, the Company is restating the accounting for a deferred compensation plan that had been accounted for on a net basis. The adjustment results in the recording of a long-term deferred compensation liability and a corresponding investment representing trading securities held for this plan. These items were originally discovered and corrected in the Companys Form 10-Q as of and for the six months ended June 30, 2004. The effect of these provisions results in an increase in short-term investments of $987,000 and $421,000 at December 31, 2003 and 2002, respectively; an increase in lease acquisition costs of $1.2 million at December 31, 2003; an increase in other accrued liabilities of $176,000 and $14,000 at December 31, 2003 and 2002, respectively; an increase in other long-term liabilities of $987,000 and $421,000 at December 31, 2003 and 2002, respectively; an increase in additional paid-in capital of $1.2 million at December 31, 2003; an increase in depreciation and amortization of $20,000 for the year ended December 31, 2003; and an increase in interest expense of $163,000 and $14,000 for the years ended December 31, 2003 and 2002, respectively.
 
 **F-18**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 A summary of the significant effect of the restatement is as follows (in thousands except per share data):
  **December 31,**

**December 31,**

**December 31,**

**December 31,****2003**

**2003**

**2002**

**2002****Balance Sheets**

**As originally reported**

**As restated**

**As originally reported**

**As restated**Short-term investments

$
-

$
987

$
2,759

$
3,180Total current assets

$
17,761

$
18,748

$
20,569

$
20,990Property and equipment, net

$
117,546

$
326,595

$
119,583

$
160,244Lease acquisition costs, net

$
19,052

$
20,223


N/C


N/CTotal assets

$
178,587

$
389,794

$
163,159

$
204,241Current portion of capital lease and financing obligations

$
-

$
5,735

$
-

$
1,119Other accrued expenses

$
7,941

$
8,117

$
9,080

$
9,094Total current liabilities

$
51,122

$
57,033

$
47,054

$
48,187Capital lease and financing obligations

$
-

$
215,324

$
-

$
40,949Deferred gain on sale of communities

$
37,389

$
30,438

$
20,324

$
20,451Deferred rent

$
263

$
4,032

$
2,508

$
5,728Other long-term liabilities

$
519

$
1,506

$
894

$
1,315Total liabilities

$
257,681

$
476,721

$
222,667

$
268,517Additional paid-in capital

$
71,703

$
72,894


N/C


N/CAccumulated deficit

$
(150,798
)
$
(159,822
)
$
(155,258
)
$
(160,026
)Total shareholders' deficit

$
(79,094
)
$
(86,927
)
$
(85,066
)
$
(89,834
)Total liabilities and shareholders' deficit

$
178,587

$
389,794

$
163,159

$
204,241Note: N/C means there was no change between what was originally reported and as restated
 
 
 ****

**Year Ended December 31,****2003**

**2003**

**2002**

**2002**

**2001**

**2001****Statements of Operations**

**As originally reported**

**As restated**

**As originally reported**

**As restated**

**As originally reported**

**As restated**Community revenue


N/C


N/C

$
137,662

$
139,189

$
129,561

$
129,256Total operating revenues


N/C


N/C

$
153,129

$
154,656

$
140,577

$
140,272Depreciation and amortization

$
7,336

$
12,450

$
7,223

$
9,363


N/C


N/CFacility lease expense

$
41,043

$
33,831

$
29,975

$
27,193

$
27,123

$
27,606Total operating expenses

$
199,710

$
197,612

$
152,132

$
151,490

$
133,076

$
133,559Income from operations

$
6,947

$
9,045

$
997

$
3,166

$
7,501

$
6,713Interest expense

$
(13,144
)
$
(19,387
)
$
(11,728
)
$
(14,135
)

N/C


N/COther, net

$
2,124

$
2,013

$
4,105

$
4,111


N/C


N/CNet other expense

$
(10,354
)
$
(16,708
)
$
(7,220
)
$
(9,621
)

N/C


N/CLoss before income taxes

$
(3,407
)
$
(7,663
)
$
(6,223
)
$
(6,455
)
$
(4,234
)
$
(5,022
)Net loss

$
(3,825
)
$
(8,081
)
$
(6,223
)
$
(6,455
)
$
(4,234
)
$
(5,022
)Net income (loss) to common shareholders

$
4,460

$
204

$
(13,566
)
$
(13,798
)
$
(10,602
)
$
(11,390
)Income (loss) per common share:Basic

$
0.43

$
0.02

$
(1.33
)
$
(1.35
)
$
(1.04
)
$
(1.12
)Diluted

$
0.39

$
0.02

$
(1.33
)
$
(1.35
)
$
(1.04
)
$
(1.12
)Note: N/C means there was no change between what was originally reported and as restated
 
 
 **F-19**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - Continued**
 Table of Contents
 Index to Consolidated Financial Statements
 **Year Ended December 31****2003**

**2003**

**2002**

**2002**

**2001**

**2001****Cash Flows**

**As originally reported**

**As restated**

**As originally reported**

**As restated**

**As originally reported**

**As restated**Cash flows from operating activities:Net loss

$
(3,825
)
$
(8,081
)
$
(6,223
)
$
(6,455
)
$
(4,234
)
$
(5,022
)Depreciation and amortization

$
7,336

$
12,450

$
7,223

$
9,363


N/C


N/CAmortization of deferred gain

$
(1,073
)
$
(962
)
$
(320
)
$
(327
)

N/C


N/CGain on refinancings and sale of properties, net


N/C


N/C

$
(4,544
)
$
(4,410
)

N/C


N/CWrite down of loan fees and amortization

$
896

$
1,363

$
381

$
395


N/C


N/CDeferred revenue


N/C


N/C

$
2,884

$
1,357

$
-

$
305Deferred rent

$
(26
)
$
524

$
104

$
314

$
272

$
755Net cash provided by operating activities

$
6,372

$
8,358

$
3,840

$
4,572


N/C


N/CCash flows from investing activities:Sale of property and equipment

$
44,800

$
11,346


N/C


N/C


N/C


N/CNet cash provided by (used in) investing activities

$
23,004

$
(10,450
)

N/C


N/C


N/C


N/CCash flows from financing activities:Proceeds from long-term borrowings and financings

$
19,600

$
28,763


N/C


N/C


N/C


N/CRepayment of long-term borrowings

$
(24,350
)
$
(59
)

N/C


N/C


N/C


N/CRepayment of capital lease and financing obligations

$
-

$
(1,986
)
$
-

$
(732
)

N/C


N/CNet cash provided by (used in) financing activities

$
(30,309
)
$
1,159

$
(9,930
)
$
(10,662
)

N/C


N/CSupplemental disclosure of cash flow information -cash paid during the period for interest

$
12,992

$
19,235

$
12,852

$
15,260


N/C


N/CCommon stock warrants issued

$
1,358

$
2,549


N/C


N/C


N/C


N/CCapital Lease and financing obligations

$
-

$
222,221

$
-

$
42,800


N/C


N/CNote: N/C means there was no change between what was originally reported and as restated
  **(3)**  **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**2003

$
-

$
-

$
-2002

$
1,512

$
1,247

$
2,7592001

$
1,512

$
(136
)
$
1,376
  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
 
 **F-20**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 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.
 
 Short-term investments designated as trading securities represent funds for the deferred compensation plan and totaled $987,000 and $421,000 at December 31, 2003 and 2002, respectively.
 
 
 **(4)**  **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 304 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.
 
 
 **(5)**  **Other Receivables**
 
 Other receivables consisted of the following at December 31 (In thousands):
  **2003**

**2002**Working capital advances to third parties and affiliates

$
152

$
1,264Interest receivable


470


772Other receivables.


1,339


1,609$
1,961

$
3,645
 
 
 **F-21**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 
 **(6)**  **Property and Equipment**
 
 Property and equipment consist of the following at December 31 (In thousands):
  **2003**

**2002****As restated**Land and improvements

$
15,835

$
12,378Buildings and improvements


319,147


154,886Furniture and equipment


16,962


14,542Vehicles


5,413


4,247Leasehold improvements


7,787


6,285365,144


192,338Less accumulated depreciation and amortization


39,419


32,475325,725


159,863Construction in progress


870


381$
326,595

$
160,244
 
 Included in the above schedule are property and equipment under capital leases. Equipment under capital leases is $495,000 and $244,000 at December 31, 2003 and 2002, respectively, with accumulated depreciation of $121,000 and $29,000, respectively. Vehicles under capital leases are $981,000 and $331,000 at December 31, 2003 and 2002, respectively, with accumulated depreciation of $186,000 and zero, respectively. Buildings under capital leases are $187.6 million and $42.8 million at December 31, 2003 and 2002, respectively, with accumulated depreciation of $2.7 million and $2.1 million, respectively.
 
 
 **(7)**  **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 funds to the Baty-related entity of $1.0 million, 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 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, and $2.5 million, including accrued interest of $724,000, at December 31, 2002.
 
 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. The Company recognized its share of partnership gain of $175,000 and $98,000 in 2003 and 2002, respectively, and its share of partnership losses of $313,000 in 2001, which is included in "Other, net".
 
 
 **F-22**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 
 **(8)**  **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.
 
 
 **(9)**  **Long-term Debt**
 
 Long-term debt consists of the following at December 31 (In thousands):
 
 **2003**

**2002**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)

$
57,042

$
58,000Notes payable, interest only at 12% payable monthly, plus capitalized interest of 1.75% (13.75% at December 31, 2003), unpaid principal and capitalized interest due December 2007


16,298


16,020Note payable, interest only at 12.13% (12.13% at December 31, 2003) payable monthly with a 50 basis point increase each anniversary capped at 13%, principal and interest starting the second year, and unpaid principal and interest due June 2007


25,800


6,800Notes payable, principal and 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


6,647


6,800Notes payable, interest at 7.43%, payable in monthly installments, unpaid principal and interest due October 2009, refinanced with long-term debt


-


24,640Notes payable, interest at rates from 8.0% to 12%, payable in monthly installments, due March 2013


11,412


11,231Notes payable, principal and interest at 6.98%, payable in monthly installments, due August 2008


22,639


-Notes payable, principal and interest at prime, payable in monthly installments, due September 2005


1,300


-Subtotal


141,138


123,491Less current portion


4,750


3,604Long-term debt, less current portion

$
136,388

$
119,887
 
  
  *
LIBOR is the London Interbank Offering Rate.
 
 Substantially all long-term debt is secured by the Companys property and equipment.
 
 **F-23**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (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 matures 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. This note is included in the $11.4 million in the table above.
 In May 2003, in connection with the *Lease of Eight Communities in May* 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 $11.4 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.
 
 *Debt Consolidation.* 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 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 the Company's option, through the increase in the amount of the lease financing based on the portfolio achieving certain coverage ratios.
 
 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 and require maintenance of specific operating ratios, and levels of working capital. As of December 31, 2003, the Company was in compliance with all such covenants. Many of our 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 17 owned assisted living properties. Accordingly, any event of default could cause a material adverse effect on our financial condition if such debts are cross-defaulted. The Company expects to be in compliance at least through 2004 and for the foreseeable future.
 
 **F-24**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 Principal maturities of long-term debt at December 31, 2003, are as follows (In thousands):
 
 2004.

$
4,7502005.


6,4172006.


68,8572007.


40,4122008.


20,096Thereafter ..


606Total

$
141,138
 
 
 **(10)**  **Convertible Debentures**
 
 The Company has $32.0 million of 6.25% convertible subordinated debentures (the Debentures) that are due in 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.
 
 
 **(11)**  **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, 2002, and 2001, the Company accumulated dividends aggregating $1.7 million, $2.75 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.
 
 **F-25**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 *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 (18).
 
 
 **(12)**  **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.
 Income taxes of $418,000 in 2003 are due primarily because of gains on sale-leaseback transactions involving several communities in 2003, which have been deferred for accounting purposes. The Company believes that it will be required to pay an alternative minimum income tax for 2003 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):
 
 
 **2003**

**2002****As restated**Gross deferred tax liabilities - Insurance, lease, depreciation and amortization

$
(7,634
)
$
(6,812
)Gross deferred tax assets:Net operating loss carryforwards


25,303


29,433Deferred gains on sale-leasebacks


13,811


7,621Impairment of investment securities


-


2,411Unearned rental income and deferred move-in fees


4,012


1,066Vacation accrual


740


481Health Insurance accrual


928


723Insurance accrual


-


746Incentive compensation accrual


485


270Interest expense


61


5Deferred lease payments


1,414


1,8021,680


479Federal AMT credit


142


-Other


88


5548,664


45,092Less valuation allowance


(41,030
)

(38,280
)Deferred tax assets, net


7,634


6,812Net deferred tax assets

$
-

$
-
  
 **F-26**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 The increase in the valuation allowance was $2.8 million, $1.8 million, and $2.8 million for 2003, 2002, and 2001, respectively. The increases were primarily due to the amount of net operating loss carryforwards 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, 2003, available to offset future federal taxable income, if any, of approximately $74.4 million expiring beginning in 2005.
 **(13)**  **Shareholders Deficit**
 
 *Preferred Stock*
 
 In December 1999, the Company entered an agreement to sell 40,000 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. On December 30, 1999, the Company completed the sale of 30,000 shares of Series B Preferred Stock, and agreed to complete the sale of the remaining 10,000 shares during the first half of 2000. 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. The net proceeds to be received by the Company from the sale of all 40,000 shares of the Series B Preferred Stock were to be approximately $38.6 million, after fees and expenses of the transaction estimated at $1.4 million. The purchase agreement and related documents provided that the Company's use of the proceeds would be subject to Saratoga's approval after June 2000 if a substantial portion had not been used for the acquisition of specified properties. Under a letter agreement dated May 15, 2000, the agreements with Saratoga were modified to (i) cancel the sale of the remaining 10,000 shares of Series B Preferred Stock, (ii) remove all restrictions and requirements relating to the use of proceeds received from the sale of the original 30,000 shares, and (iii) provide that the Company would issue 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 or, in the alternative, make a specified cash payment to Saratoga. On August 31, 2000, the Warrant was issued to Saratoga.
 
 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 will be 6% of the stated value of $1,000, of which 2% is payable in cash and 4% is 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 will be 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 2000, the Company accrued $1.3 million in cash dividends, including one quarter at the higher arrearage rate, and $1.2 million equivalent to 1,224 shares of Series B Preferred Stock as in-kind dividends, of which $302,000 were paid and 609 shares were issued in 2000. In 2001, the Company accrued $2.4 million in cash dividends at the higher arrearage rate, and $1.3 million equivalent to 1,266 shares of Series B Preferred Stock as in-kind dividends, none of which were paid or issued in 2001. 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,
 
 **F-27**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 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. Accordingly, the Company had a cumulative commitment to issue 348 shares, 334 shares, and 1,881 shares of Series B Preferred Stock at December 31, 2003, 2002, and 2001, respectively.
 
 As of December 31, 2003, the Company has accrued its obligation to pay cash dividends to the Series B preferred shareholders, which amounted to approximately $8.2 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.
 
 Series B preferred dividends are to be paid in cash and in additional shares of Series B preferred shares. As of December 31, 2003, an additional 4,830 Series B preferred shares had been issued as paid-in-kind dividends for all periods through the third quarter of 2003. As of January 1, 2004, an additional 348 shares of Series B preferred stock were issued as paid-in-kind dividends for the fourth quarter of 2003.
 
 *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 185,983 were available for future awards at December 31, 2003. Options generally vest 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 will fully vest 2 1/2 years from the date the new options are granted under the following schedule: 33 1/3 percent will vest six months after the date of grant; 33 1/3 percent will vest 18 months after the date of grant; and 33 1/3 percent will vest 30 months after the date of grant. In all other respects, the terms of the new options were the same as the terms of the options tendered for exchange.
 
 **F-28**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 
 A summary of the activity in the Companys stock option plans follows:
 
 **2003**

**2002**

**2001****Weighted-**



**Weighted-**



**Weighted-****Average**



**Average**



**Average****Exercise**



**Exercise**



**Exercise****Shares**

**Price**

**Shares**

**Price**

**Shares**

**Price**Outstanding at beginning of year


1,714,333

$
2.56


1,192,552

$
2.39


1,321,707

$
9.13Granted


536,500

$
3.94


601,000

$
2.94


1,144,083

$
2.11Exercised


(50,223
)
$
2.44


(7,501
)
$
2.11


-

$
-Canceled


(49,167
)
$
3.03


(71,718
)
$
2.96


(1,273,238
)
$
9.13Outstanding at end of year


2,151,443

$
2.89


1,714,333

$
2.56


1,192,552

$
2.39Options exercisable at year-end


916,941

$
2.57


420,110

$
2.82


49,869

$
9.21
 
 The following is a summary of stock options outstanding at December 31, 2003:
 
 **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


1,076,030


7.95

$
2.11


714,963

$
2.10$
2.56


-

$
4.06


1,045,663


8.64

$
3.45


172,228

$
2.95$
6.50


-

$
7.25


5,750


5.98

$
6.60


5,750

$
6.60$
9.63


-

$
9.81


500


4.88

$
9.63


500

$
9.63$
10.25


-

$
15.25


23,500


3.87

$
13.01


23,500

$
13.012,151,443


8.23

$
2.89


916,941

$
2.57
 
 *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 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 2003, 2002, and 2001, employees purchased, net of open market repurchases; zero; 43,695; and 75,985 common shares, respectively, through the Plan, for an aggregate total of 175,975 since inception of the Plan.
 
 **F-29**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 **(14) Comprehensive Income (Loss)**
 
 Comprehensive income (loss) consists of the following for the years ended December 31, 2003, 2002, and 2001, respectively (In thousands):
 
 **2003**

**2002**

**2001****As restated**Net income (loss) to common shareholders

$
204

$
(13,798
)
$
(11,390
)Other comprehensive income (loss):Unrealized holding gainson investment securities


144


1,383


951Realized gains on investment securities


(1,391
)

-


-Comprehensive income (loss)

$
(1,043
)
$
(12,415
)
$
(10,439
)
 
 
 **(15)**  **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 $137.1 million versus a carrying value of $141.1 million; and the convertible debentures have an estimated fair value, based on the Companys incremental borrowing rate, of $31.9 million versus a book value of $32.0 million at December 31, 2003.
 
 
 **(16)**  **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 owned or controlled by Mr. Baty relating to 20 communities at December 31, 2003. 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 $4.4 million, $4.3 million, and $2.4 million in 2003, 2002, and 2001, 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 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
 
 **F-30**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 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.
 
 **(17)**  **Leases**
 
 At December 31, 2003, the Company leased office space and 109 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 2004 to 2018 and contain various extension options, ranging from five to 15 years.
 
 Minimum lease payments under noncancelable operating leases at December 31, 2003, are as follows (In thousands, as restated):
 
 2004

$
36,4362005


36,9982006


37,5092007


38,0082008


38,514Thereafter


170,883Total

$
358,348
 
 Facility lease expense under noncancelable operating leases was approximately $33.8 million, $27.2 million, and $27.6 million for 2003, 2002, and 2001, respectively, which included non-cash expense of approximately $550,000, $344,000, and $483,000, 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. In 2003, additional facility lease expense under these provisions was approximately $2.1 million. 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.
 
 Facility lease expense under noncancelable operating leases with entities in which Mr. Baty has a financial interest was approximately $5.8 million and $1.5 million, for 2003, 2002, respectively. There were no such leases in 2001.
 
 Minimum lease payments under noncancelable capital leases and financing obligations at December 31, 2003, are as follows (In thousands, as restated):
 
 2004

$
21,2722005


21,8752006


22,4822007


23,0902008


23,700Thereafter


251,604Subtotal


364,023Less imputed interest at rates ranging between 6.0% and 9.5%


142,964Capital lease and financing obligations


221,059Less current portion


5,735Capital lease and financing obligations, less current portion

$
215,324
 
 **F-31**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 
 Table of Contents
 Index to Consolidated Financial Statements
 Facility interest expense under noncancelable capital leases and financing obligations was approximately $6.1 million and $2.4 million for 2003 and 2002, respectively; depreciation was approximately $5.1 million and $2.1 million for 2003 and 2002, respectively; and principal payments were approximately $1.9 million and $732,000 for 2003 and 2002, respectively. There were no capital leases or financing obligations in 2001.
 
 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 104 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. At the time of the original filing of the Company's Form 10-K 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 did become in violation of one or more covenants in certain of its leases, but was able to obtain waivers from the owners such that it was still deemed to be in compliance and thus, was not in default.
 
 **(18)**  **Sales and Acquisitions, including Certain Related-Party Transactions**
 
 Since 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 2003, 2002, and 2001, the Company managed the Emeritrust I communities, which included 25 of the 46 communities, under a management agreement providing 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. Under this arrangement, the Company received management fees (net of its funding obligations) of approximately $2.7 million, $1.8 million, and $2.8 million in 2003, 2002, and 2001, 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. In March 2004, this management agreement was amended to provide for a management fee of 5% of gross revenues. In 2004, the Company does not expect to receive management fees for the Emeritrust I communities at the same level as it did in 2003. The interest rate on the mortgage financing of the communities was increased effective June 30, 2003, and may be increased further in 2004, which will have the effect of reducing cash flow from the communities and, correspondingly, reducing the additional management fee that is payable to the extent of 50% of cash flow. The Company also expects that additional communities could be sold, thereby reducing the number of communities subject to the management agreement. Because this management agreement can be terminated by either party on short notice, there can be no guaranty that the management arrangement will continue for its full term.
 
 *Emeritrust II Communities Management.* During 2003 (through September 30), 2002 and 2001, the Company 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 the five of the communities also required the Company to fund cash operating losses of those communities. Under this arrangement, Emeritus received management fees (net of its funding obligations) of approximately $2.0 million in 2003 (through September 30), and approximately $2.6 million in each of the years 2002 and 2001.
 
 **F-32**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 *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 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 on our consolidated balance sheet totaling approximately $121.3 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 trust decides to sell. The lease is a triple-net lease, with annual base rent of $14.6 million (of which $10.5 million is attributable to the Emeritrust II communities), and periodic escalators. 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 described in Note 8, "Long-Term Debt." 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 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. The Company believes this option exercise price is currently well above fair value based on current operations. Under the lease Emeritus have 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 $3.45 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 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 we 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 will be 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 and provides for a base annual rent of approximately $3.5 million, with periodic escalators. 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 financing 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.
 
 **F-33**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 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 discussed above. The debt matured 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 for the assumption of the mortgage debt relating to the owned community and the lease obligations relating to the leased communities. 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 expiring April 30, 2007, with the Baty entities 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 (including interest and principal) plus 25% of cash flow (after accounting for assumed management fees and capital expenditures). 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 level index. The Company will pay 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 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, and an entity controlled by Mr. Baty and in which he holds an indirect 36% interest, which holds a 35% minority stake. 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
 
 **F-34**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 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 $24.8 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 plans to offer both assisted and memory loss services in selected communities. Rent expense under the Fretus lease was $5.8 million and $1.5 million for the years ended December 31, 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 its 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 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 million, that will both be 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 liability of $42.8 million and a corresponding long-term asset of the same amount. The statement of operations includes charges for depreciation and interest, as well as principal payments, based on this asset and liability.
 
 *Other Transactions.* Effective July 1, 2003, the Company ceased managing 12 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 two communities located in Tacoma, Washington, and Coeur d'Alene, Idaho.
 
 On November 1, 2003, the Company entered into a 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 plans to offer memory loss services.
 
 *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 plans to offer both assisted and memory loss services to select communities.
 
 **F-35**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 The initial allocations of purchase cost at fair value are based upon available information for the acquired business (*Five Community Mortgage Assumption)*and are finalized when any contingent purchase price amounts are resolved. The final allocations did not differ materially from the initial allocations. Aggregate purchase cost allocations were as follows (In thousands):

**December 31,****2003**

**2002**Trade accounts receivable

$
-

$
159Land


3,588


2,943Buildings


18,477


17,748Furniture and fixtures


579


587Loan fees


411


725Liabilities assumed


22,639


23,678Aggregate purchase cost

$
45,694

$
45,840

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 both of the periods presented (In thousands, except per share data).

Year ended December 31,**2003**

**2002**As restated(unaudited)Net revenues

$
215,377

$
256,479Net loss


(8,276
)

(6,541
)Preferred dividends


(6,238
)

(7,343
)Gain on repurchase of Series A preferred stock


14,523


-Net income (loss) to common shareholders

$
9

$
(13,884
)Income (loss) per common share:Basic and diluted

$
-

$
(1.36
)Weighted average common shares outstanding:Basic and diluted


10,255


10,207 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 both of the periods presented. 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-36**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 **(19)**  **Commitments and Contingencies**
 
 In February 2004, the California Public Interest Research Group announced that it intended to bring an action against operators of assisted living communities (including Emeritus) and other senior housing facilities. The announced 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. While the Company has not yet been served, it intends to defend the action vigorously and has entered into a joint defense agreement with other operators in California.
 
 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 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.
 
 
 **(20)**  **Liquidity**
 
 The Company has incurred significant operating losses since its inception and has a working capital deficit of $38.3 million, although $6.1 million represents deferred revenue and $8.2 million of preferred dividends is due only if declared by the Company's board of directors. In 2003, 2002, and 2001, 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.
 
 In 2002, 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 17 owned assisted living properties and 104 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. At the time of filing of the original Form 10-K for the year ended December 31, 2003, Management believed the Company would be in compliance at least through 2004 and/or the foreseeable future. However, in 2004, the Company did become in violation of one or more covenants in certain of its leases, but was able to obtain waivers from the owners such that it was still deemed to be in compliance and thus, was not in default.
 
 At the time of filing of the original Form 10-K for the year ended December 31, 2003, Management believed that the Company would be able to sustain positive operating cash flow at least through 2004 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. This, in fact, came about in 2004 even considering the violations and waivers mentioned above.
 
 
 **F-37**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 
 **(21)**  **Quarterly Results (Unaudited)**
 
 **(In thousands, except per share data)****2003**

**Q1**

**Q2**

**Q3**

**Q4****As restated**Total operating revenue

$
47,177

$
49,398

$
50,210

$
59,872Income from operations


2,913


2,898


635


2,599Other income and (expense)


(3,897
)

(2,486
)

(4,206
)

(6,119
)Income (loss) before income taxes


(984
)

412


(3,571
)

(3,520
)Provision for income taxes**(a)**


-


-


(576
)

158Net income (loss)


(984
)

412


(4,147
)

(3,362
)Preferred dividends


(1,870
)

(1,906
)

(1,464
)

(998
)Gain on repurchase of Series A preferred stock


-


-


14,465


58Net income (loss) to common shareholders

$
(2,854
)
$
(1,494
)
$
8,854

$
(4,302
)Income (loss) per common share:Basic

$
(0.28
)
$
(0.15
)
$
0.86

$
(0.41
)Diluted

$
(0.28
)
$
(0.15
)
$
0.57

$
(0.41
)
 
 
 **2002**

**Q1**

**Q2**

**Q3**

**Q4****As restated**Total operating revenue

$
36,117

$
35,570

$
36,037

$
46,932Income from operations


1,968


798


486


(86
)Other income and (expense)**(b)**


(3,384
)

(3,714
)

(3,741
)

1,218Net income (loss)


(1,415
)

(2,916
)

(3,255
)

1,131Preferred dividends


(1,997
)

(1,732
)

(1,777
)

(1,837
)Net loss to common shareholders

$
(3,412
)

(4,648
)

(5,032
)

(706
)Loss per common share -- basic and diluted

$
(0.33
)
$
(0.46
)
$
(0.49
)
$
(0.07
)The sum of quarterly per share data may not equal the per share total reported for the year.(a) Tax provision relates to alternative minimum tax liability from sale-leaseback transactions.(b) Other income in Q4 includes a gain of $5.1 million related to discounts received upon the payoffof existing financing, partially offset by interest expense of $3.1 million.
 
 
 **F-38**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 ****
 Table of Contents
 Index to Consolidated Financial Statements
 A summary of the significant effect of the restatement on quarterly results is as follows (in thousands except per share data):
 
 **2003**

**Q1**

**Q2****As originally reported**

**As restated**

**As originally reported**

**As restated**Income from operations

$
2,677

$
2,913

$
2,637

$
2,898Other income and (expense)

$
(3,070
)
$
(3,897
)
$
(1,664
)
$
(2,486
)Income (loss) before income taxes

$
(393
)
$
(984
)
$
973

$
412Net income (loss)

$
(393
)
$
(984
)
$
973

$
412Net income (loss) to common shareholders

$
(2,263
)
$
(2,854
)
$
(932
)
$
(1,494
)Income (loss) per common share:Basic

$
(0.22
)
$
(0.28
)
$
(0.09
)
$
(0.15
)Diluted

$
(0.22
)
$
(0.28
)
$
(0.09
)
$
(0.15
)****

**Q3**
**Q4****As originally reported**


**As restated**


**As originally reported**


**As restated**Income from operations

$
436

$
635

$
1,197

$
2,599Other income and (expense)

$
(3,042
)
$
(4,206
)
$
(2,578
)
$
(6,119
)Income (loss) before income taxes

$
(2,606
)
$
(3,571
)
$
(1,381
)
$
(3,520
)Net income (loss)

$
(3,182
)
$
(4,147
)
$
(1,223
)
$
(3,362
)Net income (loss) to common shareholders

$
9,819

$
8,854

$
(2,164
)
$
(4,302
)Income (loss) per common share:Basic

$
0.96

$
0.86

$
(0.21
)
$
(0.41
)Diluted

$
0.63

$
0.57

$
(0.21
)
$
(0.41
)
  **2002**

**Q1**

**Q2****As originally reported**

**As restated**

**As originally reported**

**As restated**Total operating revenue

$
36,146

$
36,117

$
34,015

$
35,571Income from operations

$
2,082

$
1,968

$
(1,021
)
$
798Other income and (expense)


N/C


N/C

$
(2,913
)
$
(3,714
)Net income (loss)

$
(1,302
)
$
(1,415
)
$
(3,934
)
$
(2,916
)Net loss to common shareholders

$
(3,299
)
$
(3,412
)
$
(5,666
)
$
(4,648
)Loss per common share -- basic and diluted

$
(0.32
)
$
(0.33
)
$
(0.56
)
$
(0.46
)**Q3**
**Q4****As originally reported**


**As restated**


**As originally reported**


**As restated**Income from operations

$
243

$
486

$
(307
)
$
(86
)Other income and (expense)

$
(2,945
)
$
(3,741
)
$
2,022

$
1,218Net income (loss)

$
(2,702
)
$
(3,255
)
$
1,715

$
1,131Net loss to common shareholders

$
(4,479
)
$
(5,032
)
$
(122
)
$
(706
)Loss per common share -- basic and diluted

$
(0.44
)
$
(0.49
)
$
(0.01
)
$
(0.07
)Note: N/C means there was no change between what was originally reported and as restated
  
 **F-39**
 **EMERITUS CORPORATION**
**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS AS RESTATED - (Continued)**
 Table of Contents
 Index to Consolidated Financial Statements
 
 **(22)**  **Subsequent Events (Unaudited)**
 
 Since January 2004, the Company has been reviewing acquisition opportunities and seeking to take ownership or lease positions in communities that the Company manages. To this end, the Company intends to pursue a lease with a REIT for up to 13 communities that the Company formerly managed, nine communities with memory loss facilities, and two other communities, for a total of 24 communities. The Company expects the lease to be accounted for as a capital lease. These purpose-built assisted living and memory loss communities are located in 13 states, and have an aggregate capacity of approximately 1,740 units. Mr. Baty holds an interest in the entities that will be the sellers of the properties in this proposed transaction.
 
 The preliminary master lease agreement has a 15-year lease term, with three 5-year extension options. The lease is a triple-net lease, with base rental approximating $16.8 million annually with variable lease escalators based on the lesser of four times CPI or 3%. Management believes that the Company will close this transaction as early as March 31, 2004, and as late as the end of the second quarter of 2004.
 
 **(23)**  **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. FASB Statement No. 144 *Accounting for Impairment or disposal of Long-Lived Assets* requires that an impairment charge be recorded on long-lived assets when the carrying amount of those assets exceeds its fair value. The Company recorded an impairment of $950,000 in community operations.
 
 
 
 
 
  
 **F-40**
 
 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 5, 2004, except as to footnote 2, which is as of January 21, 2005 , we reported on the consolidated balance sheets of Emeritus Corporation and subsidiaries as of December 31, 2003 and 2002, 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, 2003, which are included in the Form 10-K/A. 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, 2003 in the Form 10-K/A. 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 5, 2004
 
 **S-1**
 
 
 Table of Contents
 Index to Consolidated Financial Statements
 **SCHEDULE II******EMERITUS CORPORATION******VALUATION AND QUALIFYING ACCOUNTS****Years Ended December 31, 2003, 2002, and 2001****(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 (1)**

**of Year****Description**Year 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
)
$
327Year ended December 31, 2001:Valuation accounts deducted from assets:Allowance for doubtful receivables

$
594

$
466

$
(662
)
$
398
 
 _____________
 (1) Represents amounts written off
 
  **S-2**