UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


______________________





FORM
10-Q


(Mark
      One)x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE
      SECURITIES EXCHANGE ACT 1934





For the
quarterly period ended September 30, 2008





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





Commission
file number   1-14012





EMERITUS
CORPORATION


(Exact
name of registrant as specified in its charter)





WASHINGTON
            91-1605464(State
      or other jurisdiction
            (I.R.S
      Employerof
      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)


____________________________





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. YesþNoo





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definitions of “large accelerated filer”, “accelerated filer”, and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):





Large
accelerated fileroAccelerated
filerþNon-accelerated
fileroSmaller
reporting company o





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). YesoNoþ





As of
October 31, 2008, there were 39,126,125 shares of the Registrant’s Common Stock,
par value $0.0001, outstanding.











EMERITUS
      CORPORATIONTable of ContentsPart I.  Financial
  InformationPage No.Item 1.  Financial Statements
      (unaudited):
            1Condensed Consolidated Balance Sheets as of September 30, 2008,
      and December 31, 2007
            2Condensed Consolated Statements of Operations for the three
      months and nine months ended September 30, 2008 and
    2007
            3Condensed Consolidated Statements of Cash Flows for the nine
      months ended September 30, 2008 and 2007
            4Notes to Unaudited Condensed Consolidated Financial
      Statements
            6It.em 2
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            20Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            43Item 4.
            Controls and Procedures
            43Part II.  Other
InformationNote:
            Items
      2, 3, 4, and 5 of Part II are omitted because they are not
      applicable.Item 1.
            Legal Proceedings
            44Item 1A.
            Risk Factors
            44Item 6.
            Exhibits
            44Signature
            45Index to Exhibits
            46











Table of Contents


PART I. Financial Information





Item 1.  Financial Statements (unaudited)








[The rest
of this page is intentionally left blank]











1


Table of Contents





EMERITUS
      CORPORATIONCONDENSED
      CONSOLIDATED BALANCE SHEETS(In
      thousands, except share data)ASSETSSeptember
      30,
            
            
            December
      31,2008
            
            
            2007(unaudited)Current
      Assets:Cash
      and cash equivalents
            
            $
            43,641
            
            
            $
            67,710Short-term
      investments
            
            
            2,075
            
            
            
            2,453Trade
      accounts receivable, net of allowance of $811 and $995
            
            
            5,646
            
            
            
            6,383Other
      receivables
            
            
            4,905
            
            
            
            11,510Tax,
      insurance, and maintenance escrows
            
            
            22,205
            
            
            
            18,566Prepaid
      workers' compensation
            
            
            17,714
            
            
            
            18,224Other
      prepaid expenses
            
            
            8,175
            
            
            
            10,744Property
      held for sale
            
            
            15,134
            
            
            
            –Total
      current assets
            
            
            119,495
            
            
            
            135,590Long-term
      investments
            
            
            6,921
            
            
            
            4,749Property
      and equipment, net of accumulated depreciation of $141,683 and
      $179,620
            
            
            1,621,850
            
            
            
            1,418,152Construction
      in progress
            
            
            23,190
            
            
            
            12,694Restricted
      deposits
            
            
            18,085
            
            
            
            19,808Lease
      and contract acquisition costs, net of amortization of $52,425 and
      $23,940
            
            
            19,336
            
            
            
            67,227Goodwill
            
            
            75,498
            
            
            
            70,659Other
      intangible assets, net of amortization of $13,089 and
    $3,944
            
            
            133,629
            
            
            
            142,774Other
      assets, net
            
            
            19,001
            
            
            
            13,827Total
      assets
            
            $
            2,037,005
            
            
            $
            1,885,480LIABILITIES
      AND SHAREHOLDERS' EQUITYCurrent
      Liabilities:Current
      portion of long-term debt
            
            $
            79,403
            
            
            $
            22,613Current
      portion of capital lease and financing obligations
            
            
            10,057
            
            
            
            23,774Current
      portion of convertible debentures
            
            
            –
            
            
            
            10,455Trade
      accounts payable
            
            
            5,909
            
            
            
            7,844Accrued
      employee compensation and benefits
            
            
            37,450
            
            
            
            35,815Accrued
      interest
            
            
            6,697
            
            
            
            4,527Accrued
      real estate taxes
            
            
            12,532
            
            
            
            7,715Accrued
      professional and general liability
            
            
            15,352
            
            
            
            13,545Accrued
      income taxes
            
            
            4,835
            
            
            
            5,377Other
      accrued expenses
            
            
            9,191
            
            
            
            10,610Deferred
      revenue
            
            
            13,134
            
            
            
            10,446Unearned
      rental income
            
            
            15,647
            
            
            
            14,302Total
      current liabilities
            
            
            210,207
            
            
            
            167,023Long-term
      debt, less current portion
            
            
            1,177,770
            
            
            
            711,664Capital
      lease and financing obligations, less current portion
            
            
            222,053
            
            
            
            497,039Deferred
      gain on sale of communities
            
            
            4,942
            
            
            
            21,259Deferred
      rent
            
            
            12,681
            
            
            
            6,231Other
      long-term liabilities
            
            
            20,301
            
            
            
            23,757Total
      liabilities
            
            
            1,647,954
            
            
            
            1,426,973Commitments
      and contingenciesShareholders'
      Equity (Deficit):Preferred
      stock, $.0001 par value. Authorized 20,000,000 shares, none
      issuedCommon
      stock, $.0001 par value. Authorized 100,000,000 shares; issued and
      outstanding39,108,392
      and 39,030,597 shares at September 30, 2008, and December 31, 2007,
      respectively
            
            
            4
            
            
            
            4Additional
      paid-in capital
            
            
            718,994
            
            
            
            714,258Accumulated
      other comprehensive income
            
            
            86
            
            
            
            –Accumulated
      deficit
            
            
            (330,033
            )
            
            
            (255,755
            )Total
      shareholders' equity
            
            
            389,051
            
            
            
            458,507Total
      liabilities and shareholders' equity
            
            $
            2,037,005
            
            
            $
            1,885,480





See
accompanying Notes to Unaudited Condensed Consolidated Financial
Statements








2


Table of Contents





EMERITUS
      CORPORATIONCONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)(In
      thousands, except per share data)Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Revenues:Community
      revenue
            
            $
            191,761
            
            
            $
            133,875
            
            
            $
            562,203
            
            
            $
            347,833Management
      fees
            
            
            1,266
            
            
            
            1,415
            
            
            
            3,648
            
            
            
            3,221Total
      operating revenues
            
            
            193,027
            
            
            
            135,290
            
            
            
            565,851
            
            
            
            351,054Expenses:Community
      operations (exclusive of depreciation and amortizationand
      facility lease expense shown separately below)
            
            
            123,726
            
            
            
            86,525
            
            
            
            364,338
            
            
            
            221,496General
      and administrative
            
            
            14,737
            
            
            
            12,999
            
            
            
            44,079
            
            
            
            34,335Depreciation
      and amortization
            
            
            29,199
            
            
            
            20,046
            
            
            
            89,554
            
            
            
            48,670Facility
      lease expense
            
            
            22,339
            
            
            
            12,205
            
            
            
            66,968
            
            
            
            29,655Total
      operating expenses
            
            
            190,001
            
            
            
            131,775
            
            
            
            564,939
            
            
            
            334,156Operating
      income from continuing operations
            
            
            3,026
            
            
            
            3,515
            
            
            
            912
            
            
            
            16,898Other
      income (expense):Interest
      income
            
            
            480
            
            
            
            2,618
            
            
            
            1,915
            
            
            
            3,799Interest
      expense
            
            
            (25,169
            )
            
            
            (18,403
            )
            
            
            (68,952
            )
            
            
            (48,736
            )Change
      in fair value of interest rate swaps
            
            
            (119
            )
            
            
            -
            
            
            
            16
            
            
            
            -Equity
      gains (losses) in unconsolidated joint ventures
            
            
            (33
            )
            
            
            (805
            )
            
            
            (890
            )
            
            
            5,691Other,
      net
            
            
            (517
            )
            
            
            737
            
            
            
            (689
            )
            
            
            766Net
      other expense
            
            
            (25,358
            )
            
            
            (15,853
            )
            
            
            (68,600
            )
            
            
            (38,480
            )Loss
      from continuing operations before income taxes
            
            
            (22,332
            )
            
            
            (12,338
            )
            
            
            (67,688
            )
            
            
            (21,582
            )Benefit
      of (provision for) income taxes
            
            
            (270
            )
            
            
            1,290
            
            
            
            (750
            )
            
            
            (30
            )Loss
      from continuing operations
            
            
            (22,602
            )
            
            
            (11,048
            )
            
            
            (68,438
            )
            
            
            (21,612
            )Loss
      from discontinued operations
            
            
            (474
            )
            
            
            (525
            )
            
            
            (5,840
            )
            
            
            (1,285
            )Net
      loss
            
            $
            (23,076
            )
            
            $
            (11,573
            )
            
            $
            (74,278
            )
            
            $
            (22,897
            )Basic
      and diluted loss per common share:Continuing
      operations
            
            $
            (0.58
            )
            
            $
            (0.34
            )
            
            $
            (1.75
            )
            
            $
            (0.93
            )Discontinued
      operations
            
            
            (0.01
            )
            
            
            (0.02
            )
            
            
            (0.15
            )
            
            
            (0.06
            )$
            (0.59
            )
            
            $
            (0.36
            )
            
            $
            (1.90
            )
            
            $
            (0.99
            )Weighted
      average common shares outstanding-basic and diluted
            
            
            39,082
            
            
            
            32,001
            
            
            
            39,059
            
            
            
            23,165








See
accompanying Notes to Unaudited Condensed Consolidated Financial
Statements





3


Table of Contents


EMERITUS
      CORPORATIONCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(In
      thousands)Nine
      Months Ended September 30,2008
              
              
              2007Cash
      flows from operating activities:Net
      loss
              
              $
              (74,278
              )
              
              $
              (22,897
              )Adjustments
      to reconcile net loss to net cash provided byoperating
      activitiesDepreciation
      and amortization
              
              
              89,554
              
              
              
              48,670Amortization
      of above/below market rents
              
              
              7,572
              
              
              
              860Amortization
      of deferred gain
              
              
              (1,134
              )
              
              
              (1,567
              )Impairment
      of long-lived assets and investments
              
              
              4,930
              
              
              
              -Amortization
      of loan fees
              
              
              1,849
              
              
              
              1,284Allowance
      for doubtful receivables
              
              
              1,096
              
              
              
              798Equity
      investment losses and distributions
              
              
              890
              
              
              
              1,651Stock
      option compensation
              
              
              3,786
              
              
              
              3,456Change
      in fair value of interest rate swap
              
              
              (16
              )
              
              
              -Other
              
              
              648
              
              
              
              883Changes
      in operating assets and liabilitiesDeferred
      revenue
              
              
              2,688
              
              
              
              456Deferred
      rent
              
              
              7,012
              
              
              
              1,348Change
      in operating assets and liabilities - other
              
              
              11,860
              
              
              
              (4,387
              )Net
      cash provided by operating activities
              
              
              56,457
              
              
              
              30,555Cash
      flows from investing activities:Acquisition
      of property and equipment
              
              
              (574,970
              )
              
              
              (784,877
              )Acquisition
      deposits
              
              
              (3,167
              )
              
              
              -Sale
      of property and equipment
              
              
              6,754
              
              
              
              -Payment
      for purchase of Summerville, net of acquired cash
              
              
              -
              
              
              
              (770
              )Lease
      and contract acquisition costs
              
              
              (686
              )
              
              
              (170
              )Payments
      from affiliates and other managed communities, net
              
              
              394
              
              
              
              371Investment
      in affiliates/other
              
              
              (2,976
              )
              
              
              (306
              )Net
      cash used in investing activities
              
              
              (574,651
              )
              
              
              (785,752
              )Cash
      flows from financing activities:Proceeds
      from sale of stock, net of issuance costs
              
              
              950
              
              
              
              330,863Decrease
      in restricted deposits
              
              
              1,882
              
              
              
              8,555Debt
      issuance and other financing costs
              
              
              (9,405
              )
              
              
              (5,570
              )Proceeds
      from long-term borrowings and financings
              
              
              663,496
              
              
              
              643,093Repayment
      of long-term borrowings and financings
              
              
              (151,055
              )
              
              
              (153,628
              )Repayment
      of capital lease and financing obligations
              
              
              (11,743
              )
              
              
              (15,594
              )Net
      cash provided by financing activities
              
              
              494,125
              
              
              
              807,719Net
      increase (decrease) in cash and cash equivalents
              
              
              (24,069
              )
              
              
              52,522Cash
      and cash equivalents at the beginning of the period
              
              
              67,710
              
              
              
              14,049Cash
      and cash equivalents at the end of the period
              
              $
              43,641
              
              
              $
              66,571










See
accompanying Notes to Unaudited Condensed Consolidated Financial
Statements





4


Table of Contents








EMERITUS
      CORPORATIONCONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)(In
      thousands)Nine
      Months Ended September 30,2008
            
            
            2007Supplemental
      disclosure of cash flow information -Cash
      paid during the period for interest
            
            $
            65,143
            
            
            $
            40,982Cash
      paid during the period for income taxes
            
            
            1,667
            
            
            
            1,447Cash
      received during the period for income tax refunds
            
            
            2,647
            
            
            
            -Non-cash
      financing and investing activities:Adjustments
      related to purchase of leased properties:Capital
      and financing lease buyouts
            
            
            281,925
            
            
            
            126,565Deferred
      gains and losses
            
            
            15,462
            
            
            
            467Lease
      acquisition costs in a lease buyback
            
            
            13,570
            
            
            
            2,438Deferred
      rent
            
            
            562
            
            
            
            3,912Capital
      lease and financing obligations
            
            
            4,964
            
            
            
            2,884Contingent
      purchase price adjustment to goodwill
            
            
            4,458
            
            
            
            -Summerville
      accrued transaction costs
            
            
            -
            
            
            
            3,277Unrealized
      gain on investment in marketable equity securities
            
            
            86
            
            
            
            -Conversion
      of convertible debentures
            
            
            -
            
            
            
            16,120Debt
      assumed in acquisitions
            
            
            -
            
            
            
            122,393Summerville
      acquisition:Fair
      value of Summerville assets acquired
            
            
            -
            
            
            
            408,954Cash
      paid for Summerville acquisition
            
            
            -
            
            
            
            4,471Stock
      issued for Summerville
            
            
            -
            
            
            
            273,349Liabilities
      assumed upon merger
            
            
            -
            
            
            
            131,134





See
accompanying Notes to Unaudited Condensed Consolidated Financial
Statements











5


Table of Contents





EMERITUS CORPORATION


NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


September
30, 2008





1.
            Description
      of Business





Emeritus
Corporation (Emeritus or the Company) is an assisted living and Alzheimer’s and
dementia care service provider that operates residential style communities
located throughout the United States.  These communities provide a
residential housing alternative for senior citizens who need help with the
activities of daily living, with an emphasis on assisted living and personal
care services.  As of September 30, 2008, the Company owned 149
communities and leased 106 communities.  These 255 communities
comprise the communities included in the consolidated financial
statements.





The
Company also provides management services to independent and related-party
owners of assisted living communities.  At September 30, 2008, the
Company managed 34 communities, of which 23 are owned by joint ventures in which
the Company has a financial interest.  Management agreements typically
provide for fees of from 5% to 6% of gross revenues.





Effective
September 1, 2007, Emeritus completed a merger transaction with Summerville
Senior Living, Inc. (Summerville), pursuant to which the Company acquired all of
the outstanding stock of Summerville (see Note 4, Acquisitions and Other Significant
Transactions).  Summerville operated 81 communities comprising
7,935 units in 13 states, which provided independent living, assisted living,
and Alzheimer’s and dementia-related services to senior
citizens.  Financial results for periods subsequent to the merger
include the combined operations of Emeritus and Summerville.





Emeritus
has one operating segment, which is assisted living and related
services.





2.
            Summary
      of Significant Accounting Policies and Use of
  Estimates





The
preparation of condensed 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,
inputs to the Black-Scholes option pricing model, and
litigation.  Emeritus bases its estimates on historical experience and
on various other assumptions that it believes 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.





Emeritus
believes that certain critical accounting policies are most significant to the
judgments and estimates used in the preparation of its condensed 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.  A detailed discussion of the Company’s significant accounting
policies and use of estimates is contained in the Company’s Annual Report on
Form 10-K for the fiscal year ended December 31, 2007, which was filed with the
Securities and Exchange Commission (SEC) on March 17, 2008.




Effective
September 1, 2007, the Company changed its estimate of the maximum useful life
of buildings from 40 years to 50 years and applied this new policy prospectively
for all acquired properties.  This change in estimate did not have a
material impact on the periods presented herein.





6
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





Basis
of Presentation





The
unaudited interim financial information furnished herein, in the opinion of the
Company’s management, reflects all adjustments, consisting of only normally
recurring adjustments, which are necessary to state fairly the financial
position, results of operations, and cash flows of Emeritus as of September 30,
2008 and for all periods presented.  The results of operations for the
period ended September 30, 2008, are not necessarily indicative of the operating
results that may be achieved for the full year ended December 31,
2008.  The Company presumes that those reading this interim financial
information have read or have access to its 2007 audited consolidated financial
statements and Management’s Discussion and Analysis of Financial Condition and
Results of Operations that are contained in the Company’s Annual Report on Form
10-K for the fiscal year ended December 31, 2007, which was filed with the SEC
on March 17, 2008.  Therefore, the Company has omitted certain
footnotes and other disclosures that are disclosed in the Form
10-K.





Recent
Accounting Pronouncements Not Yet Adopted





In March
2008, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 161, Disclosures about Derivative
Instruments and Hedging Activities—an amendment of FASB Statement No.
133.  SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, establishes, among other things, the
disclosure requirements for derivative instruments and for hedging
activities.  SFAS No. 161 amends and expands the disclosure
requirements of SFAS No. 133 with the intent to provide users of financial
statements with an enhanced understanding of:  (a) how and why an
entity uses derivative instruments; (b) how derivative instruments and related
hedged items are accounted for under SFAS No. 133 and its related
interpretations; and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows.  To meet those objectives, SFAS No. 161 requires qualitative
disclosures about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements.  SFAS No. 161 will have no impact on the Company’s
consolidated financial statements when it is adopted effective January 1,
2009.





In
December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of Accounting Research Bulletin
No. 51 (SFAS No.160), which establishes accounting and reporting
standards for noncontrolling interests (“minority interests”) in subsidiaries.
SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary should be
accounted for as a component of equity separate from the parent’s equity. SFAS
No. 160 will be effective for Emeritus on January 1, 2009 and must be applied
prospectively, except for the presentation and disclosure requirements, which
will apply retrospectively. SFAS No. 160 will have no impact on the Company’s
statements of operations or cash flow and is not expected to have a material
impact on its statement of financial condition when adopted.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations(SFAS
No. 141R).  SFAS No. 141R replaces the existing SFAS No. 141 but
retains the fundamental requirements in SFAS No. 141 that the acquisition method
of accounting be used for all business combinations and that an acquirer be
identified for each business combination.  SFAS No. 141R defines the
acquirer as the entity that obtains control of one or more businesses in the
business combination and establishes the acquisition date as the date that the
acquirer achieves control.  It also requires an acquirer to recognize
the assets acquired, the liabilities assumed, and any noncontrolling interest in
the acquiree at their fair values at the acquisition date.  The
additional fair value measurements of SFAS No. 141R replace the cost-allocation
process of SFAS No. 141, which required that the cost of an acquisition be
allocated to the individual assets acquired and liabilities assumed based on
their estimated fair values.  In addition, all acquisition-related
costs are to be expensed and liabilities related to contingent consideration are
to be remeasured to fair value each subsequent reporting
period.  Costs incurred by the acquirer to effect the acquisition are
not allocated to the assets acquired or liabilities assumed, but are recognized
separately.  SFAS No. 141R is effective prospectively for Emeritus for
business combinations consummated on or after January 1, 2009.





7
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





Reclassifications





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





3.
            Stock-Based
      Compensation





The
Company records compensation expense based on fair value for all awards, which
is estimated using the Black-Scholes option pricing model.  The
Company recorded stock-based compensation expense for stock options and shares
issued under the Company's various equity incentive plans and the Employee
Stock Purchase (ESP) Plan of approximately $968,000 and $2.1 million for the
three months ended September 30, 2008 and 2007, respectively, and approximately
$3.8 million and $3.5 million for the nine months ended September 30, 2008 and
2007, respectively.





During
the nine months ended September 30, 2008, the Company granted options to
purchase 10,000 shares of common stock from the 2006 equity incentive plan (the
2006 Plan) and options to purchase 52,500 shares of common stock from the
non-employee director plan.





The
following table summarizes the Company’s stock option activity for the nine
months ended September 30, 2008 and 2007:





2008
            
            
            2007Weighted-
            
            
            Aggregate
            
            
            
            
            
            Weighted-
            
            
            AggregateAverage
            
            
            Intrinsic
            
            
            
            
            
            Average
            
            
            IntrinsicExercise
            
            
            Value
            
            
            
            
            
            Exercise
            
            
            ValueShares
            
            
            Price
            
            
            $
            (000
            )
            
            Shares
            
            
            Price
            
            
            $
            (000
            )Outstanding
      at beginning of year
            
            
            2,166,575
            
            
            $
            18.76
            
            
            
            
            
            
            
            1,510,189
            
            
            $
            9.09Granted
            
            
            62,500
            
            
            $
            20.03
            
            
            
            
            
            
            
            1,082,500
            
            
            $
            27.34Exercised
            
            
            (42,708
            )
            
            $
            11.82
            
            
            $
            437
            
            
            
            (282,825
            )
            
            $
            6.66
            
            
            $
            6,822Cancellations
      and forfeitures
            
            
            (36,832
            )
            
            $
            19.52
            
            
            
            
            
            
            
            (38,077
            )
            
            $
            17.47Outstanding
      at September 30, 2008 and 2007
            
            
            2,149,535
            
            
            $
            18.92
            
            
            $
            15,669
            
            
            
            2,271,787
            
            
            $
            17.95
            
            
            $
            21,100Options
      exercisable at September 30, 2008 and 2007
            
            
            1,353,295
            
            
            $
            14.17
            
            
            $
            15,401
            
            
            
            1,164,976
            
            
            $
            9.98
            
            
            $
            19,974Weighted-average
      fair value of options granted
            
            
            
            
            
            $
            11.25
            
            
            
            
            
            
            
            
            
            
            $
            13.05Options
      in the money
            
            
            974,535
            
            
            
            
            
            
            $
            15,401
            
            
            
            1,062,476
            
            
            
            
            
            
            $
            19,974Options
      out of the money
            
            
            378,760
            
            
            
            
            
            
            
            
            
            
            
            102,500





The
amount of cash received from the exercise of stock options under
the Company's various equity incentive plans and stock purchased through
the ESP Plan was $950,000 and $873,000 in the nine months ended September 30,
2008 and 2007, respectively.  As of September 30, 2008, there were
122,278 shares available for purchase under the ESP Plan, 1,519,992 shares
available for grant under the 2006 Plan, and 69,000 shares available for grant
under the 1995 Stock Incentive Plan, which includes options available under the
non-employee director plan.





Of the
outstanding exercisable options as of September 30, 2008, 974,535 were
exercisable at a price below the closing price of the Company’s stock of $24.90
on the New York Stock Exchange as of that date and 378,760 were exercisable
at a price above the closing price.





The
Company estimates the fair value of its options using the Black-Scholes option
pricing model.  Option valuation models require the input of various
assumptions, including the expected stock price volatility, risk-free interest
rate, dividend yield, and forfeiture rate.  The Company groups its
options into two main categories based on expected life, which are the employee
group and the non-employee directors.  The fair value of the
stock options granted was estimated





8
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


using a
risk-free rate that is the five-year or seven-year U.S. Treasury yield in effect
at the time of grant.  The expected life of the stock options granted
(five or seven years) was estimated using the historical exercise behavior of
option holders.  Expected volatility was based on historical
volatility for a period equal to the stock option’s expected life, ending on the
date of grant.  Forfeitures are estimated at the time of valuation and
reduce expense ratably over the vesting period.  The forfeiture rate,
which was estimated at 10.2% of the options awarded, is adjusted periodically
based on the extent to which actual forfeitures differ, or are expected to
differ, from the previous estimate.  The Company's options have
characteristics significantly different from those of traded options and changes
in the various input assumptions can materially affect the fair value
estimates.  The fair value of options granted for the nine months
ended September 30, 2008 and 2007, were estimated at the date of grant using the
following weighted average assumptions:





For
      Employees and Key ExecutivesNine
      Months Ended September 30,2008
            
            
            2007Expected
      life from vest date (in years)
            
            
            5
            
            
            
            5Risk-free
      interest rate
            
            
            2.69
            %
            
            
            4.26%
      - 4.31
            %Volatility
            
            
            42.7
            %
            
            
            48.9
            %Dividend
      yield
            
            
            -
            
            
            
            -Weighted
      average fair value (per share)
            
            $
            8.75
            
            
            $
            13.13





For
      DirectorsNine
      Months Ended September 30,2008
            
            
            2007Expected
      life from vest date (in years)
            
            
            7
            
            
            
            7Risk-free
      interest rate
            
            
            3.90
            %
            
            
            4.38%
      - 4.41
            %Volatility
            
            
            54.7
            %
            
            
            70.5
            %Dividend
      yield
            
            
            -
            
            
            
            -Weighted
      average fair value (per share)
            
            $
            11.73
            
            
            $
            18.28





The
Company offers eligible employees the opportunity to purchase Emeritus common
stock through the ESP Plan at a 15% discount from the lower of the market price
on (a) the first trading date of each calendar quarter or (b) the last trading
date of each quarter.  The following table shows the number of shares
of common stock issued under the ESP Plan and the purchase price of these shares
for the first three quarters of 2008:





2008Shares
            
            
            PriceQuarter
      1
            
            
            9,360
            
            
            $
            17.73Quarter
      2
            
            
            13,621
            
            
            $
            12.43Quarter
      3
            
            
            12,106
            
            
            $
            12.24








9
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





4.
            Acquisitions
      and Other Significant Transactions





2008
HCN Purchase





On June
6, 2008, the Company entered into an asset purchase agreement (the HCN
Agreement) with Health Care REIT, Inc. (HCN) and its affiliated entities to
purchase 29 communities consisting of 2,257 units located throughout the United
States for a purchase price of $299.8 million, excluding transaction
costs.  The Company formerly leased these communities from HCN (19
under a master lease dated September 30, 2003, two under individual leases, both
dated February 26, 1996, and eight under a master lease dated September 30,
2004) and operated these communities as assisted living and memory care service
facilities.  As provided in the HCN Agreement, the transaction closed
in two phases.
 
 On June
30, 2008, the Company completed the first phase of the HCN transaction (Tranche
1).  Tranche 1 consisted of 19 communities with a capacity of 1,564
units and a purchase price of $222.6 million, plus closing costs of $1.2
million. The Company financed Tranche 1 with mortgage debt of approximately
$163.2 million and seller-provided debt of $50.0 million (see Note 5, Long-term Debt).
 
 The
Company accounted for 18 of the 19 acquired communities in Tranche 1 as capital
leases.  Upon termination of the leases, the difference between the
carrying amount of the capital lease assets and the capital lease obligations of
$27.0 million was recorded as an adjustment to the carrying amount of the
purchased communities.
 
 The purchase of
the remaining 10 communities under the HCN Agreement was completed on October
17, 2008 (see Note 13,Subsequent
Events).


2008
NHP Purchase





On
February 6, 2008, the Company entered into a purchase and sale agreement with
Nationwide Health Properties, Inc. (NHP) to purchase 24 communities consisting
of 1,672 units located in 13 states for a purchase price of $305.0 million plus
transaction costs of $9.8 million.  The Company leased these
communities from NHP and operated the communities as assisted living and
dementia care facilities.  On April 2, 2008, the Company closed on
this transaction and financed it through mortgage debt of approximately $249.9
million and seller-provided debt of $30.0 million (see Note 5, Long-term Debt).





We
accounted for these leases as capital leases.  Upon termination of the
capital leases, the difference between the carrying amount of the capital lease
assets and the capital lease obligations and related intangibles of $19.6
million was recorded as an adjustment to the carrying amount of the purchased
communities.





Summerville
Acquisition





On
September 1, 2007, the Company acquired all of the outstanding stock of
Summerville through a merger of its wholly-owned subsidiary with
Summerville.  Summerville was a San Ramon, California-based operator
of 81 communities comprising 7,935 units in 13 states, which provided
independent living, assisted living, and Alzheimer’s and dementia-related
services to seniors.  Upon completion of the Summerville acquisition,
Summerville became a wholly owned subsidiary of Emeritus.





Under the
terms of the merger agreement, a total of 8,392,656 shares of the Company’s
common stock were issued.





The total
initial purchase price for Summerville was $278.2 million.  In the
allocation of the purchase price, the Company recorded a $4.5 million accrual
for estimated federal, state and local taxes.  The Company also
recorded a $4.5 million long-term asset that represented potential reimbursement
for these tax liabilities under an indemnity agreement with the major
shareholder of Summerville.  This contingent purchase consideration
issue has been resolved, resulting in the recording of the contingent
consideration of $4.5 million to goodwill as of September 30, 2008.





10
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


2007 HCPI
Communities Purchased





In March
2007, the Company completed the purchase of seven communities consisting of 453
units located in South Carolina for approximately $28.9 million, including
transaction costs.  The Company had operated these facilities pursuant
to a master lease dated September 18, 2002, between Health Care Property
Investors, Inc. (HCPI), and Emeritus.  The Company accounted for this
master lease as an operating lease.





In
August 2007, Emeritus acquired 41 additional communities from HCPI,
consisting of 3,732 units located in 17 states.  The aggregate
purchase price was $504.9 million, including transaction costs.  Of
the 41 communities, the Company leased 33 and Summerville leased eight of the
communities pursuant to leases that were assigned to the Company when it
purchased these communities.  Summerville continued to operate the
eight communities under existing leases until Emeritus completed its acquisition
of Summerville in September 2007, at which time the leases
terminated.





2007
HRT Communities Purchased





In March
2007, the Company purchased 12 communities consisting of 786 units located in
five states for $100.2 million, including transaction costs.  The
Company had leased four of these communities from Healthcare Realty Trust (HRT)
since May 2002 and eight since May 2003.  Four of the leased
communities had been accounted for as capital leases and eight as operating
leases by the Company.





2007
Fretus Communities Purchased





In
February 2007, the Company purchased 24 communities consisting of 1,651
units located in six states for $143.5 million, including transaction
costs.  The Company had leased these communities from Fretus Investors
LLC (Fretus) since October 2002 and had accounted for them as operating
leases.





Fretus
was a private investment joint venture between Fremont Realty Capital, which
held a 65% interest, and a Baty-related entity, which held a 35% minority
interest.  Daniel R. Baty, the Company’s founder, chairman, Co-CEO and
significant shareholder, held a 16% indirect interest in the minority entity,
personally guaranteed $3.0 million of the Fretus mortgage debt covering the
communities and controlled the administrative member of Fretus.  In
conjunction with this transaction, the Baty-related entity provided $18.0
million in short-term financing to the Company, of which approximately
$5.1 million was used to fund the balance of the purchase price and the
balance was used for general business purposes.  The short-term debt
was repaid in July 2007.




2007
HCN Purchase





In August
2007, the Company completed the acquisition of three Florida communities
consisting of 431 units.  The purchase price was $25.0 million,
including transaction costs.  The Company had leased these communities
from HCN and affiliates and accounted for them as capital leases.





2007
Wegman Purchase





In August
2007, the Company completed the acquisition of nine communities that the Company
previously leased, consisting of 711 units located in the State of New
York, for an aggregate purchase price of $89.0 million including
transaction costs.





Other
2007-2008 Community Acquisitions





On June
12, 2008, the Company purchased a 54-unit community in Granger, Indiana, for
$6.9 million, including closing costs, of which $6.0 million was financed
through mortgage financing with Capmark Bank (Capmark) (see Note 5, Long-term Debt).





In
January 2008, the Company entered into a long-term lease for a newly constructed
38-unit Alzheimer’s community located in Joliet, Illinois.  This
community is included in the NHP portfolio that the Company purchased in April
2008 as detailed above and this lease was terminated in connection with such
purchase.





11
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





In
January 2008, the Company entered into a long-term lease for a 104-unit
community located in Orangevale, California.  The lease term is 15
years, expiring in January 2023, with two 10-year renewal options
available.  The initial annual lease payment is approximately
$901,000, with annual increases of 3.0%.





In
December 2007, the Company purchased a 106-unit assisted living community
located in Oak Grove, Ohio, for a price of $12.9 million.





In July
2007, the Company entered into a long-term lease for an 89-unit assisted living
community in Marietta, Ohio.  The lease term is 12 years, expiring in
July 2019, with one ten-year renewal option available.  The initial
annual lease payment is approximately $1.1 million, with annual increases based
on the greater of 3% or the change in the Consumer Price Index
(CPI).





Joint
Ventures





The
Company holds a 50.0% interest in a joint venture with an affiliate of The
Wegman Companies, Inc., which operates a newly constructed property in Stow,
Ohio (Stow JV).  The community owned by the Stow JV began operations
in May 2008 and is managed by the Company.  The Company recorded
equity losses of approximately $63,000 and $214,000 for the three and nine
months ended September 30, 2008, respectively.  The Company recorded
management fee income of approximately $18,000 and $50,000 for the three and
nine months ended September 30, 2008, respectively.





The
Company holds a 19.0% interest in a joint venture with Blackstone Real Estate
Advisors that began operations in December 2006 and operates a portfolio of 24
properties as of September 30, 2008, 23 of which are managed by the Company
(Blackstone JV).  The Company recorded equity gains of approximately
$30,000 and equity losses of $637,000 for the three months ended September 30,
2008 and 2007, respectively, and equity losses of $676,000 and $1.5 million for
the nine months ended September 30, 2008 and 2007, respectively.  The
Company recorded management fee income of approximately $864,000 and $762,000
for the three months ended September 30, 2008 and 2007, respectively, and $2.5
million and $2.1 million for the nine months ended September 30, 2008 and 2007,
respectively.





5.
            Long-Term
      Debt





On June
30, 2008, in conjunction with the 2008 HCN Purchase discussed in Note 4, the
Company entered into financing agreements for Tranche 1 of the transaction
consisting of $163.2 million of mortgage debt at a fixed rate of 6.65%
originated by KeyBank through a Freddie Mac credit facility and a $50.0 million
note from HCN with a fixed rate of 8.0%, increasing on each anniversary date by
25 basis points.  The Freddie Mac credit facility has a term of 10
years, with interest-only payments for the first year and, thereafter, interest
and principal payments based on a 30-year amortization schedule.  The
HCN note has a term of three years, with interest-only payments over the
three-year term.





On June
12, 2008, the Company purchased a 54-unit community in Granger, Indiana, for
$6.9 million, including closing costs, of which $6.0 million was financed
through mortgage financing with Capmark.  This is a three-year loan
with monthly payments of interest only based on the monthly London Interbank
Offered Rate (LIBOR) plus 250 basis points with a floor of 5.25%.  A
deferred loan fee of 1.0% of the outstanding principal balance is due when the
loan is paid off, unless it is refinanced with Capmark.





On April
30, 2008, the Company repaid the $20.0 million outstanding balance of a mortgage
loan (the GMAC Mortgage) secured by five of its existing
communities.  The interest rate on the GMAC Mortgage was 6.98% and the
note was to mature in August 2008.





The
Company refinanced the GMAC Mortgage with new credit
facilities.  Three of the five communities secure notes totaling $25.4
million at a fixed rate of 6.29%, (the Fixed Rate Notes), with a term of 10
years.  The Fixed Rate Notes require payments in the first three years
of interest only, and payments of principal and interest thereafter based on a
30-year amortization.  The Fixed Rate Notes were originated by KeyCorp
Real Estate Capital Markets,





12
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


Inc. and
were purchased by Fannie Mae.  The Fixed Rate Notes may be prepaid
subject to a prepayment penalty based on a formula defined in the loan
agreements.  The Fixed Rate Notes contain cross-default provisions and
customary events of default, including those related to non-payment and the sale
or transfer of collateral.





The
remaining two communities secure variable rate notes (the Variable Rate Notes)
totaling $13.3 million, of which $7.2 million was withheld at closing and is
available for funding of construction projects on these two
communities.  The Variable Rate Notes have terms of three years and an
initial weighted average annual interest rate of 5.06% (LIBOR plus 2.25% to
2.40%).  KeyBank is the lender.  The maturity dates may be
extended for one additional year at the Company’s option (the Extension Period)
depending upon the attainment of certain debt service coverage ratios as defined
in the loan agreements.  Monthly payments are interest only for three
years and, if extended, include scheduled principal reductions during the
Extension Period.  The Variable Rate Notes may be prepaid at any time
without penalty.  The Variable Rate Notes contain various events of
default, including non-payment and the maintenance of specified levels of
occupancy and debt service coverage ratios.  The Company received
approximately $11.2 million in cash from these refinancing transactions, which
will be used for general corporate purposes.





On April
29, 2008, the Company refinanced the mortgage debt on 18 of its existing
properties, which were purchased from Fretus in February 2007 (see Note 4, Acquisitions
and Other Significant Transactions).The original
loan of $132.0 million bore interest at a fixed annual rate of 6.5475% and was
secured by 24 properties. Of the $132.0 million principal balance outstanding,
$112.0 million was paid down as part of this refinancing.  The
original loan agreement was amended to provide that: (i) the remaining balance
of $20.0 million is secured by five properties, with one property released from
the security pool and (ii) the interest rate changed from a fixed rate of
6.5475% to a variable rate equal to LIBOR plus 280 basis points (5.80% at
closing), adjusted monthly, with a floor of 5.80%.  Subsequent to the
close of this transaction, the Company further reduced the $20.0 million loan to
$16.8 million with the proceeds from the sale of a property.





The new
debt of $129.0 million has a term of 10 years at a fixed rate of 6.21%, with
payments in the first three years of interest only and payments of principal and
interest thereafter based on a 30-year amortization period.  Both the
existing and the new mortgages were provided by Capmark and purchased by Freddie
Mac.  The notes on the 18 properties contain cross-default
provisions.  The new debt may be prepaid subject to a prepayment
penalty based on a formula defined in the loan agreement.  The loan
agreement contains customary events of default, including payment
defaults.  The Company received approximately $14.4 million in net
cash proceeds from this transaction, which will be used for general corporate
purposes.





On April
2, 2008, the Company closed on the NHP Purchase as discussed in Note
4, Acquisitions
and Other Significant Transactions, and financed the transaction through
mortgage debt of approximately $241.9 million, with an interest rate of 5.9% and
seller-provided debt of $30.0 million with an interest rate of
7.25%.  The mortgage debt was originated by Capmark through a Fannie
Mae credit facility.  In addition, the seller agreed to a 12-month
extension on an existing $21.4 million note originally maturing in March 2008
(the NHP Note), including a reduction in the interest rate from 10.0% to
8.5%.  The Company also secured the ability to borrow up to an
additional $8.1 million under this Fannie Mae credit facility based on portfolio
performance.  This portfolio includes a memory loss community, which
was financed separately with variable interest rate mortgage debt financing of
$8.0 million provided by Capmark.  Interest is based on the monthly
LIBOR plus 265 basis points with a floor of 5.65%.  The interest rate
as of the closing date was 5.65%.





Effective
October 22, 2008, the NHP Note was amended to extend the maturity date to March
31, 2012  (see Note 13, Subsequent
Events).





On
February 8, 2008, Emeritus entered into a credit agreement with Wells Fargo
Bank, which provides a $25.0 million unsecured revolving line of
credit.  The credit agreement permits the Company to borrow from time
to time up to $25.0 million on an unsecured basis.  The credit
agreement also allows the Company to obtain letters of credit from the lender,
provided that outstanding letters of credit and any borrowings outstanding do
not exceed $25.0 million.  The line of credit matures on February 15,
2009.  Outstanding borrowings will bear interest at a variable rate of
0.5% below Wells Fargo’s prime rate, payable monthly.  The Company may
partially or wholly repay borrowings and reborrow provided that the total
outstanding borrowings may not at any time exceed $25.0
million.  Emeritus is required to pay a commitment fee of 0.25% on the
average daily unused amount of the line of credit, which is payable
quarterly.  In addition, the Company is required to pay fees equal to
1.0% of every letter of credit





13
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


issued as
well as the negotiation fees on each letter.  The Company must
maintain a zero balance on advances for 30 consecutive days during each fiscal
year, a $20.0 million minimum balance in cash, cash equivalents and/or publicly
traded marketable securities, meet a fixed charge coverage ratio, and comply
with customary affirmative and negative covenants.





The
Company intends to use the line of credit for general corporate
purposes.  There were no outstanding borrowings under this credit
facility as of September 30, 2008.





Effective
February 1, 2008, Emeritus entered into an interest rate swap contract that has
a notional amount of $12.4 million and matures on January 1,
2010.  The swap effectively converts the interest rate on the related
mortgage debt from a floating rate equal to the LIBOR plus 225 basis points to a
fixed rate of 4.965%, thus mitigating the impact of interest rate changes on
future interest expense.  The Company did not designate the swap as a
hedging instrument (see Note 11, Fair
Value Disclosures).





6.
            Shareholders’
      Equity





Debenture
Conversion





In
February 2007, the Company offered to pay a cash incentive to debenture holders
if they elected to convert their debentures into common stock by March 8,
2007.





Holders
of $16.1 million principal amount converted their debentures into 732,725 shares
of common stock at the stated conversion rate of $22.00 per share.  Of
the debentures converted into common stock, $15.8 million principal amount was
owned by entities controlled by Mr. Baty.  On April 16, 2007, the
Company paid the incentive fee of $1.3 million in connection with this
conversion, which amount is equal to the interest that would have otherwise been
paid if the debentures were held to maturity.  The incentive payment
was expensed to “Other, net” in the condensed consolidated statement of
operations in the first quarter of 2007.





The
remaining $10.5 million principal amount of debentures outstanding was
repaid at maturity on July 1, 2008.





7.
            Loss
      Per Share





Basic
loss per share is computed based on the weighted average number of shares
outstanding and excludes any potential dilution.  Diluted loss per
share is computed based on the weighted average number of shares outstanding
plus dilutive potential common shares, which include convertible debentures and
stock options.  Options are included using the “treasury stock method”
to the extent they are dilutive.  Certain shares issuable upon the
exercise of stock options and conversion of convertible debentures have been
excluded from the computation because the effect of their inclusion would be
anti-dilutive.





The
following table summarizes those potential common shares that are excluded in
each period because they are anti-dilutive (in thousands):





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September,
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Convertible
      Debentures
            
            
            –
            
            
            
            475
            
            
            
            –
            
            
            
            475Options
            
            
            2,150
            
            
            
            2,272
            
            
            
            2,150
            
            
            
            2,2722,150
            
            
            
            2,747
            
            
            
            2,150
            
            
            
            2,747








14
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





8.
            Comprehensive
      Loss





The
following table summarizes the comprehensive loss for the periods indicated (in
thousands):





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      loss
            
            $
            (23,076
            )
            
            $
            (11,573
            )
            
            $
            (74,278
            )
            
            $
            (22,897
            )Other
      comprehensive income:Unrealized
      holding gains (losses)on
      available-for-sale investment securities
            
            
            24
            
            
            
            –
            
            
            
            86
            
            
            
            –Comprehensive
      loss
            
            $
            (23,052
            )
            
            $
            (11,573
            )
            
            $
            (74,192
            )
            
            $
            (22,897
            )





9.
            Discontinued
Operations





During
the first quarter of 2008, the Company decided to discontinue operations at four
of its communities and put the assets and businesses up for
sale.  During the second quarter of 2008, the Company decided to
discontinue operations at one more community and put the assets and business up
for sale.  The Company decided to sell these communities primarily
because they have consistently incurred operating losses over a sustained period
of time due to geographic location and local market conditions.  Two
of the communities were sold in the second quarter of 2008 and the remaining
three are expected to be sold within the next six months.  Financial
statements for the three and nine months ended September 30, 2007, have been
reclassified to present the operations of these communities as discontinued
operations.  In 2007, the Company determined that the carrying amounts
of three communities were not recoverable from expected undiscounted cash flows
generated from the use of the assets and recognized an aggregate loss of $4.8
million to write down the related carrying amounts of these properties to their
estimated fair values.  In the second quarter of 2008, the Company
recognized an impairment loss of $4.3 million on the additional community
classified in discontinued operations.  In the third quarter of 2008,
the Company recognized an additional impairment loss of $592,000 primarily due
to the allocation of goodwill to discontinued operations.  The assets
of the three properties remaining to be sold, which consist of property and
equipment, are presented separately under the caption “Property held for sale”
in the accompanying condensed consolidated balance sheet at September 30,
2008.  The Company will continue to operate these communities until
sold.





The
following table shows the revenues, net loss, and net loss per common share for
the discontinued operations (in thousands, except per share data):





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Total
      revenue
            
            $
            1,761
            
            
            $
            2,771
            
            
            $
            6,800
            
            
            $
            8,157Net
      loss
            
            $
            (474
            )
            
            $
            (525
            )
            
            $
            (5,840
            )
            
            $
            (1,284
            )Basic
      and diluted net loss per common share
            
            $
            (0.01
            )
            
            $
            (0.02
            )
            
            $
            (0.15
            )
            
            $
            (0.06
            )Weighted
      average common shares outstanding-basic and diluted
            
            
            39,082
            
            
            
            32,001
            
            
            
            39,059
            
            
            
            23,165








15
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


10.
              Liquidity





As of
September 30, 2008, the Company has a working capital deficit of $90.7
million.  The Company is able to operate in the position of a working
capital deficit because revenues are collected more quickly, often in advance,
than obligations are required to be paid.  This can result in a low
level of current assets to the extent cash has been deployed in business
development opportunities or to pay down long-term liabilities.  Along
those lines, the working capital deficit includes, as part of current
liabilities, $28.8 million of deferred revenue and unearned rental income, which
will not require a future outlay of cash.  The level of current
liabilities is not expected to change from period to period in such a way as to
require the use of significant cash, except for (i) the current portion of debt
of $79.4 million maturing by September 30, 2009, and (ii) long-term debt
maturities of $50.1 million due after September 2009 but prior to September 30,
2010, which the Company plans to refinance prior to their due dates or pay off
at maturity.





The
Company reported net cash from operating activities in its condensed
consolidated statements of cash flows of $56.5 million and $30.6 million for the
nine months ended September 30, 2008 and 2007, respectively.  While
the Company has reported positive cash flows from operating activities over the
past three years, the cash flows have not always been sufficient to pay all of
its long-term obligations and the Company has been dependent upon third-party
financing or disposition of assets to fund operations.  The Company
cannot guarantee that, if necessary in the future, such transactions will be
readily available, or on terms attractive to the Company.










The
downturn in the United States housing market in 2007 triggered a constriction in
the availability of credit that is expected to continue for the remainder of
2008 and into 2009.  This could impact the Company’s ability to borrow
money or refinance existing obligations at acceptable rates of
interest.  Thus far, the Company has experienced no significant
barriers to obtaining credit and does not expect to in the near
future.





Management
believes that the Company will be able to generate sufficient operating cash
flows and will have adequate cash for all necessary operating, investing, and
financing activities including required debt service and capital expenditures
for at least the next twelve months.





11.
            Fair
      Value Disclosures




Investment securities
available-for-sale. The carrying values of investment securities
classified as available-for-sale are recorded at their fair values based on
quoted market prices utilizing public information for the issuers (see Note 8,
Comprehensive Loss).




Derivative financial
instruments.  The Company enters into derivative financial
instruments, specifically interest rate swaps, for non-trading
purposes.  The Company uses interest rate swaps to manage interest
rate risk associated with floating rate debt.  As of September 30,
2008, the Company was party to two interest rate swaps with a total notional
amount of $32.0 million.  The Company elected not to apply hedge
accounting for these interest rate swaps even though they are economic hedges of
the Company’s floating rate debt and the Company does not enter into derivatives
for speculative purposes.  These derivative contracts currently have
negative net fair values based on current market conditions affecting interest
rates and are recorded in other long-term liabilities.





16
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents





The table
that follows summarizes the interest rate swap contracts outstanding at
September 30, 2008 (in thousands):





Notional
            
            Effective
            
            Expiration
            
            EstimatedAmount
            
            Date
            
            Date
            
            Fair
      ValueInterest
      rate swap
            
            $
            19,640
            
            10/1/2007
            
            8/6/2012
            
            $
            (770
            )Interest
      rate swap
            
            
            12,405
            
            2/1/2008
            
            1/1/2010
            
            
            61




As of
January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements.The
standard defines fair value, establishes a framework for measuring fair value,
and also expands disclosures about fair value measurements.  Under
this standard, fair value is defined as the price that would be received to sell
an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly
transaction between market participants at the measurement date.  SFAS
No. 157 also requires the Company to consider its own credit spreads when
measuring the fair value of liabilities, including derivatives.  In
February 2008, the FASB issued FASB Staff Position SFAS 157-2, Effective Date of FASB Statement No. 157(SFAS
157-2), which defers the effective date of SFAS No. 157 for all non-financial
assets and non-financial liabilities, except those that are recognized or
disclosed at fair value on a recurring basis, until fiscal years beginning after
November 1, 2008, and interim periods within those fiscal years.  The
Company does not believe the adoption of SFAS No. 157 for non-financial assets
and liabilities will have a significant impact on the Company’s future
consolidated statements.





The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of September 30, 2008, and
indicates the fair value hierarchy of the valuation techniques utilized by the
Company to determine such fair value (in thousands):





Quoted Prices in
            
            
            SignificantActive
      Markets
            
            
            Other
            
            
            Significant
            
            
            Balance
      atfor
      Identical
            
            
            Observable
            
            
            Unobservable
            
            
            September
      30,Assets
      (Level 1)
            
            
            Inputs (Level 2)
            
            
            Inputs (Level 3)
            
            
            2008AssetsInvestment
      securities – available-for-sale
            
            $
            3,062
            
            
            $
            -
            
            
            $
            -
            
            
            $
            3,062LiabilitiesDerivative
      financial instruments
            
            
            -
            
            
            
            709
            
            
            
            -
            
            
            
            709





In
general, fair values determined by Level 1 inputs utilize quoted prices in
active markets for identical assets or liabilities that the Company has the
ability to access.  For example, the Company’s investment in
available-for-sale equity securities is valued based on the quoted market price
for that security.





Fair
values determined by Level 2 inputs utilize inputs other than quoted prices
included in Level 1 that are observable for the asset or liability, either
directly or indirectly.  Level 2 inputs include quoted prices for
similar assets and liabilities in active markets, and inputs other than quoted
prices that are observable for the asset or liability.  For example,
the Company uses market interest rates and yield curves that are observable at
commonly quoted intervals in the valuation of its interest rate swap
contracts.





Level 3
inputs are unobservable inputs for the asset or liability, and include
situations where there is little, if any, market activity for the asset or
liability.  The Company’s assessment of the significance of a
particular input to the fair value measurement in its entirety requires
judgment, and considers factors specific to the asset or liability.




For the
three months and nine months ended September 30, 2008, the Company recognized an
unrealized loss of $119,000 and an unrealized gain of $16,000, respectively,
which represent the change in the fair value of the interest rate
swaps.







17
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


During
the three months and nine months ended September 30, 2008, the Company recorded
impairment losses of $653,000 and $4.9 million, of which $592,000 and $4.9
million, respectively, is included in loss from discontinued operations (see
Note 9, Discontinued
Operations).The fair value of property held for sale was determined
based on recent offers from prospective purchasers (Level 2
input).


The
Company also adopted SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities—Including an amendment of FASB Statement
No. 115, as of January 1, 2008, but has not made any fair value
elections with respect to any of its eligible assets or liabilities as of
September 30, 2008.





12.
            Income
      Taxes





Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109, which clarifies the
accounting and reporting for uncertainties in income tax law. In accordance with
FIN 48, the Company recognizes the tax benefit from an uncertain tax position
only if it is more likely than not that the tax position will be sustained on
examination by the taxing authorities, based on the technical merits of the
position. The tax benefits recognized in the financial statements from such a
position are measured based on the largest benefit that has a greater than 50%
likelihood of being realized upon settlement.





Included
in the Company's income tax accruals are liabilities for unrecognized tax
benefits, including penalties and interest, which were recorded in connection
with the Summerville purchase price allocation (see Note 4, Acquisitions
and Other Significant Transactions).  This liability, amounting
to $3.6 million, is the result of uncertainty surrounding the deductibility of
certain items included in Summerville tax returns for periods prior to the
merger.





13.
            Subsequent
      Events





NHP
Note




Acquisitions and
Other Significant Transactions





2008
HCN Purchase—Tranche 2





On
October 17, 2008, the Company completed the second phase (Tranche 2) of the HCN
transaction described in Note 4.  This closing consisted of 10
communities with a capacity of 693 units for a purchase price of $77.2 million,
excluding financing and closing costs.





Tranche 2
was financed with $56.4 million of mortgage debt, of which $29.0 million is at a
weighted average fixed rate of 6.654% and was originated by KeyBank through a
Freddie Mac credit facility, and $27.4 million of variable rate debt provided by
KeyBank at the one-month LIBOR rate plus 3.0%.  The Freddie Mac credit
facility has a term of 10 years.  The variable rate loan has a term of
three years and may be prepaid without penalty.





The
Company accounted for nine of the leases as capital leases and one as an
operating lease.  Upon termination of the leases, the difference
between the carrying amount of the capital lease assets and the capital lease
obligations will be recorded as an adjustment to the carrying amount of the
purchased communities, in addition to adjustments for straight-line rent
accruals and deferred gains on sale.  This total reduction in the cost
basis of the Tranche 2 properties will be approximately $8.0
million.  The current annual lease payment for these properties is
approximately $4.6 million, of which approximately $2.0 million was recorded as
capital lease interest expense, $1.7 million as principal payments on capital
lease obligations, and $900,000 as facility lease expense for the one community
accounted for as an operating lease.





As part
of this purchase, eight of these communities were contributed to a 50/50 joint
venture owned by the Company and a Baty-related entity, which contributed
approximately $6.8 million to the joint venture for the





18
 EMERITUS
CORPORATION
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 Continued
 September
30, 2008


Table of Contents


purchase
of the properties.  These eight communities are currently subject to a
cash flow sharing agreement with the Baty-related entity, and the joint venture
provides for similar economic terms and conditions as the existing cash flow
sharing agreement.  The joint venture will be included in the
consolidated financial statements of Emeritus.





2008
HCP Lease Agreement





On August
22, 2008, the Company entered into a Master Lease and Security Agreement (the
HCP Agreement) to lease 11 communities from affiliates of HCP, Inc.
(collectively, HCP), which is expected to close in the fourth quarter of
2008.  The communities are comprised of 1,462 units/beds consisting of
approximately 21 independent living units, 969 assisted living units, 292
Alzheimer’s units, and 180 skilled nursing beds and are located in California,
Connecticut, Massachusetts, Maryland, New Jersey, and Virginia.





The HCP
Agreement is for a term of ten years with an option to purchase the properties
beginning at the end of the fifth year and continuing through the end of the
lease term.  Annual rents are fixed at $17.5, $21.0, $25.0, $28.0, and
$30.0 million in years one through five, respectively, and thereafter will
increase by the greater of the increase in the CPI or 3.0%.  The
purchase option price is based on the greater of fair market value or $300.0
million (the minimum option price) and contains an appreciation sharing
arrangement if the fair market value exceeds the minimum option
price.





The HCP
Agreement requires a security deposit of approximately $1.1 million, which
escalates each year in proportion to the annual rent increases.  The
HCP Agreement also requires that HCP and the Company each contribute $1.5
million in each of the first two years for capital improvements to the
communities.  In the third year, capital expenditures are required at
a rate of $550 per unit and increase by $50 per unit each year through the fifth
year.  Beginning in the sixth year and continuing through the end of
the lease term, the per unit capital expenditure requirement increases by the
greater of the increase in CPI or 3.0%.  The lease contains typical
events of default, including but not limited to, non-payment of rents, default
on any other agreement between the Company and HCP, and default or acceleration
of any indebtedness of the Company in excess of $1.0 million.





The
closing of this lease transaction is subject to customary closing conditions,
including but not limited to, a due diligence process, execution of an
operations transfer agreement with the current operator, and approval of the
lease by HCP’s current lender.





19


Table of Contents


Item
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND


RESULTS
OF OPERATIONS





Forward-Looking
Statements





This report contains “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act
of 1995, as amended.  This Act provides a “safe harbor” for
forward-looking statements to encourage companies to provide prospective
information about themselves so long as they identify these statements as
forward-looking and provide meaningful cautionary statements identifying
important factors that could cause actual results to differ from the projected
results.  In some cases, you can identify forward-looking statements
by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,”
“expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “should” or
“will,” or the negative of those terms, or comparable
terminology.  Some of the forward-looking statements included in this
report and documents incorporated by reference and in some of our other public
statements relate to, among other things:





·
            the
      effects of competition and economic conditions on the occupancy levels in
      our communities, including possible excess assisted living
      capacity;




·
            our
      ability under current market conditions to maintain and increase our
      resident charges without adversely affecting occupancy
    levels;




·
            our
      ability to control community operating expenses, including the management
      of costs largely beyond our control (such as insurance and utility costs)
      without adversely affecting the level of occupancy and resident
      charges;




·
            our
      ability to generate cash flow sufficient to service our debt and other
      fixed payment requirements;




·
            our
      vulnerability to defaults as a result of noncompliance with various debt
      and lease covenants, including the effects of cross-default
      provisions;




·
            uncertainties
      relating to competition, construction, licensing, environmental
      regulation, and other matters that affect acquisition, disposition, and
      development of assisted living
communities;




·
            our
      ability to find sources of financing and capital on satisfactory terms to
      meet our cash requirements to the extent that they are not met by
      operations; and




·
            uncertainties
      related to professional liability
claims.







Any or
all of our forward-looking statements in this report and in any other public
statements we make may turn out to be inaccurate.  Please carefully
review Item 1A—Risk
Factors of our 2007 Annual Report on Form 10-K for important factors that
could cause our actual results to differ materially from the forward-looking
statements included in this report and presented elsewhere by our management
from time to time.  Incorrect assumptions we might make and known or
unknown risks and uncertainties may affect the accuracy of our forward-looking
statements.  Forward-looking statements reflect our current
expectations or forecasts of future events or results and are inherently
uncertain, and accordingly, you should not place undue reliance on
forward-looking statements.





Although
we believe that the expectations and forecasts reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, performance, or
achievements.  Consequently, no forward-looking statement can be
guaranteed and future events and actual or suggested results may differ
materially.  We undertake no obligation to publicly update any
forward-looking statements, whether as a result of new information, future
events, or otherwise.  You are advised, however, to consult any
further disclosures we make in our quarterly reports on Form 10-Q and
current reports on Form 8-K.





Overview





During
the first nine months of 2008, we continued to concentrate on implementing our
previously disclosed growth strategy, which focuses on increasing our revenues
and cash flows through a combination of: (i) organic growth in








20
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


our
existing operations; (ii) selected acquisitions of additional communities; and
(iii) expansion of our existing communities.





In 2007,
we acquired 88 communities that we previously had leased and eight communities
previously leased by Summerville, leased one, and purchased one additional
community, and, as a result of our acquisition of Summerville, began operating
another 73 communities leased by Summerville. During the nine months ended
September 30, 2008, we acquired 43 communities we previously had leased, entered
into leases for two additional communities, and purchased one other new
community.  In 2007 and continuing into 2008, we have also focused
more on internal growth through expansion of existing properties and
construction of new communities.





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





As
      of September 30,
            
            As
      of December 31,
            
            As
      of September 30,2008
            
            2007
            
            2007Buildings
            
            Units
            
            Buildings
            
            Units
            
            Buildings
            
            UnitsOwned
      (1)
            149
            
            11,981
            
            107
            
            8,781
            
            106
            
            8,675Leased
      (2 )
            106
            
            9,971
            
            147
            
            12,978
            
            147
            
            12,978Consolidated
      Portfolio
            255
            
            21,952
            
            254
            
            21,759
            
            253
            
            21,653Managed/Admin
      Services
            11
            
            1,265
            
            10
            
            1,184
            
            10
            
            1,184Joint
      Venture/Partnership
            23
            
            1,737
            
            23
            
            1,737
            
            25
            
            1,975Operated
      Portfolio
            289
            
            24,954
            
            287
            
            24,680
            
            288
            
            24,812Percentage
      increase  (3)
            0.7%
            
            1.1%
            
            41.4%
            
            49.5%
            
            41.9%
            
            50.3%





(1)   Owned
      communities increased from September 30, 2007, due to the acquisition
      of one community in December 2007, 24 communities on April 2, 2008,
      one community on June 12, 2008, and 19 communities on June 30, 2008, less
      two communities sold on May 15, 2008.  Of the owned communities,
      three are held for sale and are in discontinued operations, representing
      310 units.


(2)   Of
      the 106 leased communities at September 30, 2008, 71 are accounted for as
      operating leases, in which the assets and liabilities of the communities
      are not included in our condensed consolidated balance sheet and 31 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 condensed consolidated financial statements as owned communities
      because of accounting requirements related to sale-leaseback accounting,
      notwithstanding the legal sale of the communities and their subsequent
      leasing by us.


(3)   The
      percentage increase indicates the change from the prior year, or, in the
      case of September 30, 2008 and 2007, from the end of the prior fiscal
      year.





The
      total consolidated portfolio of 21,952 units at September 30, 2008,
      consists of the following unit
types:





Total
      UnitsIndependent
      Living
            
            
            1,448Assisted
      Living
            
            
            16,958Alzheimer's
      Care
            
            
            2,939Skilled
      Nursing Care
            
            
            72Operating
      Units
            
            
            21,417Held
      for sale (3 properties)
            
            
            310Units
      taken out of service
            
            
            225Designed
      Capacity Units
            
            
            21,952





The units
taken out of service represent rooms that have been converted for alternative
uses, such as additional office space, and are not available for immediate
occupancy; therefore, they are excluded from the calculation of the average
occupancy rate.  These units are placed into service as demand
dictates.





21
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


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.  In evaluating the rate component, we generally rely on
the average monthly revenue per occupied unit, computed by dividing the total
community revenue for a particular period by the average number of occupied
units for the same period.  In evaluating the occupancy component, we
generally rely on an average occupancy rate, computed by dividing the average
units occupied during a particular period by the average number of units
available during the period.  We evaluate these and other operating
components for our consolidated portfolio, which includes the communities we own
and lease, and our operating portfolio, which also includes the communities we
manage.





The table
below shows the average monthly revenue per occupied unit and occupancy rate for
our consolidated portfolio for the three and nine months ended September 30,
2008 and 2007.  Please refer to the completecomparison of the three
and nine-month periods ended September 30, 2008 and 2007 contained herein for
further analysis of these rate and occupancy statistics.





Three
      Months ended September 30,
            
            Nine
      Months Ended September 30,2008
            
            2007
            
            $
      D
            
            %
      D
            
            2008
            
            2007
            
            $
      D
            
            %
      DAverage
      monthly revenueper
      occupied unit
            $
      3,449
            
            $
      3,293
            
            $
      156
            
            4.7%
            
            $
      3,383
            
            $
      3,234
            
            $
      149
            
            4.6%Average
      occupancy rate
            86.6%
            
            87.2%
            
            
            
            (.6)
            ppt*
            86.7%
            
            86.8%
            
            
            
            (.1)
            ppt*





*
percentage points





We
believe that occupancy rates reflect industry-wide factors and other economic
conditions, as well as our own actions and policies, including the various
acquisitions and development projects we completed in 2007 and
2008.  Although occupancy rates have recently leveled off or declined
slightly, we continue to evaluate the factors of rate and occupancy to find the
optimum balance in each community.





Since our
inception in 1993, we have incurred operating losses totaling approximately
$330.0 million as of September 30, 2008.  We believe that these losses
have resulted from our 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 and increased emphasis on risk management and financial
reporting controls, the impact in the early years on many of our leases from
capital and financing lease treatments, and occupancy rates remaining lower for
longer periods than we anticipated.  Our current emphasis is on
maximization of cash flows as we work toward improvements in occupancy and
average rates, selective growth, and changes in our capital structure, such as
acquisition of leased properties and refinancing of existing high-rate
debt.





22
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


Significant
Transactions





In recent
periods, and continuing into 2008, we entered into a number of transactions that
affected the number of communities we own, lease, and manage; our financing
arrangements; and our capital structure.  These transactions are
summarized in Notes 4 and 5 to the Unaudited Condensed Consolidated Financial
Statements above.





The
following table shows the changes in buildings from December 31, 2006, through
September 30, 2008, including those transactions previously
described:


Month
            
            Owned
            
            
            Leased
            
            
            Consolidated
            
            
            Managed
            
            
            TotalDecember
      31, 2006
            
            
            
            10
            
            
            
            161
            
            
            
            171
            
            
            
            32
            
            
            
            203Walking
      Horse Meadows – disposition
            Jan-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )Fretus
      Purchase
            Feb-07
            
            
            24
            
            
            
            (24
            )
            
            
            –
            
            
            
            –
            
            
            
            –HRT
      Purchase
            Mar-07
            
            
            12
            
            
            
            (12
            )
            
            
            –
            
            
            
            –
            
            
            
            –HCPI
      Purchase
            Mar-07
            
            
            7
            
            
            
            (7
            )
            
            
            –
            
            
            
            –
            
            
            
            –March
      31, 2007
            
            
            
            53
            
            
            
            118
            
            
            
            171
            
            
            
            31
            
            
            
            202Additional
      JV– management agreements
            May-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            3
            
            
            
            3June
      30, 2007
            
            
            
            53
            
            
            
            118
            
            
            
            171
            
            
            
            34
            
            
            
            205Inn
      at Marietta
            Jul-07
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1HC
      REIT Purchase
            Aug-07
            
            
            3
            
            
            
            (3
            )
            
            
            –
            
            
            
            –
            
            
            
            –HCPI
      Purchase (including 8 Summerville communities)
            Aug-07
            
            
            41
            
            
            
            (33
            )
            
            
            8
            
            
            
            –
            
            
            
            8Wegman
      Purchase
            Aug-07
            
            
            9
            
            
            
            (9
            )
            
            
            –
            
            
            
            –
            
            
            
            –Isle
      of Ledgewood
            Sep-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1
            
            
            
            1Summerville
      Merger
            Sep-07
            
            
            –
            
            
            
            73
            
            
            
            73
            
            
            
            –
            
            
            
            73September
      30, 2007
            
            
            
            106
            
            
            
            147
            
            
            
            253
            
            
            
            35
            
            
            
            288Cooper
      George - disposition
            Oct-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )Gardens
      at Westlake - disposition
            Oct-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )Pinnacle
      - purchase
            Dec-07
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            –
            
            
            
            1December
      31, 2007
            
            
            
            107
            
            
            
            147
            
            
            
            254
            
            
            
            33
            
            
            
            287Courtyard
      of Loyalton - acquisition
            Jan-08
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1Summerville
      at Hazel Creek - acquisition
            Jan-08
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1March
      31, 2008
            
            
            
            107
            
            
            
            149
            
            
            
            256
            
            
            
            33
            
            
            
            289NHP
      Purchase
            Apr-08
            
            
            24
            
            
            
            (24
            )
            
            
            –
            
            
            
            –
            
            
            
            –Galleria
      Oaks - disposition
            May-08
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )Meridian
      Oaks - disposition
            May-08
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )Arborwood
      - purchase
            Jun-08
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            –
            
            
            
            1Emeritus
      at Stow - development
            Jun-08
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1
            
            
            
            1HCN
      Purchase
            Jun-08
            
            
            19
            
            
            
            (19
            )
            
            
            –
            
            
            
            –
            
            
            
            –June
      30, 2008
            
            
            
            149
            
            
            
            106
            
            
            
            255
            
            
            
            34
            
            
            
            289No
      acquisitions or dispositions in the quarter
            
            
            -
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –September
      30, 2008
            
            
            
            149
            
            
            
            106
            
            
            
            255
            
            
            
            34
            
            
            
            289








23
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


Results
of Operations





Significant
Accounting Policies and Use of Estimates





For a
description of our significant accounting policies and estimates, see our Annual
Report on Form 10-K for the year ended December 31, 2007.





Statements
of Operations as Percentage of Revenues and Period-to-Period Percentage
Change





The
following table sets forth, for the periods indicated, certain items from our
condensed consolidated statements of operations as a percentage of total
revenues and the percentage change of the dollar amounts from period to
period.





Period-to-PeriodPercentageChangePercentage
      of Revenues
            
            
            Fav
      / (Unfav)Three
      Months
            
            
            Nine
      MonthsThree
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Ended
            
            
            EndedSeptember
      30,
            
            
            September
      30,
            
            
            September
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007
            
            
            
            2008-2007
            
            
            
            2008-2007Revenues:
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            42.7
            %
            
            
            61.2
            %Expenses:Community
      operations*
            
            
            64.1
            
            
            
            64.0
            
            
            
            64.4
            
            
            
            63.1
            
            
            
            (43.0
            )
            
            
            (64.5
            )General
      and administrative
            
            
            7.6
            
            
            
            9.6
            
            
            
            7.8
            
            
            
            9.8
            
            
            
            (13.4
            )
            
            
            (28.4
            )Depreciation
      and amortization
            
            
            15.1
            
            
            
            14.8
            
            
            
            15.8
            
            
            
            13.9
            
            
            
            (45.7
            )
            
            
            (84.0
            )Facility
      lease expense
            
            
            11.6
            
            
            
            9.0
            
            
            
            11.8
            
            
            
            8.4
            
            
            
            (83.0
            )
            
            
            (125.8
            )Total
      operating expenses
            
            
            98.4
            
            
            
            97.4
            
            
            
            99.8
            
            
            
            95.2
            
            
            
            (44.2
            )
            
            
            (69.1
            )Operating
      income from continuing operations
            
            
            1.6
            
            
            
            2.6
            
            
            
            0.2
            
            
            
            4.8
            
            
            
            (13.9
            )
            
            
            (94.6
            )Other
      income (expense)Interest
      income
            
            
            0.2
            
            
            
            1.9
            
            
            
            0.3
            
            
            
            1.1
            
            
            
            (81.7
            )
            
            
            (49.6
            )Interest
      expense
            
            
            (13.0
            )
            
            
            (13.6
            )
            
            
            (12.2
            )
            
            
            (13.9
            )
            
            
            (36.8
            )
            
            
            (41.5
            )Change
      in fair value of interest rate swaps
            
            
            (0.1
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            N/A
            
            
            
            N/AEquity
      gains (losses) in unconsolidated joint ventures
            
            
            -
            
            
            
            (0.6
            )
            
            
            (0.2
            )
            
            
            1.6
            
            
            
            95.9
            
            
            
            115.6Other,
      net
            
            
            (0.3
            )
            
            
            0.5
            
            
            
            (0.1
            )
            
            
            0.2
            
            
            
            (170.1
            )
            
            
            (189.9
            )Net
      other expense
            
            
            (13.2
            )
            
            
            (11.8
            )
            
            
            (12.2
            )
            
            
            (11.0
            )
            
            
            (60.0
            )
            
            
            (78.3
            )Loss
      from continuing operations before income taxes
            
            
            (11.6
            )
            
            
            (9.2
            )
            
            
            (12.0
            )
            
            
            (6.2
            )
            
            
            (81.0
            )
            
            
            (213.6
            )Benefit
      of ( provision for) income taxes
            
            
            (0.2
            )
            
            
            1.0
            
            
            
            (0.1
            )
            
            
            -
            
            
            
            120.9
            
            
            
            (2,400.0
            )Loss
      from continuing operations
            
            
            (11.8
            )
            
            
            (8.2
            )
            
            
            (12.1
            )
            
            
            (6.2
            )
            
            
            (104.6
            )
            
            
            (216.7
            )Loss
      from discontinued operations
            
            
            (0.2
            )
            
            
            (0.4
            )
            
            
            (1.0
            )
            
            
            (0.3
            )
            
            
            9.7
            
            
            
            (354.5
            )Net
      loss
            
            
            (12.0
            %)
            
            
            (8.6
            %)
            
            
            (13.1
            %)
            
            
            (6.5
            %)
            
            
            (99.4
            )
            
            
            (224.4
            )





*  exclusive
of depreciation and amortization and facility lease expense shown
separately.











24
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


Comparison of the Three
Months Ended September 30, 2008 and 2007





Total
Operating Revenues:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Community
      revenue
            
            $
            191,761
            
            
            $
            133,875
            
            
            $
            57,886
            
            
            
            43.2
            %Management
      fees
            
            
            1,266
            
            
            
            1,415
            
            
            
            (149
            )
            
            
            (10.5
            %)Total
      operating revenues
            
            $
            193,027
            
            
            $
            135,290
            
            
            $
            57,737
            
            
            
            42.7
            %





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      DAverage
      monthly revenue per occupied unit
            
            $
            3,449
            
            
            $
            3,293
            
            
            $
            156
            
            
            
            4.7
            %Average
      occupancy rate
            
            
            86.6
            %
            
            
            87.2
            %
            
            
            
            
            
            
            (.6
            )
      ppt*





*
percentage points





Of the
$57.9 million increase in community revenues for the three months ended
September 30, 2008, compared to the three months ended September 30, 2007,
approximately $51.5 million was due to the addition of 86 new communities,
including the Summerville communities.  The remaining increase of $6.4
million was primarily due to the increase in the average monthly revenue per
occupied unit.





We
continue our efforts to build our occupancy through increased marketing
initiatives, programs that address resident mix and a focus on property
improvements and other community-level enhancements to attract additional
long-term residents and increase occupancy while maintaining growth in average
monthly revenue per unit.  We believe that these initiatives will
continue to have a positive impact on operating performance over
time.





The
management fee revenue was derived primarily from the Blackstone joint venture
(Blackstone JV), from which we recorded $864,000 and $762,000 in the three-month
periods ended September 30, 2008 and 2007, respectively.  However, the
increase in the management fee revenue from the Blackstone JV was more than
offset by decreases caused by discontinued management contracts and other
adjustments made in the third quarter of 2007.





Community
Operations:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Community
      operations
            
            $
            123,726
            
            
            $
            86,525
            
            
            $
            37,201
            
            
            
            43.0
            %As
      a percent of revenue
            
            
            64.1
            %
            
            
            64.0
            %
            
            
            
            
            
            
            1.3
            ppt








Of the
$37.2 million increase in community operations expenses, $34.4 million was due
to the addition of 86 new communities, including the Summerville
communities.  The remaining increase of $2.8 million includes an
increase





25
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


in
employee salaries and benefits of $3.2 million, which was offset in part by a
$1.8 decrease in workers compensation expense, a $545,000 increase in utilities,
and the balance in all other community operating expenses.





General
and Administrative:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)General
      and administrative
            
            $
            14,737
            
            
            $
            12,999
            
            
            $
            1,738
            
            
            
            13.4
            %As
      a percent of revenue
            
            
            7.6
            %
            
            
            9.6
            %
            
            
            
            
            
            
            (2.0
            )
      ppt





The
increase in general and administrative expenses of $1.7 million reflects the
Company’s growth over the past year resulting from the addition of 86 new
communities, including the Summerville communities.  Salaries and
benefits for regional and corporate overhead positions increased by $1.6
million, resulting from both increases in the number of personnel and in average
salaries.  The increase in salaries and benefits was offset in large
part by a $1.2 million decrease in non-cash stock compensation expense, which
amounted to $968,000 and $2.1 million for the three months ended September 30,
2008 and 2007, respectively.  Of the $2.1 million in 2007 stock
compensation, approximately $1.3 million represents immediately vested stock
options granted to Granger Cobb, our  Co-Chief Executive Officer and
President upon consummation of the Summerville merger.  Ongoing stock
option expense is approximately $936,000 per quarter based on the current stock
options outstanding.





Legal,
accounting and other professional fees increased by $989,000 over the prior year
period.  The remaining increase in general and administrative expenses
is due to payroll processing fees, travel expenses and other overhead
costs.





General
and administrative expense as a percentage of operating revenues for all
communities, including managed communities, may be more meaningful for
industry-wide comparisons.  General and administrative expense as a
percentage of community operating revenues for all managed and consolidated
communities decreased to 6.7% for the three months ended September 30, 2008 from
8.1% for the three months ended September 30, 2007.





Depreciation
and Amortization:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Depreciation
      and amortization
            
            $
            29,199
            
            
            $
            20,046
            
            
            $
            9,153
            
            
            
            45.7
            %As
      a percent of revenue
            
            
            15.1
            %
            
            
            14.8
            %
            
            
            
            
            
            
            .3
            ppt





The
increase in depreciation and amortization expense of $9.2 million was primarily
the result of $10.3 million in depreciation and amortization expense related to
new communities we acquired, partially offset by a decrease of $1.1 million in
depreciation expense for the remaining communities.





26
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Facility
Lease Expense:






Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            % D(in
      thousands, except percentages)Operating
      lease expense
            
            $
            17,596
            
            
            $
            10,315
            
            
            $
            7,281
            
            
            
            70.6
            %Above/below
      market rent
            
            
            2,524
            
            
            
            860
            
            
            
            1,664
            
            
            
            193.5
            %Straight-line
      rent
            
            
            2,219
            
            
            
            1,030
            
            
            
            1,189
            
            
            
            115.4
            %Total
      facility lease expense
            
            $
            22,339
            
            
            $
            12,205
            
            
            $
            10,134
            
            
            
            83.0
            %As
      a percent of revenue
            
            
            11.6
            %
            
            
            9.0
            %
            
            
            
            
            
            
            2.6
            ppt





The
increase in facility lease expense of $10.1 million was due to the addition of
new leased communities, primarily Summerville facilities.  Operating
lease expense increased by $7.3 million mostly due to the acquisition of 66
newly leased communities (primarily Summerville), offset by
the purchase of 49 leased communities formerly operated by us under
operating leases.  Above/below market rent expense and straight-line
rent expense increased primarily due to the Summerville
communities.  We leased 71 and 72 communities under operating leases
as of September 30, 2008 and 2007, respectively.





Interest
Income:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Interest
      income
            
            $
            480
            
            
            $
            2,618
            
            
            $
            (2,138
            )
            
            
            (81.7
            %)As
      a percent of revenue
            
            
            0.2
            %
            
            
            1.9
            %
            
            
            
            
            
            
            (1.7
            )
      ppt





Interest
income is primarily attributable to interest earned on invested cash balances,
interest earned on collateral paid in advance for workers’ compensation, and
interest earned on restricted deposits.  Cash balances were
considerably higher in the third quarter of 2007 as compared to the third
quarter of 2008, primarily as a result of cash received in the common stock
offering in July 2007.  In addition, interest rates were much higher
in the third quarter of 2007 as compared to the third quarter of
2008.





Interest
Expense:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Interest
      expense
            
            $
            25,169
            
            
            $
            18,403
            
            
            $
            6,766
            
            
            
            36.8
            %As
      a percent of revenue
            
            
            13.0
            %
            
            
            13.6
            %
            
            
            
            
            
            
            (.6
            )
      ppt





The
increase in interest expense of $6.8 million for the third quarter of 2008 as
compared to the 2007 period was primarily due to an increase of $5.7 million in
interest expense resulting from financings to acquire communities and debt
assumed in the Summerville acquisition.  The remaining increase of
$1.1 million was due to other borrowings.







27
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Change
      in Fair Value of Interest Rate
Swaps:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Change
      in fair value of interest rate swaps
            
            $
            (119
            )
            
            $
            –
            
            
            $
            (119
            )
            
            
            N/AAs
      a percent of revenue
            
            
            (0.1
            %)
            
            
            –
            
            
            
            
            
            
            
            (.1
            )
      ppt





For the
three months ended September 30, 2008, we had unrealized losses of $119,000,
which represent the change in the fair value of the interest rate
swaps.





Equity
Losses in Unconsolidated Joint Ventures:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Equity
      losses inunconsolidated
      joint ventures
            
            $
            (33
            )
            
            $
            (805
            )
            
            $
            772
            
            
            
            (95.9
            %)As
      a percent of revenue
            
            
            –
            
            
            
            (0.6
            %)
            
            
            
            
            
            
            .6
            ppt





The
equity losses of $63,000 from the Stow JV were partially offset by gains of
$30,000 from the Blackstone JV for the three months ended September 30,
2008.  The equity losses of $805,000 in the three months ended
September 30, 2007, primarily reflect net equity losses of $637,000 in the
Blackstone JV.





Other,
net:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Other,
      net
            
            $
            (517
            )
            
            $
            737
            
            
            $
            (1,254
            )
            
            
            N/AAs
      a percent of revenue
            
            
            (0.3
            %)
            
            
            0.5
            %
            
            
            
            
            
            
            (.8
            )
      ppt











Income
Taxes:





Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Provision
      for income taxes
            
            $
            (270
            )
            
            $
            1,290
            
            
            $
            (1,560
            )
            
            
            N/AAs
      a percent of revenue
            
            
            (0.2
            %)
            
            
            1.0
            %
            
            
            
            
            
            
            1.2
            ppt








28
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


The
income tax provision in 2008 represents estimated state income and franchise tax
liabilities.  The benefit of income taxes for the quarter ended September
30, 2007, is principally due to the reversal of $1.3 million of estimated
federal taxes recorded for the first six months of 2007, primarily because the
acquisition of previously leased communities in the third quarter
created an estimated tax loss for the year compared to the previous estimated
taxable income.




Net Loss and Property-Related
Expense:





In
comparing the net loss for the three months ended September 30, 2008 and 2007,
it is important to consider our property-related expenses, which include
depreciation and amortization, facility lease expense, and interest expense that
are directly related to our communities, and which include capital lease
accounting treatment, finance accounting treatment, or straight-line accounting
treatment of rent escalators for many of our leases.  These accounting
treatments all result in greater property-related expense than actual lease
payments made in the early years of the affected leases and less
property-related expense than actual lease payments made in later years, as
detailed in the tables below.





Detail
      of property-related expenses from lease accounting
    treatment:Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
  D(in
      thousands, except percentages)Total
      property-related expense:Depreciation
      and amortization
            
            $
            29,199
            
            
            $
            20,046
            
            
            $
            9,153
            
            
            
            45.7
            %Total
      facility lease expense
            
            
            22,339
            
            
            
            12,205
            
            
            
            10,134
            
            
            
            83.0
            %Interest
      expense
            
            
            25,169
            
            
            
            18,403
            
            
            
            6,766
            
            
            
            36.8
            %Total
      property-related expense
            
            $
            76,707
            
            
            $
            50,654
            
            
            $
            26,053
            
            
            
            51.4
            %Property-related
      expenses from lease accounting treatment:Depreciation
      and amortization
            
            $
            4,238
            
            
            $
            9,055
            
            
            $
            (4,817
            )
            
            
            (53.2
            %)Interest
      expense
            
            
            4,488
            
            
            
            8,473
            
            
            
            (3,985
            )
            
            
            (47.0
            %)Straight-line
      lease expense
            
            
            2,219
            
            
            
            1,031
            
            
            
            1,188
            
            
            
            115.2
            %Operating
      lease expense
            
            
            17,595
            
            
            
            10,315
            
            
            
            7,280
            
            
            
            70.6
            %Total
      property-related lease expense
            
            
            28,540
            
            
            
            28,874
            
            
            
            (334
            )
            
            
            (1.2
            %)Actual
      lease payments
            
            
            (24,219
            )
            
            
            (24,010
            )
            
            
            (209
            )
            
            
            0.9
            %Expense
      in excess of lease payments
            
            $
            4,321
            
            
            $
            4,864
            
            
            $
            (543
            )
            
            
            (11.2
            %)





Our
property-related expense associated with our leases exceeded our actual lease
payments by $4.3 million and $4.9 million for the three months ended September
30, 2008 and 2007, respectively.  The impact of lease accounting
decreased by $543,000 in the current year quarter from the comparable quarter
last year due primarily to a reduction in interest expense on the capital leases
in connection with the normal paydown of the lease obligation and the
termination of leases from the acquisition of the formerly leased communities,
partially offset by increases due to the Summerville
acquisition.  Notwithstanding the effects of lease accounting
treatment, the actual lease payments required under most of our leases will
continue to increase annually and, as a result, we will need to improve our
results from community operations to cover these increases.  However,
in the quarter ended September 30, 2008, the actual lease payments increased
from the comparable period in the prior year due to the acquisition transactions
discussed in Note 4 to the Unaudited Condensed Consolidated Financial
Statements.








29
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Comparison of the Nine
Months Ended September 30, 2008 and 2007





Total
Operating Revenues:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Community
      revenue
            
            $
            562,203
            
            
            $
            347,833
            
            
            $
            214,370
            
            
            
            61.6
            %Management
      fees
            
            
            3,648
            
            
            
            3,221
            
            
            
            427
            
            
            
            13.3
            %Total
      operating revenues
            
            $
            565,851
            
            
            $
            351,054
            
            
            $
            214,797
            
            
            
            61.2
            %





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      DAverage
      monthly revenue per occupied unit
            
            $
            3,383
            
            
            $
            3,234
            
            
            $
            149
            
            
            
            4.6
            %Average
      occupancy rate
            
            
            86.7
            %
            
            
            86.8
            %
            
            
            
            
            
            
            (.1
            )
      ppt*





Of the
$214.4 million increase in community revenues for the nine months ended
September 30, 2008, compared to the nine months ended September 30, 2007,
approximately $199.8 million was due to the addition of 86 new communities,
including the Summerville communities.  The remaining increase of
$14.6 million was primarily due to increases in the average monthly revenue per
occupied unit.





We
continue our efforts to build our occupancy through increased marketing
initiatives, programs that address resident mix and a focus on property
improvements and other community-level enhancements to attract additional
long-term residents and increase occupancy while maintaining growth in average
monthly revenue per unit.  We believe that these initiatives will
continue to have a positive impact on operating performance over
time.





The
increase in management fee revenue was primarily due to the Blackstone JV, from
which we recognized $2.5 million and $2.1 million in the nine-month periods
ended September 30, 2008 and 2007, respectively.





Community
Operations:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Community
      operations
            
            $
            364,338
            
            
            $
            221,496
            
            
            $
            142,842
            
            
            
            64.5
            %As
      a percent of revenue
            
            
            64.4
            %
            
            
            63.1
            %
            
            
            
            
            
            
            1.3
            ppt








Of the
$142.8 million increase in community operating expense, $131.6 million was due
to the addition of 86 new communities, including the Summerville
communities.  Of the remaining increase of $11.2 million, $7.5 million
was primarily due to increases in labor-related costs.  Employee
salaries and benefits increased by $9.5 million over the prior period, offset in
part by a $2.0 decrease in workers’ compensation expense.  The
remaining increase of $3.7 million was primarily related to a $1.1 million
increase in utilities expense, and the balance in all other community operating
expenses.





30
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents


General
and Administrative:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)General
      and administrative
            
            $
            44,079
            
            
            $
            34,335
            
            
            $
            9,744
            
            
            
            28.4
            %As
      a percent of revenue
            
            
            7.8
            %
            
            
            9.8
            %
            
            
            
            
            
            
            (2.0
            )
      ppt





The
increase in general and administrative expenses of $9.7 million reflects the
Company’s growth over the past year resulting from the addition of 86 new
communities, including the Summerville communities.  Salaries and
benefits for regional and corporate overhead positions increased by $5.9
million, resulting from both increases in the number of personnel and in average
salaries.  Salaries and benefits included non-cash stock option
compensation expense of $3.8 million and $3.5 million in 2008 and 2007,
respectively.  Included in stock option compensation expense in the
2007 period was $1.3 million of expense related to immediately vested stock
options granted to Granger Cobb, our  Co-Chief Executive Officer and
President, upon consummation of the Summerville merger.





Legal,
accounting and other professional fees increased by $2.2 million over the prior
year period.  The remaining increase in general and administrative
expenses is due to payroll processing fees, travel expenses and other overhead
costs.





General
and administrative expense as a percentage of operating revenues for all
communities, including managed communities, may be more meaningful for
industry-wide comparisons.  General and administrative expense as a
percentage of community operating revenues for all managed and consolidated
communities decreased to 6.8% for the nine months ended September 30, 2008 from
8.1% for the nine months ended September 30, 2007.





Depreciation
and Amortization:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Depreciation
      and amortization
            
            $
            89,554
            
            
            $
            48,670
            
            
            $
            40,884
            
            
            
            84.0
            %As
      a percent of revenue
            
            
            15.8
            %
            
            
            13.9
            %
            
            
            
            
            
            
            1.9
            ppt








The
increase in depreciation and amortization expense of $40.9 million was primarily
the result of $38.5 million in depreciation and amortization expense related to
new communities we acquired and an increase of $2.4 million in depreciation
expense for the remaining communities.





31
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Facility
Lease Expense:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Operating
      lease expense
            
            $
            52,384
            
            
            $
            27,438
            
            
            $
            24,946
            
            
            
            90.9
            %Above/below
      market rent
            
            
            7,572
            
            
            
            860
            
            
            
            6,712
            
            
            
            780.5
            %Straight-line
      rent
            
            
            7,012
            
            
            
            1,357
            
            
            
            5,655
            
            
            
            416.7
            %Total
      facility lease expense
            
            $
            66,968
            
            
            $
            29,655
            
            
            $
            37,313
            
            
            
            125.8
            %As
      a percent of revenue
            
            
            11.8
            %
            
            
            8.4
            %
            
            
            
            
            
            
            3.4
            ppt





The
increase in facility lease expense of $37.3 million was due to the addition of
new leased communities, primarily Summerville facilities.  Operating
lease expense increased by $24.9 million mostly due to the acquisition of 66
newly leased communities (primarily Summerville), offset by
the purchase of 49 leased communities formerly operated by us under
operating leases.  Above/below market rent expense and straight-line
rent expense increased primarily due to the Summerville communities.  We leased 71 and 72
communities under operating leases as of September 30, 2008 and 2007,
respectively.





Interest
Income:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Interest
      income
            
            $
            1,915
            
            
            $
            3,799
            
            
            $
            (1,884
            )
            
            
            (49.6
            %)As
      a percent of revenue
            
            
            0.3
            %
            
            
            1.1
            %
            
            
            
            
            
            
            (.8
            )
      ppt





Interest
income was primarily attributable to interest earned on invested cash balances,
interest earned on collateral paid in advance for workers’ compensation, and
interest earned on restricted deposits.  The average cash balance was
somewhat higher in the first nine months of 2007 as compared to the first nine
months of 2008, primarily as a result of cash received in the common stock
offering in July 2007.  In addition, interest rates were much higher
in the first three quarters of 2007 as compared to the first three quarters of
2008.




Interest
Expense:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Interest
      expense
            
            $
            68,952
            
            
            $
            48,736
            
            
            $
            20,216
            
            
            
            41.5
            %As
      a percent of revenue
            
            
            12.2
            %
            
            
            13.9
            %
            
            
            
            
            
            
            (1.7
            )
      ppt





The
increase in interest expense of $20.2 million for the first nine months of 2008
as compared to the 2007 period was primarily due to an increase of $22.6 million
in interest expense from financings for the acquisition of communities and debt
assumed in the Summerville acquisition, partially offset by reductions of $2.4
million in other interest expense due to the refinancings and normal reductions
on other loans and mortgages.






EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008
 32


Table of Contents




Change
      in Fair Value of Interest Rate
Swaps:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Change
      in fair value of interest rate swaps
            
            $
            16
            
            
            $
            –
            
            
            $
            16
            
            
            
            N/AAs
      a percent of revenue
            
            
            –
            
            
            
            –
            
            
            
            
            
            
            
            0.0
            ppt





For the
nine months ended September 30, 2008, we had unrealized gains of $16,000, which
represent the change in the fair value of the interest rate swaps.





Equity
Gains (Losses) in Unconsolidated Joint Ventures:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Equity
      gains (losses) inunconsolidated
      joint ventures
            
            $
            (890
            )
            
            $
            5,691
            
            
            $
            (6,581
            )
            
            
            (115.6
            %)As
      a percent of revenue
            
            
            (0.2
            %)
            
            
            1.6
            %
            
            
            
            
            
            
            (1.8
            )
      ppt





The
equity losses for the nine months ended September 30, 2008, consisted of equity
losses of $676,000 from the Blackstone JV and $214,000 from the Stow JV,
respectively. The
equity gains of $5.7 million in 2007 primarily reflects net equity gains of $7.7
million recognized in connection with the Company’s divestiture of its
investment in Senior Med, partially offset by a decrease in equity operating
losses in Senior Med of $181,000 and the Blackstone JV of $1.5
million.  We sold our interest in Senior Med in May 2007.





Other,
net:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Other,
      net
            
            $
            (689
            )
            
            $
            766
            
            
            $
            (1,455
            )
            
            
            N/AAs
      a percent of revenue
            
            
            (0.1
            %)
            
            
            0.2
            %
            
            
            
            
            
            
            (.3
            )
      ppt





Other,
net in 2008 includes $1.1 million of expenses related to the Fretus refinancing
transaction and $1.1 million of miscellaneous nonoperating expenses, partially
offset by resident late fee income and the amortization of deferred gains
totaling of $1.1 million.  The balance in 2007 primarily reflects $1.6
million of amortization of deferred gains and approximately $500,000 of other
income items, partially offset by the incentive payment of $1.3 million related
to the early conversion of approximately $16.1 million of our convertible
debentures into common stock.







33
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Income
Taxes:





Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Provision
      for income taxes
            
            $
            (750
            )
            
            $
            (30
            )
            
            $
            (720
            )
            
            
            N/AAs
      a percent of revenue
            
            
            (0.1
            %)
            
            
            –
            
            
            
            
            
            
            
            0.1
            ppt





The
income tax provisions in 2008 and 2007 represent estimated state income and
franchise tax liabilities.





Net Loss and Property-Related
Expense:





In
comparing the net loss for the nine months ended September 30, 2008 and 2007, it
is important to consider our property-related expenses, which include
depreciation and amortization, facility lease expense, and interest expense that
are directly related to our communities, and which include capital lease
accounting treatment, finance accounting treatment, or straight-line accounting
treatment of rent escalators for many of our leases.  These accounting
treatments all result in greater property-related expense than actual lease
payments made in the early years of the affected leases and less
property-related expense than actual lease payments made in later years, as
detailed in the tables below.









Detail
      of property-related expenses from lease accounting
    treatment:Nine
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      D(in
      thousands, except percentages)Total
      property-related expense:Depreciation
      and amortization
            
            $
            89,554
            
            
            $
            48,670
            
            
            $
            40,884
            
            
            
            84.0
            %Total
      facility lease expense
            
            
            66,968
            
            
            
            29,655
            
            
            
            37,313
            
            
            
            125.8
            %Interest
      expense
            
            
            68,952
            
            
            
            48,736
            
            
            
            20,216
            
            
            
            41.5
            %Total
      property-related expense
            
            $
            225,474
            
            
            $
            127,061
            
            
            $
            98,413
            
            
            
            77.5
            %Property-related
      expenses from lease accounting treatment:Depreciation
      and amortization
            
            $
            20,080
            
            
            $
            34,595
            
            
            $
            (14,515
            )
            
            
            (42.0
            %)Interest
      expense
            
            
            19,293
            
            
            
            28,122
            
            
            
            (8,829
            )
            
            
            (31.4
            %)Straight-line
      lease expense
            
            
            7,012
            
            
            
            1,357
            
            
            
            5,655
            
            
            
            416.7
            %Operating
      lease expense
            
            
            52,385
            
            
            
            27,439
            
            
            
            24,946
            
            
            
            90.9
            %Total
      property-related lease expense
            
            
            98,770
            
            
            
            91,513
            
            
            
            7,257
            
            
            
            7.9
            %Actual
      lease payments
            
            
            (82,948
            )
            
            
            (71,452
            )
            
            
            (11,496
            )
            
            
            16.1
            %Expense
      in excess of lease payments
            
            $
            15,822
            
            
            $
            20,061
            
            
            $
            (4,239
            )
            
            
            (21.1
            %)





Our
property-related expense associated with our leases exceeded our actual lease
payments by $15.8 million and $20.1 million for the nine months ended September
30, 2008 and 2007, respectively.  The impact of lease accounting
decreased by $4.2 million in the first three quarters of the current year from
the comparable period last year due primarily to a reduction in interest expense
on the capital leases in connection with the normal paydown of the lease
obligation and the termination of leases from the acquisition of the formerly
leased communities, partially offset by increases due to the Summerville
acquisition.  Notwithstanding the effects of lease accounting
treatment,





34
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





the
actual lease payments required under most of our leases will continue to
increase annually and, as a result, we will need to improve our results from
community operations to cover these increases.  However, in the nine
months ended September 30, 2008, the actual lease payments increased over the
comparable period in the prior year due to the acquisition transactions
discussed in Note 4 to the Unaudited Condensed Consolidated Financial
Statements.








35
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Same
Community Comparison





Of our
255 communities, we have operated 166 communities continuously since January 1,
2007, which we refer to as our “same communities.”  The following
table sets forth a comparison of same communities' results of operations for the
three months ended September 30, 2008 and 2007, respectively, excluding general
and administrative expenses.





Three
      Months Ended September 30,(In
      thousands)$D
            
            
            %
      D2008
            
            
            2007
            
            
            Fav
      / (Unfav)
            
            
            Fav
      / (Unfav)Revenue
            
            $
            113,473
            
            
            $
            106,295
            
            
            $
            7,178
            
            
            
            6.8
            %Community
      operations *
            
            
            (72,907
            )
            
            
            (67,973
            )
            
            
            (4,934
            )
            
            
            (7.3
            )Community
      operating income
            
            
            40,566
            
            
            
            38,322
            
            
            
            2,244
            
            
            
            5.9Depreciation
      & amortization
            
            
            (14,365
            )
            
            
            (14,923
            )
            
            
            558
            
            
            
            3.7Facility
      lease expense
            
            
            (1,359
            )
            
            
            (4,702
            )
            
            
            3,343
            
            
            
            71.1Operating
      income
            
            
            24,842
            
            
            
            18,697
            
            
            
            6,145
            
            
            
            32.9Interest
      expense, net
            
            
            (20,263
            )
            
            
            (16,470
            )
            
            
            (3,793
            )
            
            
            (23.0
            )Operating
      income after interest expense
            
            $
            4,579
            
            
            $
            2,227
            
            
            $
            2,352
            
            
            
            105.6
            %* exclusive
      of depreciation and amortization and facility lease expense shown
      separately





These
same communities represented $113.5 million or 59.2% of our total community
revenue of $191.8 million for the third quarter of 2008.  Of the $7.2
million increase in same community revenues, $4.5 million was due to
improvements in average revenue per occupied unit and $2.7 million was due to
the increase in the average occupancy rate.




Three
      Months Ended September 30,2008
            
            
            2007
            
            
            $D
            
            %
      DAverage
      monthly revenue per occupied unit
            
            $
            3,418
            
            
            $
            3,280
            
            
            $
            138
            
            
            
            4.2
            %Average
      occupancy rate
            
            
            87.2
            %
            
            
            87.1
            %
            
            
            
            
            
            
            .1
            ppt





The
increase of $4.9 million in community operations expenses for our same
communities was primarily related to normal inflationary increases in
employee-related expenses of $2.5 million including salaries and workers’
compensation expense.  The remainder was primarily related to
increases in various other community operating expenses.





Property-related
expenses (depreciation and amortization, facility lease expense, and interest
expense, net of interest income) for our same communities decreased by
approximately $108,000, which primarily reflects the effect of the termination
of leases from the acquisition of communities formerly leased, which increased
depreciation and amortization by $558,000 and increased interest expense by $3.8
million, while decreasing facility lease expense by $3.3 million.





Operating
income after interest expense for our same communities increased from $2.2
million to $4.6 million for a total increase of $2.4 million from the comparable
period of 2007, primarily as a result of an increase in operating income and of
the property-related expenses discussed above.  We will continue our
efforts to build our occupancy through increased marketing initiatives, programs
that address resident mix and a focus on property improvements and other
community-level enhancements to attract additional long-term residents and
increase occupancy while





36
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





maintaining
growth in average monthly revenue per unit.  We believe that these
initiatives will have a positive impact on operating performance over
time.





Liquidity
and Capital Resources





At
September 30, 2008, we had cash on hand of $43.6 million compared to $67.7
million at December 31, 2007.  We had working capital deficits of
$90.7 million and $31.4 million at September 30, 2008 and December 31, 2007,
respectively.





We have
incurred significant operating losses since our inception.  Due to the
nature of our business, it is not unusual to operate in the position of a
working capital deficit because revenues are collected more quickly, often in
advance, than obligations are required to be paid.  The result is a
very low level of current assets to the extent cash has been deployed in
business development opportunities or to pay down long-term
liabilities.  Along those lines, the working capital deficit at
September 30, 2008, includes $28.8 million of deferred revenue and unearned
rental income, which will not require a future outlay of cash.  The
level of current liabilities is not expected to change from period to period in
such a way as to require the use of significant cash in excess of normal
requirements, except for (i) the current portion of long-term debt of $79.4
million due by September 30, 2009, and (ii) long-term debt maturities of $50.1
million due after September 2009 but prior to September 30, 2010, which the
Company plans to refinance prior to their due dates or will pay them at
maturity.





While we
have reported positive cash flows from operating activities over the past three
years, our cash flows have not always been sufficient to pay all of our
long-term obligations and we have been dependent upon third-party financing or
disposition of assets to fund operations.  We cannot guarantee that,
if necessary in the future, such transactions will be readily available to us,
or on terms attractive to us, but we believe that we will be able to sustain
positive operating cash flow or have adequate cash reserves and sources of
capital for all necessary investing and financing activities including required
debt service and capital expenditures through at least the next 12
months.  In February 2008, we obtained a $25.0 million unsecured
revolving line of credit as described below.





The
following is a summary of cash flow information for the nine months ended
September 30, 2008 and 2007 (in thousands):





Nine
      Months Ended September 30,2008
            
            
            2007Cash
      provided by operating activities
            
            $
            56,457
            
            
            $
            30,555Cash
      used in investing activities
            
            
            (574,651
            )
            
            
            (785,752
            )Cash
      provided by financing activities
            
            
            494,125
            
            
            
            807,719Net
      increase (decrease) in cash and cash equivalents
            
            
            (24,069
            )
            
            
            52,522Cash
      and cash equivalents at the beginning of the period
            
            
            67,710
            
            
            
            14,049Cash
      and cash equivalents at the end of the period
            
            $
            43,641
            
            
            $
            66,571





In the
first nine months of 2008 and in each of the previous three years, we reported
positive net cash from operating activities in our consolidated statements of
cash flows.  The increase in cash provided by operating activities in
the first nine months of 2008 compared to the prior year period is due primarily
to the additional cash flow as a result of the completion of the Summerville
acquisition in September 2007, the strength of the performance of the
communities we operated during both periods, and fluctuations in the timing of
receivables and payables.  Additionally, by purchasing the real estate
underlying leased facilities, we replaced lease payments with lower levels of
debt service and also avoided future scheduled lease escalators.





The
decrease in cash used in investing activities was primarily due to the number of
current year acquisitions as compared to the prior period.  In the
first nine months of 2008, we purchased 43 communities that we previously
operated under lease agreements and purchased one additional
community.  In the first nine months of 2007, we purchased 88
communities that we previously operated under lease agreements and eight
communities previously leased by Summerville.  As a result, cash paid
for





37
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





acquisitions
of property and equipment amounted to $575.0 million in the nine months of 2008
compared to $784.9 million in the prior year period.





The
decrease in net cash provided by financing activities is related to the decrease
in acquisitions discussed above.  The prior year acquisitions were
financed in part with $330.9 million in cash proceeds from the public offering
of Emeritus common stock.  Proceeds from long-term borrowings, net of
repayments, totaled $500.7 million compared to $473.9 million in the prior year
period.







Our debt
obligations maturing in the 24 months subsequent to September 30, 2008,
excluding scheduled principal payments on amortizing loans, are as follows (in
thousands).  The Company is currently evaluating the exercise of
one-year extension options available on the variable rate debt due September
2009 totaling $76.0 million, or looking at other refinancing
alternatives:





AtSeptember
      30,2008Variable
      rate note, interest only at LIBOR plus 1.70%, due September 2009(1)
            
            $
            26,200Variable
      rate note, interest only at LIBOR plus 1.70%, due September 2009(1)
            
            
            49,800Variable
      rate note, interest only at LIBOR plus 2.25%, due January 2010(2)
            
            
            11,326Variable
      rate note, interest only at LIBOR plus 2.65%, due March 2010 (3)
            
            
            7,250Variable
      rate note, interest only at LIBOR plus 2.90%, due April 2010 (4)
            
            
            23,414Variable
      rate note, interest only at LIBOR plus 2.00%, due July 2010 (5)
            
            
            3,009Other
            
            
            23Debt
      obligations due by October 1, 2010
            
            $
            121,022








(1)   Represents
the variable rate portion of mortgage loans provided by Capmark for the purchase
of 41 communities from HCPI in August 2007.





(2)   Represents
financing provided by KeyBank for a newly constructed community in Ohio that we
purchased in  December 2007.  The interest rate is
effectively fixed at 4.965% with an interest rate swap.





(3)  Represents a construction loan with Capmark entered into in
April 2008 for the development of an Alzheimer’s community in Illinois; the loan
commitment is for $8.0 million.





(4)   Mortgage
financing provided by Capmark for the purchase of seven communities from HCPI in
March 2007; 2.0% exit fee due upon retirement unless refinanced by
Capmark.





38
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





(5)   Represents
a construction loan with Guaranty Bank entered into in February 2007 for the
development of an Alzheimer’s community in Iowa; the loan commitment is for $7.4
million.





In April
2008, we refinanced the mortgage debt on 23 of our existing properties, which
provided net cash proceeds of $25.6 million.  We also extended the
term of a $21.4 million note payable due in March 2008 to March 2009, which in
October 2008 was further extended to March 2012.  We will need to
continue our improvements in operating performance or seek other sources of cash
to meet our payment obligations in future years.  The United States
economy experienced a significant decline in the housing market and a related
weakness in the availability and affordability of credit during 2007 that has
reached a crisis level in 2008.  We believe that the slowdown in the
housing market and the constriction of credit are likely to continue throughout
2009.  Moreover, leading economic indicators such as employment levels
and income growth predict a continuing downward trend in the United States
economy during the next year, and most likely a recession.  However,
we believe that need-driven demand for our services continues to grow and
remains resilient, in spite of the overall housing and economic concerns, as
evidenced by the relative stability in occupancy, improvements in cash flows,
and our ability to finance the acquisition of 141 properties during 2007 and
2008, including the acquisition of 24 NHP communities completed in April 2008
and the acquisition of 29 HCN communities in June and October of
2008.










On
February 8, 2008, we entered into a credit agreement with Wells Fargo Bank,
National Association, which provides a $25.0 million unsecured revolving line of
credit.  The credit agreement permits us to borrow from time to time
up to $25.0 million on an unsecured basis.  The credit agreement also
allows us to obtain letters of credit from the lender, provided that outstanding
letters of credit and any borrowings outstanding do not exceed $25.0
million  (see Note 5, Long-Term Debt, for further
details).  There were no outstanding borrowings under the line of
credit as of September 30, 2008.





39
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





The
following table summarizes our contractual obligations at September 30, 2008,
(in thousands):





Principal
      and Lease Payments Due by PeriodAfter
      5Contractual Obligations
            
            Total
            
            
            1 year
            
            
            2-3 years
            
            
            4-5 years
            
            
            yearsLong-term
      debt, including current portion
            
            $
            1,257,173
            
            
            $
            79,403
            
            
            $
            119,666
            
            
            $
            215,689
            
            
            $
            842,415Capital
      lease and financing obligations,including
      current portion
            
            
            232,110
            
            
            
            10,057
            
            
            
            23,382
            
            
            
            29,463
            
            
            
            169,208Operating
      leases
            
            
            841,609
            
            
            
            67,610
            
            
            
            138,195
            
            
            
            141,383
            
            
            
            494,421$
            2,330,892
            
            
            $
            157,070
            
            
            $
            281,243
            
            
            $
            386,535
            
            
            $
            1,506,044





The
following table summarizes interest on our contractual obligations at September
30, 2008, (in thousands):








Interest
      Due by PeriodAfter
      5Contractual Obligations
            
            Total
            
            
            1 year
            
            
            2-3 years
            
            
            4-5 years
            
            
            yearsLong-term
      debt
            
            $
            565,850
            
            
            $
            80,809
            
            
            $
            150,389
            
            
            $
            118,086
            
            
            $
            216,566Capital
      lease and financing obligations
            
            
            147,863
            
            
            
            17,561
            
            
            
            32,933
            
            
            
            29,279
            
            
            
            68,090$
            713,713
            
            
            $
            98,370
            
            
            $
            183,322
            
            
            $
            147,365
            
            
            $
            284,656








Recent
Accounting Pronouncements





For a
discussion of recently issued accounting pronouncements, see Note 2, Summary
of Significant Accounting Policies and Use of Estimates,to the Unaudited
Condensed Consolidated Financial Statements included in this
report.





Impact of Inflation





To date,
inflation has not had a significant impact on us.  Inflation could,
however, affect our cost of doing business, and consequently, our operating
income due to limitations on our ability to increase monthly rates because of
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, which accounted for approximately 8.4% of
revenues for the nine months ended September 30, 2008.  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.  The near-term negative economic outlook in the United States
may impact our ability to raise our prices.





Non-GAAP
Measures





A
non-GAAP financial measure is generally defined as one that purports to measure
historical or future financial performance, financial position, or cash flows,
but excludes or includes amounts that would not be included in most GAAP
measures.  In this report, we define and use the non-GAAP financial
measure of Adjusted EBITDA/EBITDAR, as set forth below:





Definition of Adjusted
EBITDA/EBITDAR:





We define
Adjusted EBITDA/EBITDAR as net loss adjusted for:





·
            gains
      or losses, net of tax, in discontinued
  operations,





40
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





·
            provision
      or benefit for income taxes,


·
            equity
      earnings or losses in unconsolidated joint
  ventures,


·
            gains
      or losses on sale of assets , termination of leases, or
      investments,


·
            depreciation
      and amortization,


·
            impairment
      losses,


·
            amortization
      of deferred gains,


·
            non-cash
      stock option compensation expense,


·
            interest
      expense,


·
            change
      in fair value of interest rate
swaps,


·
            loan
      prepayment fees and debt refinancing
costs,


·
            interest
      income, and


·
            other
      non-cash unusual adjustments





Definition of Adjusted
EBITDAR:





We define
Adjusted EBITDAR as Adjusted EBITDA adjusted for facility lease
expense.





Management's Use of Adjusted
EBITDA/EBITDAR:





We use
Adjusted EBITDA/EBITDAR to assess our overall financial and operating
performance.  We believe these non-GAAP measures, as we have defined
them, are useful in identifying trends in our day-to-day performance
because they exclude items that have little or no significance to our
day-to-day operations.  These measures provide an assessment of
controllable expenses and afford management the ability to make decisions, which
are expected to facilitate meeting current financial goals, as well as achieve
optimal financial performance.  These measures also provide indicators
for management to determine if adjustments to current spending levels are
needed.





Adjusted
EBITDA/EBITDAR provide us with measures of financial performance, independent of
items that are beyond the control of management in the short-term, such as
depreciation and amortization, taxation, interest expense, and lease expense
associated with our capital structure.  These metrics measure our
financial performance based on operational factors that management can influence
in the short-term, namely the cost structure or expenses of the
organization.  Adjusted EBITDA/EBITDAR are some of the metrics used by
senior management to review the financial performance of the business on a
monthly basis and are used by research analysts and investors to evaluate the
performance and value of the companies in our industry.





Limitations of Adjusted
EBITDA/EBITDAR:





Adjusted
EBITDA/EBITDAR have limitations as analytical tools.  Material
limitations in making the adjustments to our losses to calculate Adjusted
EBITDA/EBITDAR and using this non-GAAP financial measure as compared to GAAP net
loss includes:





·
            The
      items excluded from the calculation of Adjusted EBITDA/EBITDAR generally
      represent income or expense items that may have a significant effect on
      our financial results,


·
            Items
      determined to be non-recurring in nature could, nevertheless, re-occur in
      the future, and


·
            Depreciation
      and amortization, while not directly affecting our current cash position,
      does represent wear and tear and/or reduction in value of our
      properties.  If the cost to maintain our properties exceeds our
      expected routine capital expenditures, then this could affect our ability
      to attract and retain long-term residents at our
    communities.





An
investor or potential investor may find this important in evaluating our
performance and results of operations.  We use these non-GAAP measures
to provide a more complete understanding of the factors and trends affecting our
business.





41
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Adjusted
EBITDA/EBITDAR are not alternatives to net loss, loss from continuing
operations, or cash flows provided by or used in operating activities as
calculated and presented in accordance with GAAP.  You should not rely
on Adjusted EBITDA/EBITDAR as substitutes for any such GAAP financial
measure.  We strongly urge you to review the reconciliation of GAAP
net loss to Adjusted EBITDA/EBITDAR presented below, along with our consolidated
balance sheets, statements of operations, and cash flows.  In
addition, because Adjusted EBITDA/EBITDAR are not measures of financial
performance under GAAP and are susceptible to varying calculations, this measure
as presented may differ from and may not be comparable to similarly titled
measures used by other companies.





The table
below shows the reconciliation of net loss to Adjusted EBITDA/EBITDAR for the
three and nine months ended September 30, 2008 and 2007:





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2008
            
            
            2007
            
            
            2008
            
            
            2007Net
      loss
            
            $
            (23,076
            )
            
            $
            (11,573
            )
            
            $
            (74,278
            )
            
            $
            (22,897
            )Provision
      for income taxes
            
            
            270
            
            
            
            (1,290
            )
            
            
            750
            
            
            
            30Equity
      losses (gains) in unconsolidated joint ventures
            
            
            33
            
            
            
            805
            
            
            
            890
            
            
            
            (5,691
            )Depreciation
      and amortization
            
            
            29,199
            
            
            
            20,046
            
            
            
            89,554
            
            
            
            48,670Amortization
      of deferred gains
            
            
            (130
            )
            
            
            (464
            )
            
            
            (1,134
            )
            
            
            (1,567
            )Non-cash
      stock option compensation expenses
            
            
            968
            
            
            
            2,133
            
            
            
            3,786
            
            
            
            3,456Convertible
      debentures conversion costs
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,329Debt
      refinancing fees
            
            
            -
            
            
            
            -
            
            
            
            1,090
            
            
            
            -Interest
      expense
            
            
            25,169
            
            
            
            18,403
            
            
            
            68,952
            
            
            
            48,736Change
      in fair value of interest rate swaps
            
            
            119
            
            
            
            -
            
            
            
            (16
            )
            
            
            -Interest
      income
            
            
            (480
            )
            
            
            (2,618
            )
            
            
            (1,915
            )
            
            
            (3,799
            )Discontinued
      operations
            
            
            474
            
            
            
            525
            
            
            
            5,840
            
            
            
            1,285Other
      non-cash unusual activity:Professional
      and workers' compensation liability adjustments
            
            
            (630
            )
            
            
            (27
            )
            
            
            (2,485
            )
            
            
            (1,695
            )Adjusted
      EBITDA
            
            
            31,916
            
            
            
            25,940
            
            
            
            91,034
            
            
            
            67,857Facility
      lease expense
            
            
            22,339
            
            
            
            12,205
            
            
            
            66,968
            
            
            
            29,655Adjusted
      EBITDAR
            
            $
            54,255
            
            
            $
            38,145
            
            
            $
            158,002
            
            
            $
            97,512





Subsequent
Events





For a
discussion of subsequent event, see Note 13, Subsequent Events, to the Unaudited
Condensed Consolidated Financial Statements included in this
report.











42
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
 RESULTS
OF OPERATIONS
 Continued
 September
30, 2008


Table of Contents





Item 3.  Quantitative and Qualitative Disclosures About
Market Risk





Our
earnings are affected by changes in interest rates as a result of our short-term
and long-term borrowings.  At September 30, 2008, we had approximately
$138.6 million of variable rate borrowings based on the LIBOR.  As of
September 30, 2008, our weighted average variable rate is 2.16% in excess of the
LIBOR.  For every 1% change in the LIBOR, our interest expense will
change by approximately $1.4 million annually.  This analysis does not
consider changes in the actual level of borrowings or operating lease
obligations that may occur subsequent to September 30, 2008.  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.





We
currently have a $19.6 million interest rate swap contract that matures in
August 2012 and a $12.4 million interest rate swap contract that matures in
January 2010.  A 100 basis point increase in interest rates would
increase the combined fair value of these swaps by approximately $817,000 and a
100 basis point decrease in interest rates would decrease the combined fair
value of these swaps by approximately $850,000.





The
downturn in the United States housing market in 2007 triggered a constriction in
the availability of credit that is expected to continue for the remainder of
2008 and into 2009.  This could impact our ability to borrow money or
refinance existing obligations at acceptable rates of interest.  Thus
far, we have experienced no significant barriers to obtaining credit and do not
expect to in the near future.  See “Management’s Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources.”





Item 4.  Controls and Procedures





(a)  Evaluation of disclosure controls
and procedures.





Our
co-chief executive officers and our chief financial officer, after evaluating
the effectiveness of our “disclosure controls and procedures” (as defined in
Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the
period covered by this quarterly report, have concluded that, as of that date,
our disclosure controls and procedures were effective.





(b)
            Changes
      in internal controls





We also
carried out an evaluation of the internal control over financial reporting to
determine whether any changes occurred during the period covered by this
report.  Based on such evaluation, there has been no change in our
internal control over financial reporting that occurred during the most recently
completed fiscal quarter ended September 30, 2008, that materially affected, or
is reasonably likely to materially affect, our internal control over financial
reporting.











[The rest
of this page is intentionally left blank]





43


Table of Contents


PART II.  OTHER INFORMATION





Items
2, 3, 4, and 5 are not applicable.





Item 1.  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.  Accruals for these claims are 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.





Item 1A.  Risk Factors





In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual
Report on Form 10-K for the year ended December 31, 2007, which could materially
affect our business, financial condition or future results.  The risks
described in our Annual Report on Form 10-K are not the only risks facing our
Company.  Additional risks and uncertainties not currently known to us
or that we currently deem to be immaterial also may materially adversely affect
our business, financial condition and/or operating results.





Item 6.  Exhibits





See
      Index to Exhibits, which is incorporated by
  reference.





44


Table of Contents








SIGNATURE





Pursuant
to the requirements 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:  November
      10, 2008
            EMERITUS
      CORPORATION(Registrant)/s/
      Raymond R. BrandstromRaymond
      R. Brandstrom, Executive Vice President - Finance, Chief Financial
      Officer, and Secretary





45


Table of Contents




Index to Exhibits





FootnoteNumber
            
            Description
            
            Number10.2
            
            Amended
      and Restated Stock Option Plan for Nonemployee Directors (as amended
      throughDecember
      7, 2005).
            
            (1)10.3
            
            Amended
      and Restated 1998 Employee Stock Purchase Plan (as amended and
      restatedas
      of March 26, 2008).10.57
            
            Documents
      Relating to Purchase and Financing of Communities from Fretus Investors
      (24 Communities).10.57.07
            First
      Amendment to Loan Agreement (Amended and Restated) dated April 25, 2008,
      among 23limited
      liability companies and limited partnerships, collectively as borrower,
      and CapmarkBank,
      as lender.
            
            (2)10.57.08
            Amended
      and Restated Promissory Note of borrower dated May 1, 2008, in
      theprincipal
      amount of $16.8 million payable to Capmark Bank.
            
            (2)10.57.09
            Freddie
      Mac Security, Assignment and Subordination Agreement For Operating Lease
      datedApril
      25, 2008, among Emeritus Properties-NGH, LLC, Capmark Bank, and Fretus
      InvestorsChandler
      LLC. Representative example of 18 communities, which in total equal $129
      million.
            
            (2)10.57.10
            Multifamily
      Note dated April 25, 2008, between Fretus Investors Chandler LLC
      andCapmark
      Bank. Representative example of 18 communities which in total equal $129
      million.
            
            (2)10.59
            
            Documents
      Relating to Purchase and Financing of Communities from Alterra Healthcare
      Corporation (5 Communities)10.59.05
            Fannie
      Mae Multifamily Mortgage, Assignment of Rents and Security Agreement dated
      April30,
      2008, between Emerikeyt Liberal Springs, LLC and Keycorp Real
      Estate
            
            (2)Capital
      Markets, Inc in the principal amount of $5.3 million.10.59.06
            Fannie
      Mae Subordination, Assignment and Security Agreement dated
      April30,
      2008, between Emerikeyt Palms at Loma Linda Inc and Keycorp Real
      EstateCapital
      Markets, Inc in the principal amount of $14.5 million.
            
            (2)10.59.07
            Fannie
      Mae Subordination, Assignment and Security Agreement dated
      April30,
      2008, between Emerikeyt Springs at Oceanside Inc. and Keycorp Real
      EstateCapital
      Markets, Inc in the principal amount of $14.5 million.
            
            (2)10.59.08
            Fannie
      Mae Multifamily Note dated April 30, 2008, in the principal amount of $5.3
      millionbetween  Emerikeyt
      Liberal Springs, LLC and Keycorp Real Estate Capital Markets,
      Inc
            
            (2)10.59.09
            Fannie
      Mae Multifamily Note dated April 30, 2008, in the principal amount of
      $14.5 millionbetween  Emerikeyt
      Palms at Loma Linda Inc and  Keycorp Real Estate Capital
      Markets, Inc
            
            (2)10.59.10
            Fannie
      Mae Multifamily Note dated April 30, 2008, in the principal amount of $5.6
      millionbetween
      Emerikeyt Springs at Oceanside Inc. and  Keycorp Real Estate
      Capital Markets, Inc.
            
            (2)10.59.11
            Loan
      Agreement dated April 25, 2008, by and between Emerikeyt Fairways of
      Augusta LLCand
      Keybank National Association for $4.1 million
            
            (2)10.59.12
            Loan
      Agreement dated April 25, 2008, by and between Emerikeyt Lo of Broadmoor
      LLCand
      Keybank National Association for $9,3 million
            
            (2)10.59.13
            Promissory
      Note dated April 25, 2008, Emerikeyt Fairways of Augusta LLC payable
      toKeybank
      National Association for principal amount of $4.1 million
            
            (2)10.59.14
            Promissory
      Note dated April 25, 2008, Emerikeyt Lo of Broadmoor LLC payable
      toKeybank
      National Association for principal amount of $9.3 million.10.7
            
            Documents
      Relating to the Purchase of communities from Nationwide Health Properties,
      Inc. (NHP)(24
      communities)10.70.02
            First
      Amendment to Purchase and Sale Agreement dated March 25, 2008, by and
      among NationwideHealth
      Properties, Inc. and its affiliated signatories and Emeritus
      Corporation
            
            (1)10.70.03
            Master
      Credit Facility Agreement dated April 1, 2008, by and among Borrowers
      signatoryhereto
      and Capmark Finance, Inc.
            
            (1)10.70.04
            Master
      Promissory Note of Emeritus Corporation dated April 1, 2008, in the
      principal amount of $241.9 millionpayable
      to Capmark Bank.
            
            (1)10.70.05
            Promissory
      Note of Emeritus Corporation dated March 31, 2008, in the
      principalamount
      of $30.0 million payable to Nationwide Health Properties,
    Inc.
            
            (1)10.70.06
            Promissory
      Note of Emeritus Corporation dated April 1, 2008, in the
      principalamount
      of $8.0 million payable to Nationwide Health Properties,
    Inc.
            
            (2)10.71
            
            Documents
      Relating to the Purchase and Financing of Communities from Health Care
      REIT, Inc.  (HCN)(29
      Communities in two phases:  Phase 1: 19 communities, Phase 2: 10
      communities )10.71.01
            Asset
      Purchase Agreement dated June 9, 2008, by Emeritus Corporation and Health
      Care REIT,Inc.
      together with the affiliates of HCN
            
            (2)10.71.02
            First
      Amendment to the Asset Purchase Agreement dated June 30, 2008, by and
      between EmeritusCorporation
      and Health Care REIT, Inc. together with the affiliates of
    HCN
            
            (2)10.71.03
            Freddie
      Mac Multifamily Mortgage, Assignment of Rents and Security Agreement
      effectiveJune
      30, 2008, between Emeritol Woods at Eddy Pond LLC and KeyCorp Real Estate
      CapitalMarkets,
      Inc. Representative example of 19 communities, which in total equal $163.2
      million.
            
            (2)10.71.04
            Freddie
      Mac Multifamily Note effective June 30, 2008, Emeritol Woods at Eddy
      PondLLC
      jointly and severally promises to pay Keycorp Real Estate Capital Markets,
      Inc.Representative
      example of 19 communities, which in total equal $163.2
      million.
            
            (2)10.71.05
            Promissory
      Note of Emeritus Corporation dated June 30, 2008, in the principal amount
      of $50.0 million payable toHealth
      Care REIT, Inc.
            
            (2)10.72
            
            Documents
      Relating to the Purchase of Communities from Ventas Realty,
      LP.(5
      Communities) Dated 200810.72.01
            Agreement for the Sale of Real
      Estate dated July 25, 2008 between Ventas Realty LP and
      EmeritusCorporation
      for the property commonly referred to as Atherton Court Alzheimer's
      Residence
            
            (3)10.72.02
            Agreement for the Sale of Real
      Estate dated July 25, 2008 between Ventas Realty LP and
      EmeritusCorporation
      for the property commonly referred to as Golden Pond Assisted
      Living
            
            (3)10.72.03
            Agreement for the Sale of Real
      Estate dated July 25, 2008 between Ventas Realty LP and
      EmeritusCorporation
      for the property commonly referred to as Summerville at
      Brighton
            
            (3)10.72.04
            Agreement for the Sale of Real
      Estate dated July 25, 2008 between Ventas Realty LP and
      EmeritusCorporation
      for the property commonly referred to as Summerville at Lake
      Mary
            
            (3)10.72.05
            Agreement for the Sale of Real
      Estate dated July 25, 2008 between Ventas Realty LP and
      EmeritusCorporation
      for the property commonly referred to as Summerville at
    Mentor
            
            (3)10.73
            
            Documents
      Relating to the Lease of Communities from affiliates of HCP (collectively
      "HCP").(11
      Communities) Dated 200810.73.01
            Master Lease and Security Agreement
      dated August 22, 2008 between Affiliates of HCP(collectively
      "HCP") and Emeritus Corporation (11 communities)
            
            (3)31.1
            
            
            Certification
      of Periodic Reports31.1.1
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 302of
      the Sarbanes-Oxley Act of 2002 for Daniel R. Baty dated November 10,
      2008.
            
            (3)31.1.2
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 302of
      the Sarbanes-Oxley Act of 2002 for L. Granger Cobb dated November 10,
      2008.
            
            (3)31.1.3
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 302of
      the Sarbanes-Oxley Act of 2002 for Raymond R. Brandstrom dated November
      10, 2008.
            
            (3)32.1
            
            
            Certification
      of Periodic Reports32.1.1
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 906of
      the Sarbanes-Oxley Act of 2002 for Daniel R. Baty dated November 10,
      2008.
            
            (3)32.1.2
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 906of
      the Sarbanes-Oxley Act of 2002 for L. Granger Cobb dated November 10,
      2008.
            
            (3)32.1.3
            Certification Pursuant to 18
      U.S.C. Section 1350, as Adopted Pursuant to Section
906of
      the Sarbanes-Oxley Act of 2002 for Raymond R. Brandstrom dated November
      10, 2008.
            
            (3)










Footnotes:(1)
            Filed
      as the indicated exhibit to First Quarter Report on Form 10-Q filed
      on May 9, 2008.(2)
            Filed
      as the indicated exhibit to Second Quarter Report on Form 10-Q filed
      on August 8, 2008.(3)
            Filed
      herewith.








46