**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) OF****THE
      SECURITIES EXCHANGE ACT 1934**





For the
quarterly period ended March 31, 2005





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





Commission
file number 1-14012










**EMERITUS
CORPORATION**


(Exact
name of registrant as specified in its charter)





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. [X] Yes [ ] No





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





As of
April 29, 2005, there were 10,853,942 shares of
the Registrant's Common Stock, par value $.0001, outstanding.













**EMERITUS
      CORPORATION****Table of Contents****Part I. Financial
Information**Page
      No.**Item 1. Financial Statements (unaudited):**
    1Condensed Consolidated Balance Sheets as of March 31, 2005, and
      December 31, 2004
    2Condensed Consolidated Statements of Operations for the Three
      Months ended March 31, 2005 and 2004
    3Condensed Consolidated Statements of Cash Flows for the Three
      Months ended March 31, 2005 and 2004
    4Notes to Condensed Consolidated Financial
      Statements
    5**Item 2.**
    **Management's Discussion and Analysis of Financial
      Condition and Results of Operations**
    12**Item 3.**
    **Quantitative and Qualitative Disclosures About Market
      Risk**
    26**Item 4.**
    **Controls and Procedures**
    26**Part II. Other Information**Note:
    Items
      2 through 5 of Part II are omitted because they are not
      applicable.**Item 1.**
    **Legal Proceedings**
    28**Item 6.**
    **Exhibits**
    28**Signature**
    30
















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 CORPORATION****CONDENSED
      CONSOLIDATED BALANCE SHEETS****(unaudited)****(In
      thousands, except share data)****ASSETS****March
      31,**
    
    **December
      31,****2005**
    
    **2004**Current
      Assets:Cash
      and cash equivalents
    
    $
    6,761
    
    $
    10,748Short-term
      investments
    
    
    1,330
    
    
    1,336Trade
      accounts receivable, net of allowance of $740 and $542
    
    
    4,058
    
    
    3,982Other
      receivables
    
    
    1,916
    
    
    2,270Prepaid
      expenses and other current assets
    
    
    20,073
    
    
    18,317Property
      held for sale
    
    
    -
    
    
    7,891Total
      current assets
    
    
    34,138
    
    
    44,544Long-term
      investments
    
    
    6,884
    
    
    6,884Property
      and equipment, net
    
    
    633,066
    
    
    627,047Property
      held for development
    
    
    807
    
    
    807Notes
      receivable from and investments in affiliates
    
    
    3,547
    
    
    3,518Restricted
      deposits
    
    
    8,263
    
    
    7,642Lease
      acquisition costs, net
    
    
    27,151
    
    
    26,625Other
      assets, net
    
    
    2,280
    
    
    2,571Total
      assets
    
    $
    716,136
    
    $
    719,638**LIABILITIES
      AND SHAREHOLDERS' DEFICIT**Current
      Liabilities:Current
      portion of long-term debt
    
    $
    3,068
    
    $
    4,133Current
      portion of capital lease and financing obligations
    
    
    16,748
    
    
    15,479Trade
      accounts payable
    
    
    8,170
    
    
    9,057Accrued
      employee compensation and benefits
    
    
    15,597
    
    
    13,259Accrued
      interest
    
    
    888
    
    
    1,547Accrued
      real estate taxes
    
    
    3,287
    
    
    4,596Accrued
      dividends on preferred stock
    
    
    11,130
    
    
    10,539Accrued
      insurance liability
    
    
    26,797
    
    
    25,903Other
      accrued expenses
    
    
    7,640
    
    
    7,952Deferred
      revenue
    
    
    6,799
    
    
    6,516Unearned
      rental income
    
    
    7,624
    
    
    8,227Convertible
      debentures
    
    
    32,000
    
    
    -Deposit
      on sales contract
    
    
    -
    
    
    9,212Total
      current liabilities
    
    
    139,748
    
    
    116,420Long-term
      debt, less current portion
    
    
    51,385
    
    
    50,528Capital
      lease and financing obligations, less current portion
    
    
    623,601
    
    
    614,046Convertible
      debentures
    
    
    -
    
    
    32,000Deferred
      gain on sale of communities
    
    
    27,670
    
    
    28,517Deferred
      rent
    
    
    4,706
    
    
    4,571Other
      long-term liabilities
    
    
    1,836
    
    
    1,875Total
      liabilities
    
    
    848,946
    
    
    847,957Commitments
      and contingenciesShareholders'
      Deficit:Preferred
      stock, $.0001 par value. Authorized 5,000,000 shares.Series
      B, Authorized 70,000 shares, issued and outstanding 36,604 and 36,242
      shares atMarch
      31, 2005, and December 31, 2004, respectively
    
    
    -
    
    
    -Common
      stock, $.0001 par value. Authorized 40,000,000 shares; issued and
      outstanding10,839,193
      and 10,811,531 shares at March 31, 2005, and December 31, 2004,
      respectively
    
    
    1
    
    
    1Additional
      paid-in capital
    
    
    76,284
    
    
    75,779Accumulated
      deficit
    
    
    (209,095
    )
    
    (204,099
    )Total
      shareholders' deficit
    
    
    (132,810
    )
    
    (128,319
    )Total
      liabilities and shareholders' deficit
    
    $
    716,136
    
    $
    719,638








See
accompanying Notes to Condensed Consolidated Financial Statements and
Management's


Discussion
and Analysis of Financial Condition and Results of Operations.










**2**


Table of Contents







**EMERITUS CORPORATION****CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS****(unaudited)****(In
      thousands, except per share data)****Three
      Months ended March 31,****2005**
    
    **2004**Revenues:Community
      revenue
    
    $
    92,824
    
    $
    62,590Other
      service fees
    
    
    1,714
    
    
    1,348Management
      fees
    
    
    598
    
    
    1,633Total
      operating revenues
    
    
    95,136
    
    
    65,571Expenses:Community
      operations
    
    
    60,760
    
    
    41,774General
      and administrative
    
    
    7,333
    
    
    6,232Depreciation
      and amortization
    
    
    11,343
    
    
    5,432Facility
      lease expense
    
    
    9,737
    
    
    9,577Total
      operating expenses
    
    
    89,173
    
    
    63,015Operating
      income from continuing operations
    
    
    5,963
    
    
    2,556Other
      income (expense):Interest
      income
    
    
    231
    
    
    153Interest
      expense
    
    
    (12,177
    )
    
    (7,606
    )Other,
      net
    
    
    740
    
    
    (183
    )Net
      other expense
    
    
    (11,206
    )
    
    (7,636
    )Loss
      from continuing operations before income taxes
    
    
    (5,243
    )
    
    (5,080
    )Provision
      for income taxes
    
    
    (115
    )
    
    -Loss
      from continuing operations
    
    
    (5,358
    )
    
    (5,080
    )Income
      from discontinued operations
    
    
    1,319
    
    
    58Net
      loss
    
    
    (4,039
    )
    
    (5,022
    )Preferred
      stock dividends
    
    
    (957
    )
    
    (920
    )Net
      loss to common shareholders
    
    $
    (4,996
    )
    $
    (5,942
    )Basic
      and diluted income (loss) per common share:Continuing
      operations
    
    $
    (0.58
    )
    $
    (0.59
    )Discontinued
      operations
    
    
    0.12
    
    
    0.01$
    (0.46
    )
    $
    (0.58
    )Weighted
      average common shares outstanding:Basic
      and diluted
    
    
    10,821
    
    
    10,310








See
accompanying Notes to Condensed Consolidated Financial Statements and
Management's


Discussion
and Analysis of Financial Condition and Results of Operations.










**3**


Table of Contents





**EMERITUS CORPORATION****CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS****(unaudited)****(In
      thousands)****Three
      Months Ended March 31,****2005**
    
    **2004**Cash
      flows from operating activities:Net
      loss
    
    $
    (4,039
    )
    $
    (5,022
    )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
    
    
    11,343
    
    
    5,507Amortization
      of deferred gain
    
    
    (554
    )
    
    (596
    )Gain
      on sale of properties, net
    
    
    (1,321
    )
    
    -Write
      down of lease acquisition costs
    
    
    37
    
    
    -Write
      down of loan fees and amortization
    
    
    179
    
    
    -Equity
      investment losses
    
    
    -
    
    
    794Provision
      for doubtful accounts
    
    
    20
    
    
    -Other
    
    
    25
    
    
    -Changes
      in operating assets and liabilities, net of acquisitions:
    
    
    (761
    )
    
    (3,048
    )Net
      cash provided by (used in) operating activities
    
    
    4,929
    
    
    (2,365
    )Cash
      flows from investing activities:Acquisition
      of property and equipment
    
    
    (2,098
    )
    
    (846
    )Acquisition
      of assets in lease transactions
    
    
    (406
    )
    
    -Sale
      of property and equipment
    
    
    -
    
    
    165Management
      and lease acquisition costs
    
    
    (1,458
    )
    
    (302
    )Advances
      to affiliates and other managed communities
    
    
    (152
    )
    
    13Investment
      in affiliates
    
    
    (33
    )
    
    (303
    )Collection
      of notes receivable
    
    
    -
    
    
    2,657Net
      cash provided by (used in) investing activities
    
    
    (4,147
    )
    
    1,384Cash
      flows from financing activities:Increase
      in restricted deposits
    
    
    (621
    )
    
    (582
    )Debt
      issue and other financing costs
    
    
    (201
    )
    
    (101
    )Proceeds
      from long-term borrowings and financing obligations
    
    
    21,426
    
    
    -Repayment
      of long-term borrowings
    
    
    (21,736
    )
    
    (1,390
    )Repayment
      of capital lease and financing obligations
    
    
    (3,776
    )
    
    (1,345
    )Other
    
    
    139
    
    
    321Net
      cash used in financing activities
    
    
    (4,769
    )
    
    (3,097
    )Net
      decrease in cash and cash equivalents
    
    
    (3,987
    )
    
    (4,078
    )Cash
      and cash equivalents at the beginning of the period
    
    
    10,748
    
    
    6,368Cash
      and cash equivalents at the end of the period
    
    $
    6,761
    
    $
    2,290Supplemental
      disclosure of cash flow information -cash
      paid during the period for interest
    
    $
    12,836
    
    $
    8,089Noncash
      investing and financing activities:Accrued
      and in-kind preferred stock dividends
    
    $
    957
    
    $
    920Debt
      issued for acquisition of property and equipment
    
    $
    92
    
    $
    -Capital
      lease and financing obligations
    
    $
    14,600
    
    $
    -Reduction
      in property held for sale and related deposit
    
    $
    7,891
    
    $
    -





See
accompanying Notes to Condensed Consolidated Financial Statements and
Management's


Discussion
and Analysis of Financial Condition and Results of Operations















**4**


Table of Contents


**EMERITUS CORPORATION**


**NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**(unaudited)**





**Definitions**





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





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


2.
    "SFAS"
      refers to Statement of Financial Accounting
Standards.


3.
    "SEC"
      refers to the Securities and Exchange
Commission.


4.
    "REIT"
      refers to real estate investment trust.


5.
    "LIBOR"
      is the London Interbank Offering Rate.


6.
    "Mr.
      Baty" refers to Daniel R. Baty, the Company's chairman of the board of
      directors and chief executive officer.


7.
    "Triple-net
      lease" means a lease under which the lessee pays all operating expenses of
      the property, including taxes, licenses, utilities, maintenance, and
      insurance. The lessor receives a net rent.


8.
    "N/A"
      in a table means not applicable.


9.
    "N/M"
      in a table means not meaningful.





**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, and litigation.
Emeritus bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates 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 2004 Form 10-K filed March 31, 2005.





**Recent
Accounting Pronouncements and Proposed Statements**





In
December 2004, the FASB issued Statement of Financial Accounting Standards No.
123 (revised 2004), *Share-Based
Payment* (“SFAS
No. 123R”) . This
statement requires the Company to recognize expense for compensation cost
related to share-based payments, including stock options and employee stock
purchase plans, in its consolidated statement of operations. SFAS No. 123R would
eliminate the Company’s ability to account for share-based awards to employees
using Accounting Principles Board ("APB") Opinion 25, “ *Accounting
for Stock Issued to Employees”* and would
require that the transactions use a fair value method as of the grant
date *.* SFAS No.
123R addresses the accounting for transactions in which the Company receives
employee services in exchange for equity instruments or liabilities that are
based on the fair value of the Company’s equity instruments or that may be
settled through the issuance of such equity instruments. On April 14, 2005, the
SEC adopted a new rule that amends the compliance dates for SFAS No. 123R. Under
the new rule, the Company is required to adopt SFAS No. 123R in the first
quarter of fiscal 2006, beginning January 1, 2006. The Company has not yet
determined the method of adoption or the effect of adopting SFAS No. 123R, and
it has not determined whether the adoption will result in amounts that are
similar to the current pro forma disclosures under SFAS No. 123. The Company is
currently evaluating the impact of this statement on its financial
statements.








**5**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


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 condensed
consolidated financial position, results of operations, and cash flows of
Emeritus as of March 31, 2005, and for the three months ended March 31, 2005 and
2004. The results of operations for the period ended March 31, 2005, are not
necessarily indicative of the operating results for the full year. The Company
presumes that those reading this interim financial information have read or have
access to its 2004 audited consolidated financial statements and Management's
Discussion and Analysis of Financial Condition and Results of Operations that
are contained in the 2004 Form 10-K filed March 31, 2005. Therefore, the Company
has omitted footnotes and other disclosures herein, which are disclosed in the
Form 10-K.





**Reclassifications**





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





**Stock-Based
Compensation**





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





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







**Three
      Months ended****March
      31,****2005**
    
    **2004****(In
      thousands, except per share data )**Net
      loss to common shareholdersAs
      reported
    
    $
    (4,996
    )
    $
    (5,942
    )Add:
      Stock-based employee compensation expenseincluded
      in reported net income (loss)
    
    
    -
    
    
    -Deduct:
      Stock-based employee compensationdetermined
      under fair value based method for all awards
    
    
    (145
    )
    
    (278
    )Pro
      forma
    
    $
    (5,141
    )
    $
    (6,220
    )Net
      loss per common share:As
      reported - basic and diluted
    
    $
    (0.46
    )
    $
    (0.58
    )Pro
      forma - Basic and diluted
    
    $
    (0.48
    )
    $
    (0.60
    )





The
Company estimates the fair value of its options using the Black-Scholes option
value model, which is one of several methods that can be used to estimate option
values. The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. Option valuation models require the input of highly
subjective assumptions, including the expected stock price volatility. The
Company's options have characteristics significantly





**6**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


Table of Contents


different
from those of traded options and changes in the subjective input assumptions can
materially affect the fair value estimates. No options were granted to employees
in 2004 and the first quarter of 2005.





**Emeritrust
Transactions**





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





*Emeritrust I
Communities Management.* In
the first quarter of 2003, the Company managed 25 Emeritrust I communities
under a management agreement providing for a base fee of 3% of gross revenues
generated by the communities and an additional management fee of 4% of gross
revenues, payable to the extent of 50% of cash flow from the communities. This
management agreement, as extended several times, expired at the end of 2003. On
January 2, 2004, the Emeritrust I investors entered into a new management
agreement with the Company providing for management fees computed on the same
basis and (i) terminating all options to purchase the communities, (ii)
terminating any further funding obligation, and (iii) providing for a term
expiring September 30, 2005, provided that either party may terminate the
agreement on 90 days notice. Effective April 1, 2004, the Emeritrust I owners
extended the underlying financing on the Emeritrust I communities. In connection
with the financing extension, the management agreement was amended to provide
for a flat management fee of 5% of gross revenues and amended the term to March
31, 2005. A one-year extension to March 31, 2006, was exercised but the
management agreement is subject to termination by either party on short notice.
Sixteen communities were leased pursuant to leases discussed below, four
communities had been disposed of by the Emeritrust I owners and five communities
continue to be managed by the Company in the first quarter of 2005. The Company
received management fees (net of its funding obligations) of approximately
$127,000, and $640,000 for the three months ended March 31, 2005 and 2004
respectively.





*Emeritrust
I Communities Lease.* On
September 30, 2004, the Company completed the first phase of a transaction to
lease (Baty/REIT Lease) up to 20 assisted living communities in 12 states, with
1,824 units. These communities, which were owned by entities in which Mr. Baty
has financial interests, were acquired by an independent REIT for an investment
of approximately $170.8 million and are being leased to the Company. The Company
completed the lease on the first 18 communities on September 30, 2004, an
additional community lease on March 31, 2005, and anticipates the remaining
community will close during the second quarter 2005. Sixteen of the communities
included in this lease were part of the group owned by AL Investors and have
been referred to in past filings with the SEC as the “Emeritrust I communities.”





The
single community lease completed on March 31, 2005, is leased by the Company
from the REIT pursuant to a lease agreement with a 15-year term, with one
15-year renewal option. This lease will be accounted for as an operating lease
with straight-lined rent payments. The initial lease payment for the facilities
that have closed is approximately $14.0 million per year, with inflators to the
extent the change in the consumer price index exceeds 0%, not to exceed 40 basis
points during years two through four and 30 basis points thereafter, as
calculated with respect to the REIT's investment basis in the properties. The
initial lease payment is expected to increase by $691,000 when the remaining
facility closes. The Company is responsible for all operating costs, including
repairs, property taxes, and insurance. The new leases are cross-defaulted and
cross-collateralized with all of the Company's other leases and loans relating
to other communities owned by the REIT and contain certain financial and other
covenants. The Company has the right of first refusal to purchase these leased
communities and Mr. Baty is personally guaranteeing its obligations under the
lease. Mr. Baty will receive, based on a prescribed formula, 50% of the positive
cash flow of the 20 communities and will be responsible for 50% of any negative
cash flow. In the fourth quarter of 2004, the first quarter under this
arrangement, Mr. Baty received $200,000 as consideration. Mr. Baty received
$145,000 in the first quarter 2005.





**7**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


Table of Contents





**Debt
Consolidation**





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





The REIT
that financed the Emeritrust II transaction discussed in the Company’s 2004
10K already held $6.8 million of the Company's leasehold mortgage debt that
matured in March 2005 and bore interest at 12% per annum, commencing March 2002
with periodic increases up to 13% per annum. This REIT also provided $7.5
million in leasehold mortgage financing incurred to support the Series A
Preferred Stock repurchase in August 2003. On September 30, 2003, these two
financings, together with the $11.5 million leasehold mortgage financing related
to the Emeritrust II communities, were consolidated into a single $25.8 million
leasehold mortgage financing, secured by the 32 communities and maturing on June
30, 2007. The debt bears interest at an initial rate of 12.13% per annum with
periodic increases up to 13%. The consolidated loan requires monthly payments of
interest the first year and monthly payments of principal and interest, based on
a 10-year amortization, thereafter. Additional principal reductions may occur,
at the Company's option, through the increase in the amount of the lease
financing based on the portfolio achieving certain coverage ratios. The Company,
at its discretion, made a principal reduction of $6.0 million on August 2, 2004.
The balance on the note as of March 2, 2005, was approximately $19.5
million.





The
Company modified the existing note in full substitution with Healthcare Realty
Trust, Incorporated ("HRT"), an unrelated third party lender. Health Care REIT,
Inc. (“HCN”) sold the loan to HRT, and assigned substantially all of the
leasehold mortgages and all additional collateral securing the loan pursuant to
a certain Loan Purchase Agreement between HCN, HRT, and Emeritus. The Company
and HRT agreed to modify, amend, and restate the loan. The restated loan has a
maturity date of March 3, 2008. Interest accrues on the principal amount
outstanding at the fixed rate of 10% per annum. Commencing on the first day of
the first month after the commencement date and on the first day of each month
thereafter, the Company will make monthly interest only payments sufficient to
pay all interest accrued. On the maturity date, the Company will make a balloon
payment equal to the outstanding balance of this note including the outstanding
principal balance, all accrued and unpaid interest and all charges, expenses,
and other amounts payable by the Company to HRT. The Company will not have the
privilege of prepaying on the note in whole or in part at any time without the
prior written consent of HRT, at HRT's sole discretion. In addition, the note
contains certain subjective default clauses, which, as a remedy, HRT may declare
the loan to be immediately due and payable.





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





**Alterra
Transactions**





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





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





**8**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


Table of Contents





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





**CPM-JEA
Transactions**





In March
2005, the Company entered into agreements covering the final two communities of
the CPM/JEA lease transactions for which the first stage was completed in April
2004. One community had been previously managed by the Company and is located in
Richland, Washington. This community offers assisted living services and was
part of the CPM group. The second community located in Lubbock, Texas, offers
memory loss services and is a part of the JEA managed group of communities. It
is new to the Company's portfolio. Both facilities are under separate leases
with the independent REIT, each with a maturity date of March 31, 2019, with
three 5-year renewal options. The lease rate is 9% with fixed inflators of the
lesser of four times the change in the consumer price index or 3%. The base rent
as of March 31, 2005 , for
these two leases is approximately $107,000 per month. Due to certain subjective
default clauses in the lease and remedies, which allow for acceleration of all
unpaid rents in the event of default, these leases have been accounted for as
capital leases, which resulted in additions to property and equipment and
capital lease and financing obligations totaling approximately $14.6
million.





**Sale
of Community**





On
November 1, 2004, the Company sold a single community located in Issaquah,
Washington, for cash and assumption of liabilities for a total of $9.6 million.
Since the Company had a continuing involvement in the community until such time
as the buyer was granted a license to operate the community, which occurred on
January 7, 2005, the Company deferred recognition of the sale and associated
gain until that point. The Company recorded a gain of $1.3 million related to
this sale in "Income from discontinued operations" in its condensed consolidated
statements of operations for the three months ended March 31, 2005.





**Accrued
Dividends on Preferred Stock**





Since the
third quarter of 2000, the Company has accrued its obligation to pay cash
dividends to the Series B preferred shareholders, which amounted to
approximately $11.1 million at March 31, 2005, including all penalties for
non-payment. Because the Company has not paid these dividends for more than six
consecutive quarters, under the Designation of Rights and Preferences of the
Series B preferred stock in the Company's Articles of Incorporation, the Series
B preferred shareholders may designate one director in addition to the other
directors that they are entitled to designate under the shareholders' agreement.
As of January 1, 2002, the Series B preferred shareholders became entitled to
designate an additional director under the Articles, but thus far have chosen
not to do so.





Series B
preferred dividends are to be paid in cash and in additional shares of Series B
preferred shares. As of March 31, 2005, an additional 6,604 Series B preferred
shares had been issued as paid-in-kind dividends for all periods prior to the
first quarter of 2005, of which 362 shares were issued in the first quarter of
2005. On April 1, 2005, an additional 366 shares of Series B preferred stock
were issued as paid-in-kind dividends for the first quarter of 2005.





**Convertible
Debentures**





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





**9**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


Table of Contents





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





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





**Loss
Per Share**





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





**Three
      Months ended****March
      31,****2005**
    
    **2004**Convertible
      Debentures
    
    
    1,455
    
    
    1,455Options
    
    
    1,528
    
    
    1,884Warrants
      - Senior Housing Partners I, L.P.
    
    
    400
    
    
    400Warrants
      - Saratoga Partners
    
    
    1,000
    
    
    1,000Series
      B Preferred
    
    
    5,313
    
    
    5,1069,696
    
    
    9,845





**Comprehensive
Loss**





Comprehensive
loss is the same as net loss to common shareholders for the three-month period
ended March 31, 2005 and 2004, respectively.




**Liquidity**





The
Company has incurred significant operating losses since its inception and has a
working capital deficit of $105.6 million, although $14.4 million of this
deficit represents deferred revenue and unearned rental income, and $11.1
million represents preferred dividends that are due only if declared by the
Company's board of directors, who are currently discussing paying out the earned
dividends of the Series B preferred stock to the extent financing is available.
Additionally, due to the adverse judgment against the Company as described under
“Legal Proceedings,” an additional reserve was recorded in the fourth quarter of
2004 for $18.7 million in accordance with the Company's self-insured pool
agreement. The Company believes there are substantial grounds for an appeal and
that the damage award was not justified by the facts or the law in the case
presented. The Company has appealed the verdict and on March 16, 2005, posted
funds in the amount of $1.7 million in order to stay the proceedings while the
appellate process runs its course, which could be anywhere from 18 months to
three years. The Company will not be required to pay additional amounts until
the appeal and further litigation is completed or the case is settled. The
Company has $32.0 million of 6.25% convertible subordinated debentures that will
come due January 1, 2006. Of the $32.0 million, $21.5 million is owned by
directors and officers or their affiliates (See "Convertible Debentures” in
“Notes to Condensed Consolidated Financial Statements”). At times in the past,
the Company has been





**10**
 **EMERITUS
CORPORATION**
 **NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 Continued
 (unaudited)


Table of Contents





dependent
upon third-party financing or disposition of assets to fund operations. If such
transactions are necessary in the future, Emeritus cannot guarantee that they
will be available on a timely basis, on terms attractive to the Company, or at
all.





Throughout
2002 and continuing through the first quarter of 2005, the Company refinanced
substantially all of its debt obligations, excluding the convertible debentures,
extending the maturities of such financings to dates beyond March 31, 2006, or
thereafter, at which time the Company will need to refinance or otherwise repay
the obligations. The Company is currently in discussions with debenture holders
to extend the maturity of the convertible debentures. If the Company is
unsuccessful in extending maturity the Company would have to obtain additional
financing which may not be available. Many of the Company's debt instruments and
leases contain “cross-default” provisions pursuant to which a default under one
obligation can cause a default under one or more other obligations to the same
or other lenders or lessors. Such cross-default provisions affect 6 owned
assisted living properties and 157 properties operated under leases.
Accordingly, any event of default could cause a material adverse effect on the
Company's financial condition if such debt or leases are cross-defaulted. At
March 31, 2005, the Company complied with all such covenants, except for leases
for two communities with a REIT. The Company has obtained waivers from the
lessor and is considered to be in full compliance as of March 31, 2005.





Management
believes that the Company will be able to sustain positive operating cash flow
on an annual basis and will have adequate cash or the ability to obtain adequate
financing for all necessary investing and financing activities including
required debt service and capital expenditures through at least March 31,
2006.





**Discontinued
Operations**





On August
9, 2004, the Company sold an owned facility (“Scottsdale Royale”) to an
unrelated third party. Due to certain legal requirements of resident
notification, the Company leased the property back from the third party through
August 31, 2004. In addition, on September 30, 2004, the Company committed to
sell another owned facility (“Hearthside of Issaquah”), which under SFAS No. 144 *“Accounting
for the Impairment or Disposal of Long-Lived Assets,* ”
qualifies as an asset held for sale. A current asset of $7.9 million was
recorded on the Company's financial statements and the Company discontinued
depreciating the asset as of September 30, 2004. Hearthside of Issaquah was sold
on November 1, 2004. Both transactions qualify for discontinued operations
treatment under SFAS No. 144 and the results of discontinued operations is
reported as a separate line item in the condensed consolidated statement of
operations.





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





**Three
      months ended****March
      31,****2005**
    
    **2004****Total
      revenue:**Hearthside
      of Issaquah
    
    $
    -
    
    $
    842Scottsdale
      Royale
    
    
    -
    
    
    122Total
    
    $
    -
    
    $
    964**Net
      income (loss):**Hearthside
      of Issaquah
    
    $
    1,319
    
    $
    78Scottsdale
      Royale
    
    
    -
    
    
    (20
    )Total
    
    $
    1,319
    
    $
    58













**11**


Table of Contents





**Item
2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION****AND****RESULTS
OF OPERATIONS**


**Definitions**





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





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


2.
    "SFAS"
      refers to Statement of Financial Accounting
Standards.


3.
    "SEC"
      refers to the Securities and Exchange
Commission.


4.
    "REIT"
      refers to real estate investment trust.


5.
    "LIBOR"
      is the London Interbank Offering Rate.


6.
    "Mr.
      Baty" refers to Daniel R. Baty, the Company's chairman of the board of
      directors and chief executive officer.


7.
    "Triple-net
      lease" means a lease under which the lessee pays all operating expenses of
      the property, including taxes, licenses, utilities, maintenance, and
      insurance. The lessor receives a net rent.


8.
    "N/A"
      in a table means not applicable.


9.
    "N/M"
      in a table means not meaningful.








**Overview**





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





From 1995
through 1998, we expanded rapidly through acquisition and internal development
and by December 31, 1999, operated 129 assisted living communities with
11,726 units. We believe, however, that during this expansion, the assisted
living industry became overbuilt in certain regions, creating an environment
characterized by slower than planned occupancy and rate growth. As a result of
these difficult operating circumstances, we limited further growth and in 1999
began an increasing focus, first, on raising our occupancy and later, on
operating efficiencies and cost controls as well as implementing a systematic
rate enhancement program.





We
believe that the health of the assisted living industry is currently improving
and that opportunities are developing to improve occupancy and adjust rates. The
assisted living industry is experiencing increased regulation (varying by
state), increased insurance costs, and limited availability of capital for
smaller local and regional operators. In this type of environment, we believe
that we will continue to witness consolidation of smaller local and regional
operators into the larger national operators. Because of these circumstances, we
have been able to complete several acquisitions or leases in the last two years.
In addition, our size and ability to respond to negative environmental
conditions such as insurance availability and costs has attracted capital
resources to allow us to convert communities we managed to communities we now
lease. Going forward, we will attempt to identify additional acquisition or
lease opportunities. In 2000 and 2001, we continued to operate approximately 130
communities, but in 2002 and 2003, we increased that to 180 and 175 communities,
respectively. From the end of 2000 to the end of 2003, the communities we manage
decreased from 69 to 47 and the owned and leased communities increased from 61
to 128, reflecting our increasing confidence in the assisted living industry,
stabilization of managed properties, and the availability of capital. In 2004,
managed communities further declined to 17 and owned and leased communities
increased to 164. In the first quarter of 2005, managed communities declined to
15 and owned and leased communities increased to 167. Throughout 2004 and
continuing in 2005, we continue to review acquisition or lease
opportunities.





**12**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





In March
2005, we completed the lease of three additional communities, two we had
previously managed.





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








**As
      of March 31,**
    
    **As
      of December 31,**
    
    **As
      of March 31,****2005**
    
    **2004**
    
    **2004****Buildings**
    
    **Units**
    
    **Buildings**
    
    **Units**
    
    **Buildings**
    
    **Units**Owned
    
    
    6
    
    
    454
    
    
    6
    
    
    454
    
    
    19
    
    
    1,813Leased
      (1 )
    
    
    161
    
    
    12,820
    
    
    158
    
    
    12,589
    
    
    109
    
    
    8,303Consolidated
      Portfolio
    
    
    167
    
    
    13,274
    
    
    164
    
    
    13,043
    
    
    128
    
    
    10,116Managed/Admin
      Services (2)
    
    
    14
    
    
    1,467
    
    
    16
    
    
    1,668
    
    
    45
    
    
    4,454Joint
      Venture/Partnership
    
    
    1
    
    
    140
    
    
    1
    
    
    140
    
    
    1
    
    
    140Operated
      Portfolio
    
    
    182
    
    
    14,881
    
    
    181
    
    
    14,851
    
    
    174
    
    
    14,710Percentage
      increase (decrease) (3)
    
    
    0.6
    %
    
    0.2
    %
    
    3.4
    %
    
    0.0
    %
    
    (0.6
    %)
    
    (0.9
    %)




--------


(1) Of
the leased communities at March 31, 2005, 76 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 70 are accounted for as capital
leases, in which a long-term asset and corresponding liability is established on
our balance sheet. The remaining 15 leased communities are reflected in our
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.


(2) One
managed building was shut down and sold March 12, 2004, and we discontinued
management of one facility on September 30, 2004.


(3) The
percentage increase (decrease) indicates the change from the prior year, or, in
the case of March 31, 2005 and 2004, from the end of the prior year.





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





In
evaluating the rate component, we generally rely on the average monthly revenue
per unit, computed by dividing the total revenue for a particular period by the
average number of occupied units determined on a monthly basis for the same
period. In evaluating the occupancy component, we generally rely on an average
occupancy rate, computed by dividing the average units occupied, determined on a
monthly basis, during a particular period by the average number of units
available, determined on a monthly basis, 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.





In our
consolidated portfolio, our average monthly revenue per unit for the three
months ended March 31, 2005, increased to $2,902 from $2,779 for the same period
in 2004. This change represents an increase of $123 or 4.4%, for the three
months ended March 31, 2005, compared to the same period of 2004. This increase
is partially due to repositioning several of our acquired communities over the
past year to be more rate-competitive and to establish a new presence in their
respective markets. In addition, increased competition in certain locations has
prevented us from raising rates to the extent we otherwise would have been able.
Lastly, in order to achieve significant occupancy growth during 2005, temporary
rate discounting and / or move-in fee waivers were utilized, partially
offsetting revenue per unit growth.





**13**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





Also in
our consolidated portfolio, our average monthly revenue per unit for the three
months ended March 31, 2005, increased to $2,902 from $2,873 for the three
months ended December 31, 2004. This change represents an increase of $29 or
1.0%, for the three months ended March 31, 2005, compared to the three months
ended December 31, 2004.





In our
consolidated portfolio, our average occupancy rate increased to 85.0% for the
three months ended March 31, 2005, from 78.4% for the three months ended March
31, 2004. We believe that this increase in occupancy rates reflects
industry-wide factors, such as the declining supply of vacant units as well as
our own actions and policies. We continue to evaluate the factors of rate and
occupancy to find the optimum balance. For the fourth quarter of 2004, our
average occupancy rate was 85.3%.





We have
incurred operating losses since our inception in 1993, and as of March 31, 2005,
we had an accumulated deficit of approximately $209.1 million. We believe that
these losses have resulted from our early emphasis on expansion, financing costs
arising from multiple financing and refinancing transactions related to this
expansion, and occupancy rates remaining lower for longer periods than we
anticipated.





**Significant
Transactions**





In 2004
and continuing in 2005, we substantially increased the number of communities we
lease, reduced the number of communities we manage, and, in connection with
these changes, increased and restructured portions of our long-term financing
obligations. The transactions associated with these developments are summarized
below.





*Emeritrust
Transactions*





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





*Emeritrust I
Communities Management.* In
the first quarter of 2003, we managed 25 Emeritrust I communities under a
management agreement providing for a base fee of 3% of gross revenues generated
by the communities and an additional management fee of 4% of gross revenues,
payable to the extent of 50% of cash flow from the communities. This management
agreement, as extended several times, expired at the end of 2003. On January 2,
2004, the Emeritrust I investors entered into a new management agreement with us
providing for management fees computed on the same basis and (i) terminating all
options to purchase the communities, (ii) terminating any further funding
obligation, and (iii) providing for a term expiring September 30, 2005, provided
that either party may terminate the agreement on 90 days notice. Effective April
1, 2004, the Emeritrust I owners extended the underlying financing on the
Emeritrust I communities. In connection with the financing extension, the
management agreement was amended to provide for a flat management fee of 5% of
gross revenues and amended the term to March 31, 2005. A one-year extension to
March 31, 2006 was exercised but the management agreement is subject to
termination by either party on short notice. Sixteen communities were leased
pursuant to leases discussed below, four communities had been disposed of by the
Emeritrust I owners and five communities continue to be managed by us in the
first quarter of 2005. We received management fees (net of our funding
obligations) of approximately $127,000, and $640,000 for the three months ended
March 31, 2005 and 2004 respectively.





*Emeritrust
I Communities Lease.* On
September 30, 2004, we completed the first phase of a transaction to lease
(Baty/REIT Lease) up to 20 assisted living communities in 12 states, with 1,824
units. These communities, which were owned by entities in which Mr. Baty has
financial interests, were acquired by an independent REIT for an investment of
approximately $170.8 million and are being leased to us. We completed the lease
on the first 18 communities on September 30, 2004, an additional community lease
on March 31, 2005, and anticipate the remaining community will close during the
second quarter 2005. Sixteen





**14**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





of the
communities included in this lease were part of the group owned by AL Investors
and have been referred to in past filings with the SEC as the “Emeritrust I
communities.”





The
single community lease completed on March 31, 2005, is leased by us from the
REIT pursuant to a lease agreement with a 15-year term, with one 15-year renewal
option. This lease will be accounted for as an operating lease with
straight-lined rent payments. The initial lease payment for the facilities that
have closed is approximately $14.0 million per year, with inflators to the
extent the change in the consumer price index exceeds 0%, not to exceed 40 basis
points during years two through four and 30 basis points thereafter, as
calculated with respect to the REIT's investment basis in the properties. The
initial lease payment is expected to increase by $691,000 when the remaining
facility closes. We are responsible for all operating costs, including repairs,
property taxes, and insurance. The new leases are cross-defaulted and
cross-collateralized with all of our other leases and loans relating to other
communities owned by the REIT and contain certain financial and other covenants.
We have the right of first refusal to purchase these leased communities and Mr.
Baty is personally guaranteeing our obligations under the lease. Mr. Baty will
receive, based on a prescribed formula, 50% of the positive cash flow of the 20
communities and will be responsible for 50% of any negative cash flow. In the
fourth quarter of 2004, the first quarter under this arrangement, Mr. Baty
received $200,000 as consideration. Mr. Baty received $145,000 in the first
quarter 2005.





*Debt
Consolidation*





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





The REIT
that financed the Emeritrust II transaction discussed in our 2004 10K
already held $6.8 million of our leasehold mortgage debt that matured in March
2005 and bore interest at 12% per annum, commencing March 2002 with periodic
increases up to 13% per annum. This REIT also provided $7.5 million in leasehold
mortgage financing incurred to support the Series A Preferred Stock
repurchase in August 2003. On September 30, 2003, these two financings,
together with the $11.5 million leasehold mortgage financing related to the
Emeritrust II communities, were consolidated into a single $25.8 million
leasehold mortgage financing, secured by the 32 communities and maturing on June
30, 2007. The debt bears interest at an initial rate of 12.13% per annum with
periodic increases up to 13%. The consolidated loan requires monthly payments of
interest the first year and monthly payments of principal and interest, based on
a 10-year amortization, thereafter. Additional principal reductions may occur,
at our option, through the increase in the amount of the lease financing based
on the portfolio achieving certain coverage ratios. We made a principal
reduction of $6.0 million on August 2, 2004, at our discretion. The balance on
the note as of March 2, 2005, was approximately $19.5 million.





We
modified the existing note in full substitution with Healthcare Realty Trust,
Incorporated ("HRT"), an unrelated third party lender. Health Care REIT, Inc.
(“HCN”) sold the loan to HRT, and assigned substantially all of the leasehold
mortgages and all additional collateral securing the loan pursuant to a certain
Loan Purchase Agreement between HCN, HRT, and us. We and HRT agreed to modify,
amend, and restate the loan. The restated loan has a maturity date of March 3,
2008. Interest accrues on the principal amount outstanding at the fixed rate of
10% per annum. Commencing on the first day of the first month after the
commencement date and on the first day of each month thereafter, we will make
monthly interest only payments sufficient to pay all interest accrued. On the
maturity date, the Company will make a balloon payment equal to the outstanding
balance of this note including the outstanding principal balance, all accrued
and unpaid interest and all charges, expenses, and other amounts payable by us
to HRT. We will not have the privilege of prepaying on the note in whole or in
part at any time without the prior written consent of HRT, at HRT's sole
discretion. In addition, the note contains certain subjective default clauses,
which, as a remedy, HRT may declare the loan to be immediately due and
payable.





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 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





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





*Alterra
Transactions*





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





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





*CPM-JEA
Transactions*





In March
2005, we entered into agreements covering the final two communities of the
CPM/JEA lease transactions for which the first stage was completed in April
2004. One community had been previously managed by us and is located in
Richland, Washington. This community offers assisted living services and was
part of the CPM group. The second community located in Lubbock, Texas, offers
memory loss services and is a part of the JEA managed group of communities. It
is new to our portfolio. Both facilities are under separate leases with the
independent REIT, each with a maturity date of March 31, 2019, with three 5-year
renewal options. The lease rate is 9% with fixed inflators of the lesser of four
times the change in the consumer price index or 3%. The base rent as of March
31, 2005 , for
these two leases is approximately $107,000 per month. Due to certain subjective
default clauses in the lease and remedies, which allow for acceleration of all
unpaid rents in the event of default, these leases have been accounted for as
capital leases, which resulted in additions to property and equipment and
capital lease and financing obligations totaling approximately $14.6
million.





*Sale
of Community*





On
November 1, 2004, we sold a single community located in Issaquah, Washington,
for cash and assumption of liabilities for a total of $9.6 million. Since we had
a continuing involvement in the community until such time as the buyer was
granted a license to operate the community, which occurred on January 7, 2005,
we deferred recognition of the sale and associated gain until that point. We
recorded a gain of $1.3 million related to this sale in "Income from
discontinued operations" in our condensed consolidated statements of operations
for the three months ended March 31, 2005.










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 **AND
RESULTS OF OPERATIONS - CONTINUED**


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The
following table shows the changes in buildings from December 31, 2003, through
March 31, 2005,
including those transactions described above:







**Month**
    
    **Owned**
    
    **Leased**
    
    
    
    **Consolidated**
    
    **Managed**
    
    **Total****December
      31, 2003**
    
    
    
    
    
    **19**
    
    
    **109**
    
    
    
    
    **128**
    
    
    **47**
    
    
    **175**Madison
      Glen - disposition
    
    
    Mar-04
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )**March
      31, 2004**
    
    
    
    
    
    **19**
    
    
    **109**
    
    
    
    
    **128**
    
    
    **46**
    
    
    **174**CPM-JEA
      transactions
    
    
    Apr-04
    
    
    -
    
    
    16
    
    **1**
    
    
    16
    
    
    (8
    )
    
    8Autumn
      Ridge
    
    
    Jun-04
    
    
    -
    
    
    1
    
    **1**
    
    
    1
    
    
    (1
    )
    
    -The
      Terrace
    
    
    Jun-04
    
    
    -
    
    
    1
    
    **1**
    
    
    1
    
    
    (1
    )
    
    -**June
      30, 2004**
    
    
    
    
    
    **19**
    
    
    **127**
    
    
    
    
    **146**
    
    
    **36**
    
    
    **182**HCP
      Transaction - sale-leaseback
    
    
    Jul-04
    
    
    (11
    )
    
    11
    
    **2**
    
    
    -
    
    
    -
    
    
    -Scottsdale
      Royale - sold
    
    
    Aug-04
    
    
    (1
    )
    
    -
    
    
    
    
    (1
    )
    
    -
    
    
    (1
    )Baty/REIT
      Lease
    
    
    Sep-04
    
    
    -
    
    
    17
    
    **1**
    
    
    17
    
    
    (17
    )
    
    -**September
      30, 2004**
    
    
    
    
    
    **7**
    
    
    **155**
    
    
    
    
    **162**
    
    
    **19**
    
    
    **181**Manor
      at Essington
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **1**
    
    
    1
    
    
    -
    
    
    1Arbor
      Gardens at Corona
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **1**
    
    
    1
    
    
    -
    
    
    1Willows
      at York - disposition
    
    
    Oct-04
    
    
    -
    
    
    -
    
    
    
    
    -
    
    
    (1
    )
    
    (1
    )Loyalton
      of Cape May
    
    
    Oct-04
    
    
    -
    
    
    1
    
    **1**
    
    
    1
    
    
    (1
    )
    
    -Hearthside
      of Issaquah - disposition
    
    
    Nov-04
    
    
    (1
    )
    
    -
    
    
    
    
    (1
    )
    
    -
    
    
    (1
    )**December
      31, 2004**
    
    
    
    
    
    **6**
    
    
    **158**
    
    
    
    
    **164**
    
    
    **17**
    
    
    **181**Richland
      Gardens
    
    
    Mar-05
    
    
    **-**
    
    
    1
    
    **1**
    
    
    1
    
    
    (1
    )
    
    -Quail
      Ridge
    
    
    Mar-05
    
    
    **-**
    
    
    1
    
    **1**
    
    
    1
    
    
    **-**
    
    
    1Wilburn
      Gardens
    
    
    Mar-05
    
    
    **-**
    
    
    1
    
    
    
    
    1
    
    
    (1
    )
    
    -**March
      31, 2005**
    
    
    
    
    
    **6**
    
    
    **161**
    
    
    
    
    **167**
    
    
    **15**
    
    
    **182**


1These
      leases are accounted for as capital leases in our condensed consolidated
      statements.2These
      11 leased communities are reflected in our condensed consolidated
      financial statements as owned communities because ofaccounting requirements related to sale-leaseback accounting,
      notwithstanding the legal sale of the communities and
  theirsubsequent leasing by us.










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 **AND
RESULTS OF OPERATIONS - CONTINUED**


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**Results
of Operations**





**Summary
of Significant Accounting Policies and Use of Estimates**





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





Our
significant accounting policies and use of estimates are delineated in the Notes
to the Condensed Consolidated Financial Statements under the heading "Summary of
Significant Accounting Policies and Use of Estimates."





**Common-size
Statements of Operations 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 Period****Percentage****Change****Percentage
      of Revenues**
    
    **Fav
      / (Unfav)****Three
      Months****Three
      Months ended**
    
    **ended****March
      31,**
    
    **March
      31,****2005**
    
    **2004**
    
    **2005-2004**Revenues:
    
    
    100.0
    %
    
    100.0
    %
    
    45.1
    %Expenses:Community
      operations
    
    
    63.9
    
    
    63.7
    
    
    (45.4
    )General
      and administrative
    
    
    7.7
    
    
    9.5
    
    
    (17.7
    )Depreciation
      and amortization
    
    
    11.9
    
    
    8.3
    
    
    (108.8
    )Facility
      lease expense
    
    
    10.2
    
    
    14.6
    
    
    (1.7
    )Total
      operating expenses
    
    
    93.7
    
    
    96.1
    
    
    (41.5
    )Operating
      income from continuing operations
    
    
    6.3
    
    
    3.9
    
    
    133.3Other
      income (expense)Interest
      income
    
    
    0.2
    
    
    0.2
    
    
    51.0Interest
      expense
    
    
    (12.8
    )
    
    (11.6
    )
    
    (60.1
    )Other,
      net
    
    
    0.8
    
    
    (0.3
    )
    
    504.4Net
      other expense
    
    
    (11.8
    )
    
    (11.7
    )
    
    (46.8
    )Loss
      from continuing operations before income taxes
    
    
    (5.5
    )
    
    (7.8
    )
    
    (3.2
    )Provision
      for income taxes
    
    
    (0.1
    )
    
    -
    
    
    N/ALoss
      from continuing operations
    
    
    (5.6
    )
    
    (7.8
    )
    
    (5.5
    )Income
      from discontinued operations
    
    
    1.4
    
    
    0.1
    
    
    N/MNet
      loss
    
    
    (4.2
    %)
    
    (7.7
    %)
    
    19.6
    %















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Comparison
of the three months ended March 31, 2005 and 2004





*Total
Operating Revenues:* Total
operating revenues for the three months ended March 31, 2005, increased by $29.5
million to $95.1 million from $65.6 million for the comparable period in 2004,
or 45.1%.





Community
revenue and other service fees increased by approximately $30.6 million in the
three months ended March 31, 2005, compared to the three months ended March 31,
2004. This increase was primarily due to additional revenue related to the net
acquisitions or leases of 39 communities from March 31, 2004, to March 31, 2005.
Of the 39 communities, we had formerly managed 30. These communities represent
revenue of approximately $25.0 million in the first quarter of 2005. The
remaining increase of $5.6 million, or 8.8%, was primarily due to an increase in
occupancy and average revenue per unit. The average occupancy rate for the three
months ended March 31, 2005, increased 6.6 percentage points to 85.0% from
78.4%. The occupancy rate grew from marketing initiatives in existing
communities and from the acquisition or leasing of additional communities with
higher occupancy levels. Average community monthly revenue per unit was $2,902
for the first quarter of 2005 compared to $2,779 for the comparable quarter of
2004, an increase of approximately $123 per occupied unit, or 4.4%.





Management
fee income decreased by approximately $1.0 million to $598,000 for the three
months ended March 31, 2005, from $1.6 million for the three months ended 2004.
This decrease was primarily due to 30 communities now leased in the first
quarter of 2005 that were managed in the same quarter of the prior year.





*Community
Operations:* Community operating expenses for the three months ended March 31, 2005,
increased by $19.0 million to $60.8 million from $41.8 million in the first
quarter of 2004, or 45.4%. The change was primarily due to the net acquisition
or lease of 39 communities referred to above, which accounted for approximately
$16.0 million of expense. The remaining increase of $3.0 million, or 7.2%, was
primarily attributable to increases in costs for direct care labor, maintenance
of facilities, liability and workers compensation insurance, and marketing, as
well as related employee benefits. Community operating expenses as a percentage
of total operating revenue increased to 63.9% in the first quarter of 2005 from
63.7% in the first quarter of 2004.


*General
and Administrative:* General
and administrative (G&A) expenses for the three months ended March 31, 2005,
increased $1.1 million to $7.3 million from $6.2 million for the comparable
period in 2004, or 17.7%. As a percentage of total operating revenues, G&A
expenses decreased to 7.7% for the three months ended March 31, 2005, compared
to 9.5% for the three months ended March 31, 2004, primarily as a result of
increased revenue arising from the acquisition or lease of communities referred
to above. G&A expenses increased primarily due to increased costs associated
with Sarbanes-Oxley compliance, human resources consulting, board of director
fees, a write off of fees on discontinued acquisition projects, and increased
staffing, primarily in sales and marketing, risk prevention, resident relations,
and accounting. Since approximately 15 of the communities we operate are managed
rather than owned or leased at March 31, 2005, as compared to 46 at March 31,
2004, G&A expense as a percentage of operating revenues for all communities,
including managed communities, may be more meaningful for industry-wide
comparisons. G&A as a percentage of operating revenues for all communities
increased to 6.9% from 6.6% for the three months ended March 31, 2005 and 2004,
respectively.




*Depreciation
and Amortization:* Depreciation
and amortization for the three months ended March 31, 2005, was $11.3 million
compared to $5.4 million for the comparable period in 2004. The increase is
primarily the result of depreciation resulting from capital lease treatment
associated with the leasing of 40 additional communities since March 31,
2004 (the CPM/JEA transactions at April 1, 2004, the Baty/REIT transactions
at September 30, 2004, and several other leases). In 2005, depreciation and
amortization represented 11.9% of total operating revenues, compared to 8.3% for
the same period in 2004.





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*Facility
Lease Expense* :
Facility lease expense for the three months ended March 31, 2005, was $9.7
million compared to $9.6 million for the comparable period of 2004, representing
an increase of $160,000, or 1.7%. This increase is primarily due to
performance-based lease inflators of existing operating leases. We leased 76
communities under operating leases as of March 31, 2005 and 2004. Facility lease
expense as a percentage of revenues was 10.2% for the three months ended March
31, 2005, and 14.6% for the three months ended March 31, 2004. The decrease is
primarily a result of increased revenues.


*Interest
Income:* Interest
income for the three months ended March 31, 2005, was $231,000 versus $153,000
for the same period of 2004, an increase of $78,000. This increase was primarily
attributable to interest earned on collateral funds placed with our workers'
compensation insurance carrier.





*Interest
Expense:* Interest
expense for the three months ended March 31, 2005, was $12.2 million compared to
$7.6 million for the comparable period of 2004 an increase of $4.6 million, or
60.1%. Of this amount, $2.0 million resulted from capital lease treatment on the
Emeritrust I communities’ lease involving 18 facilities completed on September
30, 2004, and $2.6 million resulted from the capital lease treatment of the
CPM/JEA communities’ lease involving 23 communities, completed from April 1,
2004, through the first quarter of 2005. In addition, $119,000 in loan fees was
extinguished as a part of the modification of an existing note (see Debt
Consolidation for details). As a percentage of total operating revenues,
interest expense increased to 12.8% in the first quarter of 2005 from 11.6% for
the first quarter of 2004.





*Other,
net:* Other,
net for the three months ended March 31, 2005, was approximately $740,000 of
income compared to $183,000 of expense for the comparable period in 2004. The
$740,000 income for the current year quarter is primarily the result of the
amortization of deferred gains of approximately $554,000 and miscellaneous
income of $141,000. The $183,000 expense in the first quarter of 2004 is
primarily the result of equity losses in the Alterra investment of $794,000,
partially offset by the amortization of deferred gains of approximately
$596,000.





*Income
taxes:* The
provision for income taxes of $115,000 for the three months ended March 31,
2005, was principally due to Federal alternative minimum tax and state income
and franchise tax liabilities on operating income after adding back financial
accounting for leases. At March 31, 2005 and 2004, we have a 100% valuation
allowance on our deferred tax assets.





*Net
Loss and Property-Related Expense:* In
comparing the net losses for 2005 and 2004, 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.





The net
loss reflected in our consolidated statement of operations for the three months
ended March 31, 2005, was $4.0 million. Our property-related expense for this
period was $33.3 million, of which $29.8 million was associated with our leases
due to the effects of lease accounting referred to above. Our actual capital and
operating lease payments during this period were $23.8 million. Correspondingly,
the net loss of $5.0 million for the three months ended March 31, 2004,
reflected property-related expense of $22.6 million, of which $17.0 million was
associated with our leases. Our actual capital and operating lease payments for
this period were $14.7 million. The increase in total property-related expense
is due primarily to the acquisition and lease of 41 additional communities since
March 31, 2004. The amount by which the property-related expense associated
with our leases exceeded our actual lease payments was $6.0 million for the
three months ended March 31, 2005, compared to $2.3 million for the three months
ended March 31, 2004, an increase of $3.7 million. This increase is primarily
attributable to capital lease accounting treatment of leases for 40 of the 41
communities referred to above. It should be remembered that, notwithstanding the
effects of lease accounting treatment, the actual lease payments required under
most of our leases will continue to increase





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 **MANAGEMENT'S
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 **AND
RESULTS OF OPERATIONS - CONTINUED**


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annually
and, as a result, we will need to increase our revenues and our results from
community operations to cover these increases.





*Income
from Discontinued Operations:* Income
from discontinued operations for the three months ended March 31, 2005, was
approximately $1.3 million compared to $58,000 for the comparable period in
2004. The income for the first quarter of 2005 was the recognition of the
previously deferred gain on the sale of one community in 2004. We had a
continuing involvement in the community until such time as the buyer was granted
a license to operate the community, which occurred on January 7, 2005. Thus, we
deferred recognition of the sale and associated gain of $1.3 million until that
point and recorded the related assets at December 31, 2004, as held for sale.





*Preferred
dividends:* For the
three months ended March 31, 2005 and 2004, preferred dividends totaled
approximately $957,000 and $920,000, respectively. Because we have not paid the
Series B preferred dividends for more than six consecutive quarters, under the
Designation of Rights and Preferences of the Series B preferred stock in our
Articles of Incorporation, the Series B preferred shareholders may designate one
director in addition to the other directors that they are entitled to designate
under the shareholders' agreement. As of January 1, 2002, the Series B preferred
shareholders became entitled to designate an additional director under the
Articles, but thus far have chosen not to do so.








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*Same
Community Comparison*





We
operated 125 communities on a comparable basis during both the three months
ended March 31, 2005 and 2004. The following table sets forth a comparison of
same community results of operations, excluding general and administrative
expenses, for the three months ended March 31, 2005 and 2004.




**Three
      Months ended March 31,****(In
      thousands)****Dollar**
    
    **%
      Change****2005**
    
    **2004**
    
    **Change**
    
    **Fav
      / (Unfav)**Revenue
    
    $
    69,429
    
    $
    63,619
    
    $
    5,810
    
    
    9.1
    %Community
      operating expenses
    
    
    (44,468
    )
    
    (41,533
    )
    
    (2,935
    )
    
    (7.1
    )Community
      operating income
    
    
    24,961
    
    
    22,086
    
    
    2,875
    
    
    13.0Depreciation
      & amortization
    
    
    (5,486
    )
    
    (5,237
    )
    
    (249
    )
    
    (4.8
    )Facility
      lease expense
    
    
    (9,549
    )
    
    (9,392
    )
    
    (157
    )
    
    (1.7
    )Operating
      income
    
    
    9,926
    
    
    7,457
    
    
    2,469
    
    
    33.1Interest
      expense, net
    
    
    (6,857
    )
    
    (6,854
    )
    
    (3
    )
    
    (0.0
    )Operating
      income after interest expense
    
    $
    3,069
    
    $
    603
    
    $
    2,466
    
    
    409.0
    %





These 125
communities represented $69.4 million or 73.0% of our total revenue of $95.1
million for the first quarter of 2005. Same community revenues increased by $5.8
million or 9.1% for the quarter ended March 31, 2005, from the same period in
2004. This increase was primarily due to improvements in occupancy. Occupancy
increased 5.7 percentage points to 84.0% for the three months ended March 31,
2005 from 78.3% for the three months ended March 31, 2004. Average revenue per
occupied unit increased by $64 per month or 2.3% for the three months ended
March 31, 2005, as compared to the three months ended March 31, 2004.





Community
operating expenses increased approximately $2.9 million primarily from increased
costs related to direct care labor, maintenance of facilities, liability and
workers compensation insurance, and marketing, as well as related employee
benefits. Property-related expenses (depreciation and amortization, facility
lease expense, and interest expense, net) increased by approximately
$409,000,which reflects primarily the effect of rent escalators in operating
leases, which are in part performance based, the impact of changing one
community from an operating lease to a capital lease at a higher financing rate,
increasing depreciation and amortization, and a reduction in interest resulting
from partial repayment of debt in August 2004 and a lower interest rate on that
debt commencing in March 2005. Operating income after interest expense increased
$2.5 million.





**Liquidity
and Capital Resources**





For the
three months ended March 31, 2005, net cash provided by operating activities was
$4.9 million. The primary components of operating cash provided by operating
activities were depreciation and amortization of $11.3 million, the write down
of loan fees of $179,000, partially offset by the recognition of deferred gain
on sale of property, plant and equipment of $1.3 million, the net increase in
other operating assets and liabilities of $761,000, and amortization of deferred
gain of $554,000. For the three months ended March 31, 2004, net cash used in
operating activities was $2.4 million. The primary components of operating cash
used in operating activities for the three months ended March 31, 2004, were the
net increase in other operating assets and liabilities of $3.0 million and
amortization of deferred gain of $596,000, partially offset by depreciation and
amortization of $5.5 million and an adjustment for the Alterra equity investment
loss of $794,000.





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Net cash
used in investing activities amounted to $4.1 million for the three months ended
March 31, 2005, and was comprised of the acquisition of property and equipment
of $2.1 million, management and lease acquisition cost of $1.5 million,
acquisition of assets in lease transactions of $406,000, advances to affiliates
and other managed communities of $152,000, and investment in affiliates of
$33,000. Net cash provided by investing activities amounted to $1.4 million for
the three months ended March 31, 2004, and was comprised primarily of collection
of a note receivable of $2.7 million and proceeds from the sale of property and
equipment of $165,000, partially offset by purchases of approximately $846,000
of various property and equipment, investments in affiliates of $303,000, and an
expenditure for management and lease acquisition costs of approximately
$302,000.





For the
three months ended March 31, 2005, net cash used in financing activities was
$4.8 million, primarily from long-term debt repayments of $21.7 million,
repayment of capital lease and financing obligations of $3.8 million, an
increase in restricted deposits of $621,000, and debt issuance and other
financing costs of $201,000, partially offset by proceeds from long-term
borrowings and financings of $21.4 million. For the three months ended March 31,
2004, net cash used in financing activities was $3.1 million, primarily from
repayment of long-term borrowings of $1.4 million, repayment of capital lease
and financing obligations of $1.3 million, increases in restricted deposits of
$582,000, and debt issuance and other financing costs of $101,000.





We have
incurred significant operating losses since our inception and have a working
capital deficit of $105.6 million, although $14.4 million represents deferred
revenue and unearned rental income, and $11.1 million of preferred cash
dividends is only due if declared by our board of directors, who are currently
discussing paying out the earned dividends of the Series B preferred stock to
the extent financing is available. Additionally, due to the adverse judgment
against us as described under “Legal Proceedings,” an additional reserve was
recorded in the fourth quarter of 2004 for $18.7 million in accordance with our
self-insured pool agreement. We believe there are substantial grounds for an
appeal and that the damage award was not justified by the facts or the law in
the case presented. We have appealed the verdict and on March 16, 2005, we
posted funds in the amount of $1.7 million in order to stay the proceedings
while the appellate process runs its course, which could be anywhere from 18
months to three years. We will not be required to pay additional amounts until
the appeal and further litigation is completed or the case is settled. We have
$32.0 million of 6.25% convertible subordinated debentures that will come due
January 1, 2006. Of the $32.0 million, $21.5 million is owned by directors and
officers or their affiliates (See “Convertible Debentures” in “Notes to
Condensed Consolidated Financial Statements”). At times in the past, we have
been dependent upon third-party financing or disposition of assets to fund
operations. If such transactions are necessary in the future, we cannot
guarantee that they will be available on a timely basis, on terms attractive to
us, or at all.





Throughout
2004 and continuing through the first quarter of 2005, we refinanced
substantially all of our debt obligations, excluding the convertible debentures,
extending the maturities of such financings to dates beyond March 31, 2006, or
thereafter, at which time we will need to refinance or otherwise repay the
obligations. We are currently in discussions with debenture holders to extend
the maturity of the convertible debentures. If we are unsuccessful in extending
maturity, we would have to obtain additional financing which may not be
available. Many of our debt instruments and leases contain “cross-default”
provisions pursuant to which a default under one obligation can cause a default
under one or more other obligations to the same or other lenders or lessors.
Such cross-default provisions affect 6 owned assisted living properties and 157
properties operated under leases. Accordingly, any event of default could cause
a material adverse effect on our financial condition if such debt or leases are
cross-defaulted. At March 31, 2005, we complied with all such covenants, except
for leases for two communities with a REIT. We have obtained a waiver from the
lessor and are considered to be in full compliance as of March 31, 2005.





Management
believes that we will be able to sustain positive operating cash flow on an
annual basis and will have adequate cash or the ability to obtain adequate
financing for all necessary investing and financing activities including
required debt service and capital expenditures through at least March 31,
2006.









**23**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**
 Table of Contents





The
following table summarizes our contractual obligations at March 31, 2005, (in
thousands):








**Principal
      Payments Due by Period****Less
      than**
    
    
    
    
    
    **After
      5****Contractual
      Obligations**
    
    **Total**
    
    **1
      year**
    
    **1-3
      years**
    
    **4-5
      years**
    
    **years**Long-term
      debt, including current portion
    
    $
    54,453
    
    $
    3,068
    
    $
    4,539
    
    $
    43,338
    
    $
    3,508Capital
      lease and financing obligations including current portion
    
    
    640,349
    
    
    16,748
    
    
    42,819
    
    
    56,585
    
    
    524,197Operating
      leases
    
    
    346,848
    
    
    38,609
    
    
    79,633
    
    
    81,960
    
    
    146,646Convertible
      debentures
    
    
    32,000
    
    
    32,000
    
    
    -
    
    
    -
    
    
    -$
    1,073,650
    
    $
    90,425
    
    $
    126,991
    
    $
    181,883
    
    $
    674,351





The
following table summarizes interest on our contractual obligations at March 31,
2005, (in thousands):








**Interest
      Due by Period****Less
      than**
    
    
    
    
    
    **After
      5****Contractual
      Obligations**
    
    **Total**
    
    **1
      year**
    
    **1-3
      years**
    
    **4-5
      years**
    
    **years**Long-term
      debt
    
    $
    14,002
    
    $
    4,248
    
    $
    7,959
    
    $
    1,343
    
    $
    452Capital
      lease and financing obligations
    
    
    399,172
    
    
    42,223
    
    
    80,870
    
    
    74,651
    
    
    201,428Convertible
      debentures
    
    
    2,000
    
    
    2,000
    
    
    -
    
    
    -
    
    
    -$
    415,174
    
    $
    48,471
    
    $
    88,829
    
    $
    75,994
    
    $
    201,880

















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**24**
 **MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
RESULTS OF OPERATIONS - CONTINUED**


Table of Contents





**Impact
of Inflation**





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





**Forward-Looking
Statements**




“Safe
Harbor” Statement under the Private Securities Litigation Reform Act of 1995: A
number of the matters and subject areas discussed in this report that are not
historical or current facts deal with potential future circumstances,
operations, and prospects. The discussion of such matters and subject areas is
qualified by the inherent risks and uncertainties surrounding future
expectations generally, and also may materially differ from our actual future
experience as a result of such factors as: the effects of competition and
economic conditions on the occupancy levels in our communities; our ability
under current market conditions to maintain and increase our resident charges in
accordance with our rate enhancement programs without adversely affecting
occupancy levels; increases in interest costs as a result of re-financings; our
ability to control community operation expenses, including insurance and utility
costs, without adversely affecting the level of occupancy and the level of
resident charges; our ability to generate cash flow sufficient to service our
debt and other fixed payment requirements; 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 operation, and final resolution of the adverse
Texas jury verdict and other uncertainties related to professional liability
claims .We have attempted to identify, in context, certain of the factors that
we currently believe may cause actual future experience and results to differ
from our current expectations regarding the relevant matter or subject area.
These and other risks and uncertainties are detailed in our reports filed with
the Securities and Exchange Commission (SEC), including our Annual Reports on
Form 10-K and Quarterly Reports Form 10-Q.





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**25**


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 March 31, 2005, our variable rate borrowings
totaled approximately $631,000. Currently, all our variable rate borrowings are
based upon the prime rate. Additionally, we have certain operating lease
obligations based on LIBOR, subject to a LIBOR floor ranging from 2.0% to 2.5%.
As LIBOR rates increase above the current level, we will be exposed to higher
lease expense costs. As of March 31, 2005, the LIBOR rate was 3.1%. If LIBOR
interest rates were to average 2% more, our annual facility lease expense and
net loss would increase by approximately $1.1 million. This amount is determined
by considering the impact of hypothetical interest rates on our outstanding
variable rate borrowings as of March 31, 2005, and does not consider changes in
the actual level of borrowings that may occur subsequent to March 31, 2005. 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.





**Item
4. Controls and Procedures******





*Evaluation
of disclosure controls and procedures*





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





Our
current management, with the participation of our chief executive officer and
chief financial officer, has evaluated the effectiveness of our disclosure
controls and procedures as of March 31, 2005, which included an evaluation of
disclosure controls and procedures applicable to the period covered by the
filing of this periodic report. Based on this evaluation, our chief executive
officer and chief financial officer have concluded that our disclosure controls
and procedures were adequate as of March 31, 2005.




*Changes
in internal controls*


In our
Form 10K dated December 31, 2004, the Company 's management identified several
issues relating to improvement of our internal controls. Since that time, we
have implemented various changes to our controls responding to these issues, as
follows:
  ·
    Have
      hired accounting personnel with experience, skills, and knowledge relating
      to complex leasing and financing transactions and insured their direct
      involvement in the review and accounting evaluation of such
      transactions;
  ·
    Have
      included internal personnel and outside accounting consultants, if
      necessary, early in a transaction to obtain additional guidance as to the
      application of generally accepted accounting principles to a proposed
      transaction;




**26**


Table of Contents


·
    Have
      established clear responsibilities for our real estate personnel and
      accounting personnel and increased the formal interaction, responsibility
      and coordination between such personnel;
  ·
    Have
      documented the review, analysis, and related conclusions with respect to
      complex leasing transactions;
  ·
    Senior
      accounting personnel and the chief accounting officer review such
      transactions in order to evaluate, document, and approve their accounting
      treatment.
  
 Management
believes these changes to be adequate, but will continue to evaluate the
effectiveness of the Company's internal controls and make additional changes as
appropriate.


Management
believes these changes to be adequate, but will continue to evaluate the
effectiveness of the Company's internal controls and make additional changes as
appropriate.








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**27**


Table of Contents


**PART II. OTHER INFORMATION**





**Items
2 through 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.
Reserves for these claims have been accrued based upon actuarial and/or
estimated exposure, taking into account self-insured retention or deductibles,
as applicable. While we cannot predict the results with certainty, except as
noted below, we do not believe that any liability from any such lawsuits or
other matters will have a material effect on our financial position, results of
operations, or liquidity.





Proceedings
in which we are currently involved are contained in our 2004 Form 10-K Part I
Item 3 "Legal Proceedings" that was filed March 31, 2005. A discussion of our
general and professional liability is contained in the same 2004 Form 10-K under
"Significant Accounting Policies and Use of Estimates."




**Item 6 Exhibits**
 
  
 **Footnote****Number**
    
    **Description**
    
    **Number****10.53**
    
    **Emeritrust
      II communities**10.53.19
    Second
      Amended and Restated Loan Agreement between Healthcare Realty Trust and
      EmeritusCorporation
      and dated as of March 3, 2005.
    
    (2)10.53.20
    Second
      Amended and Restated Note**between
      Emeritus Corporation and Healthcare Realty TrustIncorporated
      and dated as of March 3, 2005.
    
    (2)10.53.21
    Loan
      Purchase Agreement among Healthcare Realty Trust Incorporated, Health Care
      REIT, Inc., andEmeritus
      Corporation and dated as of March 3, 2005.
    
    (2)10.53.22
    Intercreditor
      Agreement between Health Care REIT, Inc. and Healthcare Realty Trust
      Incorporated anddated
      as of March 3, 2005.
    
    (2)**10.79**
    
    **Loyalton
      of Folsom, California; The Lakes, Florida; Canterbury Woods,
      Massachusetts; Beckett Meadows,****Texas;
      Creekside, Texas; Oak Hollow, Texas; Pinehurst, Texas; Stonebridge, Texas,
      Desert Springs, Texas;****Austin
      Gardens, California; Kingsley Place Shreveport, Louisiana; Silverleaf
      Manor, Mississippi;****Pine
      Meadow, Mississippi; Pines of Goldsboro, North Carolina; Loyalton of
      Rockford, Illinois;****Charleston
      Gardens, West Virginia; Arbor Gardens at Corona, California; and Manor at
      Essington, Illinois;****Quail
      Ridge, Lubbock, Texas; Richland Gardens, Richland,
      Washington.****The
      following agreements are representative of those executed in connection
      with these properties:**10.79.10
    Lease
      dated March 1, 2005 between QR Lubbock Texas Properties, L.P., a Texas
      Limited Partnership ("Landlord"),and
      ESC IV, LP, a Washington Limited Partnership (doing business in the State
      of Texas as Texas - ESC IV, L.P.(“Tenant”).
    
    (5)10.79.11
    Guaranty
      of Lease executed as of March 1, 2005, by Emeritus Corporation, a
      Washington Corporation ("Guarantor")in
      favor of QR Lubbock Texas Properties, L.P., a Texas Limited Partnership
      ("Landlord")
    
    (5)10.79.12
    Lease
      dated February 25, 2005 to be effective as of March 1, 2005 (the
      "Effective Date") between BIP SUB I,Inc.,
      a Delaware Corporation ("Landlord"), and Emeritus Corporation, a
      Washington Corporation ("Tenant").
    
    (5)
   **28**
 Table of Contents
   **Footnote****Number**
    
    **Description**
    
    **Number****10.83**
    
    **Barrington
      Place, Lecanto, Florida; Bellaire Place, Greenville, South Carolina;
      Brookside Estates, Middleberg****Heights,
      Ohio; Dowlen Oaks, Beaumont, Texas; Eastman Estates, Longview, Texas; Elm
      Grove, Hutchinson,****Kansas;
      Emeritus Estates, Ogden, Utah; Gardens at White Chapel, Newark, Delaware;
      Habor Pointe Shores,****Ocean
      Shores, Washington; Hunters Glen, Missoula, Montana; Lakeridge Place,
      Wichita Falls, Texas;****Meadowlands
      Terrace, Waco, Texas; Myrtlewood Estates, San Angelo, Texas; Pavilion at
      Crossing Pointe,****Orlando,
      Florida; Seville Estates, Amarillo, Texas; Saddleridge Lodge, Midland,
      Texas; Springtree, Sunrise,****Florida;
      The Terrace, Grand Terrace, California; Wilburn Gardens, Fredericksburg,
      Virginia; Woodmark****at
      Summit Ridge, Reno, Nevada.**10.83.6
    Lease
      Agreement between HCRI Wilburn Gardens Properties, LLC and Emeritus
      Corporation dated March 31, 2005.
    
    (5)31.1
    
    
    Certification
      of Periodic Reports31.1.1
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
      the Sarbanes-Oxley Actof
      2002 for Daniel R. Baty dated May 12, 2005.
    
    (5)31.1.2
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of
      the Sarbanes-Oxley Actof
      2002 for Raymond R. Brandstrom dated May 12, 2005.
    
    (5)32.1
    
    
    Certification
      of Periodic Reports32.1.1
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Actof
      2002 for Daniel R. Baty dated May 12, 2005.
    
    (5)32.1.2
    Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Actof
      2002 for Raymond R. Brandstrom dated May12, 2005.
    
    (5)99.1
    
    
    Press
      Releases91.1.1
    Press
      Release dated February 25, 2005, announcing the results of a jury verdict
      and plans to appeal.
    
    (1)91.1.2
    Press
      Release dated March 3, 2005, announcing a $21.4 million
      refinance.
    
    (2)99.1.3
    Press
      Release dated March 31, 2005, reports on fourth quarter and year 2004
      results.
    
    (3)99.1.4
    Press
      Release dated May 12, 2005, reports on first quarter
    results.
    
    (4)
 
 Footnotes:(1)
    Filed
      as an exhibit to a Form 8-K filed on February 25, 2005, and incorporated
      herein by reference.(2)
    Filed
      as an exhibit to a Form 8-K filed on March 9, 2005, and incorporated
      herein by reference.(3)
    Filed
      as an exhibit to a Form 8-K filed on April 1, 2005, and incorporated
      herein by reference.(4)
    Filed
      as an exhibit to a Form 8-K filed on May 12, 2005, and incorporated herein
      by reference.(5)
    Filed
      herewith.
 
 
 
 
 
  
 **29**


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:
      May 12, 2005
    **EMERITUS
      CORPORATION**(Registrant)/s/
      Raymond R. BrandstromRaymond
      R. Brandstrom, Vice President of Finance,Chief
      Financial Officer, and Secretary









**30**