UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549


______________________





FORM
10-Q


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





For the
quarterly period ended September 30, 2009





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





Commission
file number   1-14012





EMERITUS
CORPORATION


(Exact
name of registrant as specified in its charter)





WASHINGTON
            91-1605464(State
      or other jurisdiction
            (I.R.S
      Employerof
      incorporation or organization)
            Identification
      No.)





3131
Elliott Avenue, Suite 500


Seattle,
WA 98121


(Address
of principal executive offices)





(206)
298-2909


(Registrant’s
telephone number, including area code)


____________________________





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files). YesoNoo





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





Large
accelerated fileroAccelerated
filerþNon-accelerated
fileroSmaller
reporting company o














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





As of
October 31, 2009, there were 39,254,363 shares of the Registrant’s Common Stock,
par value $0.0001, outstanding.





















EMERITUS
      CORPORATIONTable of ContentsPart I.  Financial
  InformationPage No.Item 1.  Financial Statements
      (unaudited):
            1Condensed Consolidated Balance Sheets as of September
      30, 2009, and December 31, 2008
            2Condensed Consolidated Statements of Operations
      for the three and nine months ended September 30, 2009 and
      2008
            3Condensed Consolidated Statements of Cash Flows for the
      nine months ended September 30, 2009 and 2008
            4Condensed Consolidated Statement of Shareholders’ Equity for
      the nine months ended September 30, 2009
            6Notes to Condensed Consolidated Financial
      Statements
            7Item 2.
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            18Item 3.
            Quantitative and Qualitative Disclosures About Market
      Risk
            44Item 4.
            Controls and Procedures
            44Part II.  Other
InformationNote:
            Items
      2, 3, 4, and 5 of Part II have been omitted because they are not
      applicable.Item 1.
            Legal Proceedings
            45Item 1A.
            Risk Factors
            45Item 6.
            Exhibits
            45Signature
            46Index to Exhibits
            47








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)








ASSETSSeptember
      30,
            
            
            December
      31,2009
            
            
            2008Current
      Assets:Cash
      and cash equivalents
            
            $
            52,090
            
            
            $
            27,254Short-term
      investments
            
            
            2,054
            
            
            
            1,802Trade
      accounts receivable, net of allowance of $951 and $549
            
            
            9,970
            
            
            
            11,596Other
      receivables
            
            
            5,669
            
            
            
            5,556Tax,
      insurance, and maintenance escrows
            
            
            24,466
            
            
            
            21,762Prepaid
      workers' compensation
            
            
            18,860
            
            
            
            19,288Other
      prepaid expenses and current assets
            
            
            22,980
            
            
            
            23,720Property
      held for sale
            
            
            37,354
            
            
            
            13,712Total
      current assets
            
            
            173,443
            
            
            
            124,690Long-term
      investments
            
            
            4,946
            
            
            
            4,192Property
      and equipment, net of accumulated depreciation of $200,231 and
      $144,441
            
            
            1,676,947
            
            
            
            1,725,558Restricted
      deposits
            
            
            13,071
            
            
            
            12,337Lease
      acquisition costs, net of accumulated amortization of $1,781 and
      $1,877
            
            
            3,742
            
            
            
            3,867Goodwill
            
            
            74,197
            
            
            
            73,704Other
      intangible assets, net of accumulated amortization of $25,814 and
      $76,368
            
            
            118,491
            
            
            
            131,994Other
      assets, net
            
            
            23,364
            
            
            
            18,851Total
      assets
            
            $
            2,088,201
            
            
            $
            2,095,193LIABILITIES,
      SHAREHOLDERS' EQUITY AND NON-CONTROLLING INTERESTCurrent
      Liabilities:Current
      portion of long-term debt
            
            $
            49,941
            
            
            $
            18,267Current
      portion of capital lease and financing obligations
            
            
            10,838
            
            
            
            9,172Trade
      accounts payable
            
            
            5,650
            
            
            
            7,474Accrued
      employee compensation and benefits
            
            
            39,266
            
            
            
            32,778Accrued
      interest
            
            
            7,606
            
            
            
            7,012Accrued
      real estate taxes
            
            
            13,129
            
            
            
            9,791Accrued
      professional and general liability
            
            
            9,599
            
            
            
            10,842Accrued
      income taxes
            
            
            596
            
            
            
            3,715Other
      accrued expenses
            
            
            12,822
            
            
            
            12,284Deferred
      revenue
            
            
            12,938
            
            
            
            12,463Unearned
      rental income
            
            
            16,590
            
            
            
            16,101Total
      current liabilities
            
            
            178,975
            
            
            
            139,899Long-term
      debt obligations, less current portion
            
            
            1,335,086
            
            
            
            1,355,149Capital
      lease and financing obligations, less current portion
            
            
            168,194
            
            
            
            180,684Deferred
      gain on sale of communities
            
            
            7,420
            
            
            
            2,667Deferred
      rent
            
            
            28,818
            
            
            
            14,022Other
      long-term liabilities
            
            
            37,186
            
            
            
            36,744Total
      liabilities
            
            
            1,755,679
            
            
            
            1,729,165Commitments
      and contingenciesShareholders'
      Equity and Non-controlling Interest:Preferred
      stock, $.0001 par value.  Authorized 20,000,000 shares, none
      issued
            
            
            -
            
            
            
            -Common
      stock, $.0001 par value.  Authorized 100,000,000 shares, issued
      and outstanding39,244,363
      and 39,091,648 shares at September 30, 2009, and December 31, 2008,
      respectively
            
            
            4
            
            
            
            4Additional
      paid-in capital
            
            
            723,782
            
            
            
            719,903Accumulated
      other comprehensive income
            
            
            1,235
            
            
            
            -Accumulated
      deficit
            
            
            (398,451
            )
            
            
            (360,506
            )Total
      Emeritus Corporation shareholders' equity
            
            
            326,570
            
            
            
            359,401Noncontrolling
      interest-related party
            
            
            5,952
            
            
            
            6,627Total
      shareholders' equity and non-controlling interest
            
            
            332,522
            
            
            
            366,028Total
      liabilities, shareholders' equity and non-controlling
    interest
            
            $
            2,088,201
            
            
            $
            2,095,193





See
accompanying Notes to Condensed Consolidated Financial Statements





2


Table of Contents


EMERITUS CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(unaudited)


(In
thousands, except per share data)








Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Revenues:Community
      revenue
            
            $
            221,262
            
            
            $
            189,638
            
            
            $
            655,411
            
            
            $
            555,925Management
      fees
            
            
            1,439
            
            
            
            1,266
            
            
            
            4,359
            
            
            
            3,648Total
      operating revenues
            
            
            222,701
            
            
            
            190,904
            
            
            
            659,770
            
            
            
            559,573Expenses:Community
      operations (exclusive of depreciation and amortizationand
      facility lease expense shown separately below)
            
            
            146,700
            
            
            
            122,119
            
            
            
            426,832
            
            
            
            359,504General
      and administrative
            
            
            16,429
            
            
            
            14,725
            
            
            
            47,666
            
            
            
            44,066Impairment
      loss on long-lived assets
            
            
            1,857
            
            
            
            -
            
            
            
            1,857
            
            
            
            -Depreciation
      and amortization
            
            
            18,643
            
            
            
            28,925
            
            
            
            58,031
            
            
            
            88,742Facility
      lease expense
            
            
            29,360
            
            
            
            22,339
            
            
            
            88,029
            
            
            
            66,968Total
      operating expenses
            
            
            212,989
            
            
            
            188,108
            
            
            
            622,415
            
            
            
            559,280Operating
      income from continuing operations
            
            
            9,712
            
            
            
            2,796
            
            
            
            37,355
            
            
            
            293Other
      income (expense):Interest
      income
            
            
            575
            
            
            
            480
            
            
            
            902
            
            
            
            1,913Interest
      expense
            
            
            (26,170
            )
            
            
            (24,874
            )
            
            
            (77,649
            )
            
            
            (68,030
            )Change
      in fair value of interest rate swaps
            
            
            (221
            )
            
            
            (119
            )
            
            
            621
            
            
            
            16Equity
      earnings (losses) for unconsolidated joint ventures
            
            
            (76
            )
            
            
            (33
            )
            
            
            1,108
            
            
            
            (890
            )Other,
      net
            
            
            441
            
            
            
            (440
            )
            
            
            792
            
            
            
            (481
            )Net
      other expense
            
            
            (25,451
            )
            
            
            (24,986
            )
            
            
            (74,226
            )
            
            
            (67,472
            )Loss
      from continuing operations before income taxes
            
            
            (15,739
            )
            
            
            (22,190
            )
            
            
            (36,871
            )
            
            
            (67,179
            )Provision
      for income taxes
            
            
            (360
            )
            
            
            (270
            )
            
            
            (900
            )
            
            
            (750
            )Loss
      from continuing operations
            
            
            (16,099
            )
            
            
            (22,460
            )
            
            
            (37,771
            )
            
            
            (67,929
            )Loss
      from discontinued operations
            
            
            (122
            )
            
            
            (616
            )
            
            
            (849
            )
            
            
            (6,349
            )Net
      loss
            
            
            (16,221
            )
            
            
            (23,076
            )
            
            
            (38,620
            )
            
            
            (74,278
            )Net
      loss attributable to the noncontrolling interest
            
            
            232
            
            
            
            -
            
            
            
            675
            
            
            
            -Net
      loss attributable to Emeritus Corporation common
    shareholders
            
            $
            (15,989
            )
            
            $
            (23,076
            )
            
            $
            (37,945
            )
            
            $
            (74,278
            )Basic
      and diluted loss per common share attributable toEmeritus
      Corporation common shareholders:Continuing
      operations
            
            $
            (0.41
            )
            
            $
            (0.57
            )
            
            $
            (0.95
            )
            
            $
            (1.74
            )Discontinued
      operations
            
            
            (0.00
            )
            
            
            (0.02
            )
            
            
            (0.02
            )
            
            
            (0.16
            )$
            (0.41
            )
            
            $
            (0.59
            )
            
            $
            (0.97
            )
            
            $
            (1.90
            )Weighted
      average common shares outstanding; basic and diluted
            
            
            39,208
            
            
            
            39,082
            
            
            
            39,158
            
            
            
            39,059








See
accompanying Notes to Condensed Consolidated Financial Statements





3


Table of Contents


EMERITUS CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


(In
thousands)





Nine
      Months Ended September 30,2009
              
              
              2008Cash
      flows from operating activities:Net
      loss
              
              $
              (38,620
              )
              
              $
              (74,278
              )Adjustments
      to reconcile net loss to net cash provided byoperating
      activitiesDepreciation
      and amortization - continuing operations
              
              
              58,031
              
              
              
              88,742Depreciation
      and amortization - discontinued operations
              
              
              284
              
              
              
              1,239Amortization
      of above/below market rents
              
              
              7,430
              
              
              
              7,572Amortization
      of deferred gains
              
              
              (460
              )
              
              
              (1,134
              )Impairment
      of long-lived assets and investments
              
              
              2,989
              
              
              
              4,930Amortization
      of loan fees
              
              
              2,363
              
              
              
              1,849Allowance
      for doubtful receivables
              
              
              2,317
              
              
              
              1,096Equity
      investment (earnings) losses and distributions
              
              
              (1,108
              )
              
              
              890Stock
      based compensation
              
              
              3,250
              
              
              
              3,786Change
      in fair value of interest rate swaps
              
              
              (621
              )
              
              
              (16
              )Other
              
              
              212
              
              
              
              221Changes
      in operating assets and liabilitiesDeferred
      rent
              
              
              14,796
              
              
              
              7,012Deferred
      revenue
              
              
              475
              
              
              
              2,688Change
      in operating assets and liabilities - other
              
              
              3,772
              
              
              
              11,860Net
      cash provided by operating activities
              
              
              55,110
              
              
              
              56,457Cash
      flows from investing activities:Acquisition
      of property and equipment
              
              
              (22,416
              )
              
              
              (568,035
              )Community
      acquisition
              
              
              (10,579
              )
              
              
              (6,935
              )Acquisition
      deposits
              
              
              (6,345
              )
              
              
              (3,167
              )Sale
      of property and equipment
              
              
              2,677
              
              
              
              6,754Lease
      and contract acquisition costs
              
              
              (194
              )
              
              
              (686
              )Payments
      from affiliates and other managed communities, net
              
              
              798
              
              
              
              394Distribution
      from (investment in) unconsolidated joint ventures/other
              
              
              1,589
              
              
              
              (2,976
              )Net
      cash used in investing activities
              
              
              (34,470
              )
              
              
              (574,651
              )Cash
      flows from financing activities:Proceeds
      from sale of stock
              
              
              629
              
              
              
              950Decrease
      (increase) in restricted deposits
              
              
              (477
              )
              
              
              1,882Debt
      issuance and other financing costs
              
              
              (564
              )
              
              
              (9,405
              )Proceeds
      from long-term borrowings and financings
              
              
              16,008
              
              
              
              663,496Repayment
      of long-term borrowings and financings
              
              
              (4,397
              )
              
              
              (151,055
              )Repayment
      of capital lease and financing obligations
              
              
              (7,003
              )
              
              
              (11,743
              )Net
      cash provided by financing activities
              
              
              4,196
              
              
              
              494,125Net
      increase (decrease) in cash and cash equivalents
              
              
              24,836
              
              
              
              (24,069
              )Cash
      and cash equivalents at the beginning of the period
              
              
              27,254
              
              
              
              67,710Cash
      and cash equivalents at the end of the period
              
              $
              52,090
              
              
              $
              43,641










4


Table of Contents














EMERITUS
CORPORATION


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(unaudited)


(In
thousands)





Nine
      Months Ended September 30,2009
              
              
              2008Supplemental
      disclosure of cash flow information -Cash
      paid during the period for interest
              
              $
              74,658
              
              
              $
              65,143Cash
      paid during the period for income taxes
              
              
              2,864
              
              
              
              1,667Cash
      received during the period for income tax refunds
              
              
              421
              
              
              
              2,647Non-cash
      financing and investing activities:Adjustments
      related to purchase of leased properties:Capital
      and financing lease buyouts
              
              
              -
              
              
              
              281,925Deferred
      gains and losses
              
              
              -
              
              
              
              15,462Lease
      acquisition costs
              
              
              -
              
              
              
              13,570Deferred
      rent
              
              
              -
              
              
              
              562Capital
      lease and financing obligations
              
              
              295
              
              
              
              4,964Contingent
      purchase price adjustment on goodwill
              
              
              -
              
              
              
              4,458Sales
      leaseback transactionNet
      increase in property and equipment
              
              
              968
              
              
              
              -Decrease
      in lease obligation
              
              
              4,115
              
              
              
              -Increase
      in deferred gain
              
              
              (5,212
              )
              
              
              -Decrease
      in deferred rent
              
              
              129
              
              
              
              -Unrealized
      gain on investment in marketable equity securities
              
              
              1,235
              
              
              
              86







See
accompanying Notes to Condensed Consolidated Financial Statements











5


Table of Contents


EMERITUS CORPORATION


CONDENSED
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY


(unaudited)


(In
thousands, except share data)











Emeritus
      Corporation ShareholdersAccumulatedCommon
      stock
            
            
            Additional
            
            
            other
            
            
            
            
            
            
            
            
            TotalNumber
            
            
            
            
            
            paid-in
            
            
            comprehensive
            
            
            Accumulated
            
            
            Noncontrolling
            
            
            shareholders'of
      shares
            
            
            Amount
            
            
            capital
            
            
            income
            
            
            deficit
            
            
            interest
            
            
            equityBalances
      at December 31, 2008
            
            
            39,091,648
            
            
            $
            4
            
            
            $
            719,903
            
            
            $
            –
            
            
            $
            (360,506
            )
            
            $
            6,627
            
            
            $
            366,028Issuances
      of shares under Employee Stock Purchase Plan, net of
      repurchases
            
            
            14,739
            
            
            
            –
            
            
            
            169
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            169Options
      exercised
            
            
            137,976
            
            
            
            –
            
            
            
            460
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            460Stock
      option compensation expense
            
            
            –
            
            
            
            –
            
            
            
            3,250
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            3,250Accumulated
      other comprehensive income
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1,235
            
            
            
            –
            
            
            
            –
            
            
            
            1,235Net
      loss
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (37,945
            )
            
            
            (675
            )
            
            
            (38,620
            )Balances
      at September 30, 2009
            
            
            39,244,363
            
            
            $
            4
            
            
            $
            723,782
            
            
            $
            1,235
            
            
            $
            (398,451
            )
            
            $
            5,952
            
            
            $
            332,522








See
accompanying Notes to Condensed Consolidated Financial Statements








6


Table of Contents





EMERITUS CORPORATION


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


September
30, 2009





1.
            Description
      of Business





Emeritus
Corporation (“Emeritus” or the “Company”) is an assisted living, Alzheimer’s and
dementia care service provider that operates residential style communities
located throughout the United States.  Through these communities,
Emeritus management (“we”, “our” or “us”) provides a residential housing
alternative for senior citizens who need help with the activities of daily
living, with an emphasis on assisted living and personal care
services.  As of September 30, 2009, the Company owned 165 communities
and leased 105communities.  Of
the combined 270communities, five are
accounted for as discontinued operations and 265 are accounted for as continuing
operations. These 270 communities comprise the communities included in the
consolidated financial statements.





We also
provide management services to independent and related-party owners of assisted
living communities.  As of September 30, 2009, we managed 39
communities, of which 24are owned by joint
ventures in which the Company has a financial interest.  Management
agreements typically provide for fees of 5% to 6% of gross
revenues.





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





2.
            Summary
      of Significant Accounting Policies and Use of
  Estimates





The
preparation of condensed consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosures of contingent assets and
liabilities.  On an ongoing basis, we evaluate our estimates,
including those related to resident move-in fees, bad debts, investments,
intangible assets, impairment of long-lived assets and goodwill, income taxes,
long-term service contracts, contingencies, self-insured retention, insurance
deductibles, health insurance, inputs to the Black-Scholes option pricing model,
and litigation.  We base our estimates on historical experience and on
various other assumptions that we believe 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.





We
believe that certain critical accounting policies are most significant to the
judgments and estimates used in the preparation of our condensed consolidated
financial statements.  We record revisions to such estimates to income
in the period in which the facts that give rise to the revision become
known.  A detailed discussion of our significant accounting policies
and the use of estimates is contained in the Company’s Annual Report on Form
10-K for the fiscal year ended December 31, 2008, which was filed with the
Securities and Exchange Commission (“SEC”) on March 16, 2009.  See
Note 11 for additional discussion of our policy regarding goodwill impairment
tests.





Basis
of Presentation





The
unaudited condensed consolidated financial statements reflect all adjustments
that are, in our opinion, necessary to state fairly the financial position,
results of operations, and cash flows of Emeritus as of September 30, 2009, and
for all periods presented.  Except as otherwise disclosed in these
Notes, such adjustments are of a normal, recurring nature.  The
results of operations for the period ended September 30, 2009, are not
necessarily indicative of the operating results that may be achieved for the
full year ended December 31, 2009.  We presume that those reading this
interim financial information have read or have access to the 2008 audited
consolidated financial statements and Management’s Discussion and Analysis of
Financial Condition and Results of Operations that are contained in the
Company’s Annual Report on Form 10-K for the fiscal year ended December 31,
2008.  Therefore, we have omitted certain footnotes and other
disclosures that are disclosed in the Form 10-K.





7
 EMERITUS
CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009


Table of Contents





Reclassifications
and Revisions





We recast
the 2008 financial information so that the basis of presentation is consistent
with that of the 2009 financial information.  Specifically, in 2009
our Board of Directors approved the sale of three communities and, as a result,
we reclassified the results of operations for these communities to discontinued
operations for all periods presented (see Note 9).  Additionally, we
adopted Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in
Consolidated Financial Statements — an amendment of Accounting Research Bulletin
No. 51 (SFAS No. 160) effective January 1, 2009 (superceded in
September 2009 by the Financial Accounting Standards Board Codification (“FASC”)
section 810-10-45-16).  As a result, we have classified the
”Noncontrolling interest—related party” as a separate component of shareholders’
equity in our condensed consolidated balance sheets as of September 30, 2009 and
December 31, 2008.  We also present the amount of consolidated net
loss attributable to Emeritus and to the noncontrolling interest–related party
on the face of the statement of operations.





We
revised the condensed consolidated balance sheet as of December 31, 2008, to
reflect a reallocation of approximately $15.6 million of our valuation allowance
from current deferred tax assets to noncurrent deferred tax assets, resulting in
current deferred tax assets and noncurrent deferred tax liabilities of $15.6
million in the condensed consolidated balance sheet.





Recent
Accounting Pronouncements




In June
2009, the Financial Accounting Standards Board (FASB) issued SFAS No. 167, Amendments to FASB Interpretation
No. 46(R)(SFAS No. 167), amending the consolidation guidance for
variable-interest entities under FIN 46(R), Consolidation of Variable Interest
Entities—an interpretation of ARB No. 51.  The amendments
include: (1) the elimination of the exemption for qualifying special purpose
entities, (2) a new approach for determining who should consolidate a
variable-interest entity, and (3) changes to when it is necessary to reassess
who should consolidate a variable-interest entity.  We will be
required to adopt SFAS No. 167 as of January 1, 2010.  We are
reviewing the requirements of SFAS No. 167, which applies to our investments in
unconsolidated joint ventures, and have not yet made a definitive determination
as to whether this statement will require us to consolidate our equity method
investees.





In May
2009, the FASB issued SFAS No. 165, Subsequent Events (as amended)(SFAS No. 165), which was effective for our June 30, 2009, financial
statements.  SFAS No. 165 establishes general standards for accounting
and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued, as defined in the
Statement.  As is required for public companies, we evaluate
subsequent events through the date that our financial statements are distributed
to the public.  The adoption of SFAS No. 165 did not change our
current practice and had no impact on our consolidated financial
statements.





3.
            Stock-Based
      Compensation





We have
three equity incentive plans: the 2006 Equity Incentive Plan (the “2006 Plan”),
the Amended and Restated Stock Option Plan for Non-employee Directors (the
“Directors Plan”) and the 1995 Stock Incentive Plan (the “1995
Plan”).  We also provide an Employee Stock Purchase Plan (the “2009
ESP Plan”), which replaced the Amended 1998 Employee Stock Purchase Plan (the
“1998 ESP Plan”).  We record compensation expense based on fair value
for all stock-based awards, which amounted to approximately $1.2 million and
$1.0 million for the three months ended September 30, 2009 and 2008,
respectively, and approximately $3.3 million and $3.8 million for the nine
months ended September 30, 2009 and 2008, respectively.





Stock
Incentive Plans





During
the nine months ended September 30, 2009, we granted options to purchase 91,200
shares of our common stock from the 2006 Plan and options to purchase 52,500
shares of our common stock from the Directors Plan.  The following
table summarizes our stock option activity for the nine months ended September
30, 2009:





8
 EMERITUS
CORPORATION
 NOTES TO
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 September
30, 2009


Table of Contents





Weighted-
            
            
            AggregateAverage
            
            
            IntrinsicExercise
            
            
            ValueShares
            
            
            Price
            
            
            $(000)Outstanding
      at  beginning of period
            
            
            2,840,652
            
            
            $
            16.30Granted
            
            
            143,700
            
            
            $
            12.48Exercised
            
            
            (137,976
            )
            
            $
            3.44
            
            
            $
            985Forfeited/expired
            
            
            (310,900
            )
            
            $
            18.68Outstanding
      at end of period
            
            
            2,535,476
            
            
            $
            16.49
            
            
            $
            19,272Options
      exercisable
            
            
            1,374,093
            
            
            $
            17.16
            
            
            $
            9,632Weighted-average
      fair value of options granted
            
            
            
            
            
            $
            6.99Options
      exercisable in the money
            
            
            811,576
            
            
            
            
            
            
            $
            9,632Options
      exercisable out of the money
            
            
            562,517
            
            
            
            
            
            
            $
            -





We
estimate the fair value of our options using the Black-Scholes option pricing
model.  Option valuation models require the input of various
assumptions, including the expected stock price volatility, risk-free interest
rate, dividend yield and forfeiture rate.  We group the options into
two main categories based on expected life, which are the employee group and the
non-employee directors.  We estimate the fair value of the stock
options granted using a risk-free rate that is the five-year or seven-year U.S.
Treasury yield in effect at the time of grant.  The expected life of
the stock options granted (five or seven years) is estimated using the
historical exercise behavior of option holders.  Expected volatility
is based on historical volatility for a period equal to the stock option’s
expected life, ending on the date of grant.  Forfeitures are estimated
at the time of valuation and reduce expense ratably over the vesting
period.  The forfeiture rate, which is currently estimated at 6.5% of
the options awarded, is adjusted periodically based on the extent to which
actual forfeitures differ, or are expected to differ, from the previous
estimate.  Our options have characteristics significantly different
from those of traded options and changes in the various input assumptions can
materially affect the fair value estimates.  We estimated the fair
value of the options granted in the current year period under the 2006 Plan at
the date of grant using the following weighted average assumptions:





For
      Employees and Key ExecutivesNine
      Months Ended September 30,2009
            
            
            2008Expected
      life from vest date (in years)
            
            
            5
            
            
            
            5Risk-free
      interest rate
            
            
            1.87-2.53
            %
            
            
            2.69
            %Volatility
            
            
            55.6-58.8
            %
            
            
            42.7
            %





We
estimated the fair value of options granted in the current year period under the
Directors Plan at the date of grant using the following weighted average
assumptions:





For
      DirectorsNine
      Months Ended September 30,2009
            
            
            2008Expected
      life from vest date (in years)
            
            
            7
            
            
            
            7Risk-free
      interest rate
            
            
            2.86
            %
            
            
            3.90
            %Volatility
            
            
            61.6
            %
            
            
            54.7
            %








9
 EMERITUS
CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009


Table of Contents


Employee
Stock Purchase Plan





In May
2009, the Company’s shareholders approved the 2009 ESP Plan, which replaced the
1998 ESP Plan.  The terms of the 2009 ESP Plan are substantially the
same as 1998 ESP Plan, whereby we offer eligible employees the opportunity to
purchase Emeritus common stock at a 15% discount from the lower of the market
price on (a) the first trading date of each calendar quarter or (b) the last
trading date of each quarter.  Sales of Emeritus stock to eligible
employees under the 2009 ESP Plan began for the offering period ended September
30, 2009.  We sold 14,786 shares under the 2009 ESP Plan at $11.49 per
share.





The 1998
ESP Plan was terminated by our board of directors in March 2009 after all shares
reserved for issuance under the plan had been issued.  Due to an
inadvertent error in recordkeeping, the amount of shares issued under the 1998
ESP Plan exceeded the 400,000-share reserve.  As a result, the excess
shares were not registered with the SEC.  Under the applicable
provisions of federal securities laws, plan participants who purchased such
unregistered shares have the right to require us to repurchase the shares at the
original exercise price plus interest or, if the employee bought and sold the
shares for a loss, to reimburse the employee for the amount of the
loss.  For the quarterly offering periods ended December 31, 2007
through December 31, 2008, we sold a total of 55,031 unregistered shares to plan
participants at a weighted average price of $12.56 per
share.  Accordingly, the aggregate purchase price of shares subject to
rescission, which excludes shares sold to Emeritus officers, is approximately
$650,000.  Cash paid for share purchases are recorded as a reduction
in shareholders’ equity.  As of September 30, 2009, we have
repurchased 47 shares subject to rescission at a weighted average share price of
$18.74.





We
received cash from the exercise of stock options under our various equity
incentive plans and stock purchased through the 2009 ESP Plan in the amount of
$629,000for the nine
months ended September 30, 2009.





As of
September 30, 2009, there were 385,214 shares available for purchase under the
2009 ESP Plan, 1,000,092 shares available for grant under the 2006 Plan, and
44,000 shares available for grant under the Directors Plan.





4.
            Acquisitions
      and Other Significant Transactions





The
following is a description of various transactions that affected the
comparability of the condensed consolidated financial statements included in
this Form 10-Q.





2008
Ventas Asset Acquisition





In
December 2008, we purchased five communities from Ventas Realty, LP (“Ventas”)
consisting of 432 units (the “Ventas Purchase”) for a purchase price of $64.3
million plus transaction costs of $282,000.  Prior to this
acquisition, we operated these communities under lease agreements with
affiliates of Ventas.





Previously,
we accounted for four of the communities as operating leases, and one of the
communities as a capital lease.  In connection with the Ventas
Purchase, we borrowed $55.6 million, of which $45.6 million represents mortgage
financing and $10.0 million was borrowed from Ventas under a three-year
note.





2008
HCP Lease Agreement





In
December 2008, we executed a Master Lease and Security Agreement (the “HCP
Agreement”) to lease 11 communities comprised of 1,462 units/beds from
affiliates of HCP, Inc. (collectively, “HCP”).  The HCP Agreement is
for a term of ten years.  Annual rents are fixed at $17.5, $21.0,
$25.0, $28.0, and $30.0 million in years one through five, respectively, and
thereafter will increase by the greater of the increase in the CPI or
3.0%.





2008
HCN Asset Acquisition





In June
2008, we entered into an asset purchase agreement (the “HCN Agreement”) with
Health Care REIT, Inc. (“HCN”) and its affiliated entities to purchase 29
communities consisting of 2,257 units for a purchase price of $299.9 million,
excluding transaction costs.  The Company formerly leased these
communities from HCN.  As provided in the HCN Agreement, the
transaction closed in two phases.





10
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CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009


Table of Contents


In June
2008, we completed the first phase of the HCN transaction (“Tranche
1”).  Tranche 1 consisted of 19 communities with a capacity of 1,564
units and a purchase price of $222.7 million, plus closing costs of $1.1
million.  Tranche 1 was financed with mortgage debt of approximately
$163.2 million and seller-provided debt of $50.0 million.  We
previously accounted for 18 of the 19 acquired communities in Tranche 1 as
capital leases.





In
October 2008, we completed the second phase of the HCN transaction (“Tranche
2”).  This closing consisted of 10 communities with a capacity of 693
units for a purchase price of $77.2 million plus transaction costs of
$190,000.  Tranche 2 was financed with $29.0 million of fixed rate
mortgage debt and $27.4 million of variable rate mortgage debt.  We
previously accounted for nine of the 10 acquired communities in Tranche 2 as
capital leases.





As part
of Tranche 2, eight of the 10 communities are included in a 50/50 joint venture
owned by Emeritus and Mr. Daniel R. Baty, the Company’s Chairman and Co-Chief
Executive Officer, who contributed approximately $6.8 million to the joint
venture for the purchase of the properties.  Prior to the acquisition,
these eight communities were subject to a cash flow sharing agreement with Mr.
Baty, which continues in effect after the acquisition by the joint
venture.  We have the option to buy out Mr. Baty’s membership interest
in the joint venture after January 1, 2011, for a price equal to the lesser of
fair market value or a formula specified in the joint venture operating
agreement, but in no event less than the amount of Mr. Baty’s capital
contribution.  The joint venture is included in the consolidated
financial statements of Emeritus.





2008
NHP Asset Acquisition





In April
2008, we purchased from Nationwide Health Properties, Inc. (“NHP”) 24
communities consisting of 1,672 units for a purchase price of $314.0 million
plus transaction costs of $856,000.  We had previously leased these
communities from NHP and accounted for them as capital leases.  We
financed the purchase through mortgage debt of approximately $249.1 million and
seller-provided debt of $30.0 million.





Other
Acquisitions





In June
2009, we purchased an 85-unit assisted living community that we previously
managed for an affiliate of Mr. Baty.  The purchase price was $10.6
million, of which $7.8 million was financed with mortgage debt and $1.3 million
was financed with an unsecured note payable to an affiliate of Mr. Baty (the
“Baty Note”).  We expensed closing costs of approximately $20,000
related to this purchase.





We
allocated the preliminary purchase price as follows, based on the estimated fair
value of the identified tangible and intangible assets (in
thousands):





Current
      assets
            
            $
            4Property
      and equipment
            
            
            8,800In-place
      resident contract intangible
            
            
            1,283Goodwill
            
            
            492Purchase
      price
            
            $
            10,579





During
the second quarter of 2009, we purchased the California homes of Mr. Granger
Cobb, our President and Co-Chief Executive Officer, and Mr. Budgie Amparo, our
Senior Vice President—Quality and Risk Management, in connection with their
required relocation to Seattle following the merger with Summerville Senior
Living, Inc. (“Summerville”) in September 2007.  The combined purchase
price was approximately $4.3 million.  The purchase price for each was
determined based on an independent appraisal.  The homes are included
in “Property held for sale” in the condensed consolidated balance sheet at
September 30, 2009.





In
January 2009, we entered into a lease for one community consisting of 83
units.  The lease term is ten years with two five-year renewal options
available.  The initial annual minimum rent is approximately $600,000
(less abatements in the first year of $300,000) with fixed annual increases of
3.0%.





In
December 2008, we entered into a lease for two communities consisting of 254
units.  The lease term is ten years with two five-year renewal options
available.  The initial annual lease payment is approximately $1.8
million with fixed increases for two years and increases thereafter at
3.0%.





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CORPORATION
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Table of Contents





In June
2008, we purchased a 54-unit community for $6.8 million plus closing costs of
$185,000, of which $6.0 million was financed through a mortgage
loan.





Sale-Leaseback





In 2003,
we sold four communities to HCN and leased them back.  The sale did
not qualify for sale-leaseback accounting because of our continuing involvement
in the form of a guarantee of the underlying mortgage debt, which was assumed by
HCN in the sale.  Therefore, we recorded the sale proceeds of $34.6
million as a financing lease obligation and continued to report the real estate
and equipment as owned assets.





HCN paid
the mortgage obligations in June 2009 and our guarantee
terminated.  As a result, we recorded the sale-leaseback
transaction.  Each of the four leases is now accounted for as a
capital lease.  As a result, we recorded a net increase in property
and equipment of $968,000, a net decrease in capital lease and financing
obligations of $4.1 million, an increase in deferred gains of $5.2 million and a
decrease in deferred rent of $129,000.





5.
            Long-Term
      Debt





In June
2009, we extended our credit agreement with Wells Fargo Bank, N.A. (“Wells
Fargo”) to June 30, 2010. This agreement provides a $25.0 million unsecured
revolving line of credit with interest based on our choice of either (a) a
fluctuating rate equal to the daily one-month London Interbank Offered Rate
(“LIBOR”) plus 2.50% or (b) a fixed rate for a 30-day term equal to the
one-month LIBOR plus 2.25%, payable monthly.  We must maintain a zero
balance on advances for 30 consecutive days during the one-year term, a $20.0
million minimum balance in cash, cash equivalents and/or publicly traded
marketable securities and a fixed charge coverage ratio of 1.1 to
1.0.  There were no outstanding borrowings under the line of credit as
of the periods presented.





In June
2009, we entered into two debt agreements related to the purchase of an assisted
living community (see Note 4).  The $7.8 million Freddie Mac mortgage
loan has a ten-year term, with monthly payments of interest only at 6.92%
through January 2011 and monthly payments of principal and interest thereafter
based on a 30-year amortization, with the unpaid principal balance due at
maturity.  The $1.3 million unsecured Baty Note has a five-year term,
with monthly payments of interest only at 6.5% and the principal balance due at
maturity.  The maturity date of the Baty Note will be accelerated in
the event that we sell, in a single offering, debt or equity securities in the
amount of $150.0 million or more.





In May
2009, we entered into an agreement to extend the maturity on $11.3 million of
mortgage debt from January 1, 2010 to January 1, 2011.  The LIBOR
margin on the loan increased from 2.25% to 3.50%.  Also in May 2009,
we entered into an agreement to extend the maturity on $7.4 million of mortgage
debt from March 31, 2010 to October 1, 2010.  The interest rate on the
loan increased from 2.65% over LIBOR, with a floor of 5.65%, to 3.25% over LIBOR
with a floor of 6.25%.





In June
2009, we entered into an agreement to extend the maturity of $23.0 million of
mortgage debt from April 1, 2010 to October 1, 2010.  The interest
rate on the loan increased from 2.9% over LIBOR, with no floor, to 4.0% over
LIBOR with a floor of 6.5%.





6.
            Derivative
      Instruments





In the
normal course of business, the Company is exposed to the effect of interest rate
changes and we limit these risks by following risk management policies and
procedures, including the use of derivatives.  We use derivatives to
fix the interest rate on floating-rate debt in order to address exposure to
increases in interest rates and to manage the cost of borrowing
obligations.





Emeritus
is a party to two interest rate swaps with a combined notional amount of $32.0
million.  The swaps effectively convert the interest rates on the
related mortgage debt from floating rates to fixed rates, thus mitigating the
impact of interest rate changes on future interest expense.





12


Table of Contents


EMERITUS
CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009
 
  Hedges
that are reported at fair value and presented on the balance sheet could be
characterized as either cash flow hedges or fair value hedges. Our interest rate
swap contracts are consider





As of
September 30, 2009 and December 31, 2008, the combined fair value of the two
interest rate swaps was as follows (in thousands):




Balance
      Sheet
                Location
              
              As
      of
                September
      30, 2009
                Fair
                Value
              
              
              As
      of
                December
      31, 2008
                Fair
                ValueInterest  rate
      swap
              Other
      long-term liabilities
              
              $
              1,661
              
              
              $
              2,282




7.
            Loss
      Per Share





Basic
loss per share is computed based on the weighted average number of shares
outstanding and excludes any potential dilution.  Diluted loss per
share is computed based on the weighted average number of shares outstanding
plus stock options.  All shares issuable upon the exercise of stock
options are excluded from the computation for the periods presented because the
effect of their inclusion would be antidilutive.





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





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September,
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Options
            
            
            2,535
            
            
            
            2,150
            
            
            
            2,535
            
            
            
            2,150





8.
            Comprehensive
      Loss





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





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Net
      loss
            
            $
            (16,221
            )
            
            $
            (23,076
            )
            
            $
            (38,620
            )
            
            $
            (74,278
            )Other
      comprehensive income:Unrealized
      holding gains onavailable-for-sale
      investment securities
            
            
            614
            
            
            
            24
            
            
            
            1,235
            
            
            
            86Comprehensive
      loss
            
            $
            (15,607
            )
            
            $
            (23,052
            )
            
            $
            (37,385
            )
            
            $
            (74,192
            )





13
 EMERITUS
CORPORATION
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 September
30, 2009
 Table of Contents


The
following table sets forth amounts attributable to Emeritus Corporation common
shareholders, excluding losses attributable to the noncontrolling interest (in
thousands):





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008Loss
      from continuing operations
            
            $
            (15,867
            )
            
            $
            (22,460
            )
            
            $
            (37,096
            )
            
            $
            (67,929
            )Loss
      from discontinued operations
            
            
            (122
            )
            
            
            (616
            )
            
            
            (849
            )
            
            
            (6,349
            )Net
      loss attributable to Emeritus Corporation common
    shareholders
            
            $
            (15,989
            )
            
            $
            (23,076
            )
            
            $
            (37,945
            )
            
            $
            (74,278
            )





9.
            Discontinued
      Operations





In 2008,
we decided to discontinue operations at five of our communities and put the
assets and businesses up for sale.  We decided to sell these
communities primarily because they have consistently incurred operating losses
over a sustained period of time.  Two of the communities were sold in
the second quarter of 2008 and one was sold in January 2009.





In the
first quarter of 2009, we decided to sell three additional underperforming
communities.  We recast our financial statements for the three and
nine months ended September 30, 2008 to present the operations of these
communities as discontinued operations.  We expect to sell the
remaining five communities in the next 12 months.





The
assets of all five properties remaining to be sold as of September 30, 2009,
which consist of property and equipment, are presented separately in “Property
held for sale” in the accompanying condensed consolidated balance sheet at
September 30, 2009 at their estimated fair value less costs to sell (see Note
11).  We will continue to operate these communities until
sold.





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





Three
      Months Ended September 30,
            
            
            Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Total
      revenue
            
            $
            3,627
            
            
            $
            3,881
            
            
            $
            10,839
            
            
            $
            13,082Net
      loss
            
            $
            (122
            )
            
            $
            (616
            )
            
            $
            (849
            )
            
            $
            (6,349
            )





Net loss
includes impairment losses of $0 and $592,000 in the three months ended
September 30, 2009 and 2008 and $1.1 million and $4.9 million in the nine months
ended September 30, 2009 and 2008, respectively, based on the most recent
indicative offers that we received.





10.
            Liquidity





As of
September 30, 2009, the Company had a working capital deficit of $5.5 million,
of which $15.1 million is a deferred tax asset and $29.5 million is deferred
revenue and unearned rental income.  The level of current liabilities
is not expected to increase from period to period in such a way as to require
the use of significant cash, except for debt obligations of $49.9 million
scheduled to mature in the next 12 months, of which $33.7 million is related to
properties held for sale that is due in 2012 but will be payable upon the sale
of the related properties.  We intend to refinance the remaining 2010
obligations prior to their respective due dates.





We
reported net cash generated from operating activities in the condensed
consolidated statements of cash flows of $55.1 million and $56.5 million for the
nine months ended September 30, 2009 and 2008, respectively.  While we
have reported positive cash flows from operating activities over the past three
years, the cash flows have not always been sufficient to pay all of the
Company’s long-term obligations and we have been dependent upon third-party
financing or disposition of assets to fund operations.  We cannot
guarantee that, if necessary in the future, such financing will be readily
available, or on terms attractive to us.




14
 EMERITUS
CORPORATION
 NOTES TO
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 September
30, 2009
 Table of Contents


In fiscal
2008 and into 2009, we refinanced and extended the terms of a substantial amount
of our existing debt obligations, extending the maturities of such financings to
dates in 2010 through 2019.  Many of our debt instruments and leases
contain “cross-default” provisions pursuant to which a default under one
obligation can cause a default under one or more other obligations to the same
lender or lessor.  Such cross-default provisions affect the majority
of our properties.  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.  As of September 30, 2009, we were in violation
of certain financial covenants in four debt agreements.  We have
obtained waivers from the lenders and, as such, the Company was in compliance as
of September 30, 2009.  The lenders on three of the loans modified the
minimum required coverage ratios and/or occupancy rates and we have a firm
commitment to refinance the fourth loan in the fourth quarter of
2009.  Therefore, we classified each of these loans as noncurrent in
the condensed consolidated balance sheet at September 30, 2009.





11.
            Fair
      Value Disclosures





The
following table presents information about the Company’s assets and liabilities
measured at fair value on a recurring basis as of September 30, 2009, and
indicates the fair value hierarchy of the valuation techniques that we utilize
to determine such fair value (in thousands):





Quoted Prices in
            
            
            SignificantActive
      Markets
            
            
            Other
            
            
            Significant
            
            
            Balance
      atfor
      Identical
            
            
            Observable
            
            
            Unobservable
            
            
            September
      30,Assets
      (Level 1)
            
            
            Inputs (Level 2)
            
            
            Inputs (Level 3)
            
            
            2009AssetsInvestment
      securities – trading
            
            $
            2,054
            
            
            $
            -
            
            
            $
            -
            
            
            $
            2,054Investment
      securities – available-for-sale
            
            
            2,468
            
            
            
            -
            
            
            
            -
            
            
            
            2,468Property
      held for sale
            
            
            -
            
            
            
            37,354
            
            
            
            -
            
            
            
            37,354LiabilitiesDerivative
      financial instruments
            
            
            -
            
            
            
            1,661
            
            
            
            -
            
            
            
            1,661





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





Fair
values determined by Level 2 inputs utilize inputs other than quoted prices
included in Level 1 that are observable for the asset or liability, either
directly or indirectly.  Level 2 inputs include quoted prices for
similar assets and liabilities in active markets, and inputs other than quoted
prices that are observable for the asset or liability.  For example,
we use market interest rates and yield curves that are observable at commonly
quoted intervals in the valuation of our interest rate swap
contracts.  The fair value of property held for sale was determined
based on recent offers from prospective purchasers.





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





The
Company has financial instruments other than investment securities consisting of
cash and cash equivalents, trade accounts receivable, other receivables, tax and
maintenance escrows, workers’ compensation collateral accounts, short-term
borrowings, accounts payable, capital and financing lease obligations and
long-term debt.  The fair value of the Company’s other financial
instruments at September 30, 2009 and December 31, 2008, based on their
short-term nature or current market indicators such as prevailing interest
rates, approximates their carrying value with the exception of the following (in
thousands):





15
 EMERITUS
CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009


Table of Contents





September
      30, 2009
            
            
            December
      31, 2008Carrying
            
            
            
            
            
            CarryingAmount
            
            
            Fair
      Value
            
            
            Amount
            
            
            Fair
      ValueLong-term
      debt
            
            $
            1,385,027
            
            
            $
            1,373,281
            
            
            $
            1,373,416
            
            
            $
            1,332,370





We
estimated the fair value of debt obligations using discounted cash flows based
on the Company’s assumed incremental borrowing rates of 8.0% for unsecured
borrowings and 6.5% for secured borrowings at September 30, 2009 and 8.0% for
unsecured borrowings and 6.0% for secured borrowings at December 31,
2008.  These assumptions are considered Level 3 inputs in the fair
value hierarchy.




Impairment
of Long-Lived Assets





We
recorded impairment losses of $1.9 million in the three and nine months ended
September 30, 2009 related to impairment of long-lived assets, which are
included in operating income from continuing operations.  The
impairment loss is comprised of a $623,000 adjustment to assets held for sale,
based on recent negotiations, and a $1.2 million adjustment to intangible
assets, based on our determination of the recovery of this asset from estimated
future cash flows.  In addition, we recorded impairment losses related
to our discontinued operations (see Note 9).





Goodwill
Impairment Test





Our
policy is to estimate the fair value of the Company using a combination of the
market capitalization, discounted cash flows and market comparable
approaches.  We also use market capitalization as a triggering event
that may indicate possible impairment of the reporting unit’s goodwill in
interim periods.





The
Company’s stock price declined in the first quarter of 2009 such that as of
March 31, 2009, the Company’s market price per share closed at $6.56, which was
less than net book value per share.  We therefore tested goodwill for
impairment as of March 31, 2009.  The concluded fair value estimate of
$9.80 per share at March 31, 2009 was determined using a 50-50 weighted average
of the income approach (discounted cash flows) and the market comparable
approach.  The Company’s book value per share as of March 31, 2009 was
$8.83.  Because the estimated fair value exceeded book value on that
date, we concluded that no impairment existed at March 31, 2009.





As of
September 30, 2009 and June 30, 2009, the Company’s market capitalization
exceeded its net book value; therefore, no triggering event occurred and we did
not test goodwill for impairment as of those dates.





12.
            Income
      Taxes





The FASC
sets forth the accounting and reporting for uncertainties in income tax
law.  Accordingly, we recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position.  The tax benefits recognized in the financial
statements from such a position are measured based on the largest benefit that
has a greater than 50% likelihood of being realized upon
settlement.





Our
income tax accruals include liabilities for unrecognized tax benefits, including
penalties and interest, which were recorded in connection with the purchase
price allocation in the Summerville merger.  These liabilities, which
total $2.3 million, are included in “Other long-term liabilities” and are the
result of uncertainty surrounding the deductibility of certain items included in
the Summerville tax returns for periods prior to the merger.










16
 EMERITUS
CORPORATION
 NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
 September
30, 2009


Table of Contents





13.
Commitments and Contingencies
  We
guarantee the mortgage debt payable to a bank by a joint venture in which
Emeritus has a 50% ownership interest (the Stow JV). We account for the Stow JV
as an unconsolidated equity method investment. As of September 30, 2009, the
loan balance was $8.1 million with interest at a variable rate of 2.26%.
Emeritus and the other member of the Stow JV have each provided an unconditional
guarantee of payment of this mortgage loan to the lender. In the event that we
would be required to repay this loan, we would be entitled to recoup 50% of such
payment from the other member of the Stow JV.




14.      Subsequent
Events





Acquisitions





On
October 1, 2009, we purchased a 97-unit assisted living and memory care
community that we previously managed for an affiliate of Mr.
Baty.  The purchase price was $15.8 million, of which $12.2 million
was financed with a 10-year, 6.14% mortgage note and $2.0 million was financed
with a five-year, 6.50% unsecured note payable to an affiliate of Mr. Baty, with
the balance paid in cash.





On
October 1, 2009, we purchased an 83-unit assisted living and memory care
community from Ventas that was previously operated under a management
contract.  The purchase price was $6.3 million and was financed with a
three-year first mortgage note from Ventas in the amount of $5.0 million at a
variable rate of monthly LIBOR plus 6.5%, with the balance paid in
cash.  A one-year extension option is available.





Financings





On
October 27, 2009, we extended the maturity on $22.9 million of mortgage debt for
one year from October 1, 2010 to October 1, 2011.  All other terms of
the debt remain the same.








17


Table of Contents


Item 2.  Management’s Discussion And Analysis Of Financial
Condition And Results Of Operations





Forward-Looking
Statements





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





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


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


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


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


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


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


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


·
            uncertainties
      related to professional liability and workers’ compensation
      claims.





Any or
all of our forward-looking statements in this report and in any other public
statements we make may turn out to be inaccurate.  Please carefully
review Item 1A—Risk
Factors in our Annual Report on Form 10-K for the year ended December 31,
2008 for important factors that could cause our actual results to differ
materially from the forward-looking statements included in this report and
presented elsewhere by our management from time to time.  Incorrect
assumptions we might make and known or unknown risks and uncertainties may
affect the accuracy of our forward-looking
statements.  Forward-looking statements reflect our current
expectations or forecasts of future events or results and are inherently
uncertain, and accordingly, you should not place undue reliance on
forward-looking statements.





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





Overview





During
the first nine months of 2009, we continued to concentrate on implementing our
growth strategy, which focuses on increasing our revenues and cash flows through
a combination of: (i) organic growth in








18
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





our
existing operations; (ii) selected acquisitions of additional communities; and
(iii) expansion of our existing communities.  A summary of activity in
the first nine months of 2009 as compared to the equivalent period in 2008 is as
follows:





·
            Operating
      income from continuing operations was $37.4 million compared to $293,000
      in the prior year period.  Our net loss attributable to Emeritus
      Corporation common shareholders was $37.9 million compared to $74.3
      million in the prior year period.


·
            Total
      revenue increased $100.2 million, or 17.9 %, to $659.8 million from $559.6
      million in the prior year period.


·
            Average
      occupancy decreased slightly to 86.6% from 86.8% in the prior year
      period.


·
            Average
      rate per occupied unit increased 7.9% to $3,660 from $3,393 in the prior
      year period.


·
            Net
      cash provided by operating activities was $55.1 million compared to $56.5
      million in the prior year period.


·
            We
      added one owned (formerly managed), one leased, and two managed
      communities to the Company’s portfolio, opened a new Alzheimer’s
      community, and opened an expansion at an existing
    community.


·
            We
      reclassified three underperforming communities to discontinued operations
      and sold one building that was held for
sale.





The
following table sets forth a summary of the Company’s property
interests:





As
      of September 30,
            
            
            As
      of December 31,
            
            
            As
      of September 30,2009
            
            
            2008
            
            
            2008Buildings
            
            
            Units
            
            
            Buildings
            
            
            Units
            
            
            Buildings
            
            
            UnitsOwned
      (1)
            
            
            165
            
            
            
            13,180
            
            
            
            164
            
            
            
            13,111
            
            
            
            149
            
            
            
            11,981Leased
      (2 )
            
            
            105
            
            
            
            10,632
            
            
            
            104
            
            
            
            10,548
            
            
            
            106
            
            
            
            9,971Consolidated
      Portfolio
            
            
            270
            
            
            
            23,812
            
            
            
            268
            
            
            
            23,659
            
            
            
            255
            
            
            
            21,952Managed/Admin
      Services
            
            
            15
            
            
            
            1,604
            
            
            
            14
            
            
            
            1,479
            
            
            
            11
            
            
            
            1,265Joint
      Venture/Partnership
            
            
            24
            
            
            
            1,818
            
            
            
            24
            
            
            
            1,818
            
            
            
            23
            
            
            
            1,737Operated
      Portfolio
            
            
            309
            
            
            
            27,234
            
            
            
            306
            
            
            
            26,956
            
            
            
            289
            
            
            
            24,954Percentage
      increase  (3)
            
            
            1.0
            %
            
            
            1.0
            %
            
            
            6.6
            %
            
            
            9.2
            %
            
            
            0.7
            %
            
            
            1.1
            %





(1)   Of
the owned communities at September 30, 2009, five are held for sale and are
included in discontinued operations, representing 538 units.


(2)   We
account for 79 of the 105 leased communities as operating leases and the
remaining 26 as capital leases.  We do not include the assets and
liabilities of the 79 operating lease communities on our condensed consolidated
balance sheets.


(3)   The
percentage increase indicates the change from the prior year, or, in the case of
September 30, 2009 and 2008, from the end of the prior fiscal year.





The
Company’s total consolidated portfolio of 23,812 units at September 30, 2009
consists of the following unit types:





Total
      UnitsIndependent
      Living
            
            
            1,340Assisted
      Living
            
            
            17,985Alzheimer's
      Care
            
            
            3,459Skilled
      Nursing Care
            
            
            252Operating
      Units
            
            
            23,036Held
      for sale
            
            
            538Units
      taken out of service
            
            
            238Designed
      Capacity Units
            
            
            23,812








19
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents


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





Significant
Transactions





In recent
periods, we entered into a number of transactions that affected the number of
communities we own, lease, and manage; our financing arrangements; and our
capital structure.  The following table summarizes these transactions
as of September 30, 2009.  For details on significant transactions
that affected the comparability of the financial statements included in this
Quarterly Report on Form 10-Q, see Note 4, Acquisitions and Other Significant
Transactions, in Notes to Condensed Consolidated Financial
Statements





Purchase
            
            
            AmountPrice
      (1)
            
            
            FinancedPortfolio
            Date
            
            Communities
            
            
            Units
            
            
            (in
      thousands)Individual
      community
            June
      2009
            
            
            1
            
            
            
            85
            
            
            $
            10,579
            
            
            $
            9,010
            
            (2
            )Individual
      community
            January
      2009
            
            
            1
            
            
            
            83
            
            
            
            -
            
            
            
            -
            
            (3
            )Ventas
            December
      2008
            
            
            5
            
            
            
            432
            
            
            
            64,251
            
            
            
            55,621
            
            (4
            )HCP,
      Inc.
            December
      2008
            
            
            11
            
            
            
            1,462
            
            
            
            -
            
            
            
            -
            
            (3
            )Individual
      communities
            December
      2008
            
            
            2
            
            
            
            254
            
            
            
            -
            
            
            
            -
            
            (3
            )Health
      Care REIT, Inc. (Tranche 2)
            October
      2008
            
            
            10
            
            
            
            693
            
            
            
            77,164
            
            
            
            56,398
            
            (4
            )Health
      Care REIT, Inc. (Tranche 1)
            June
      2008
            
            
            19
            
            
            
            1,564
            
            
            
            222,656
            
            
            
            213,220
            
            (4
            )Individual
      community
            June
      2008
            
            
            1
            
            
            
            54
            
            
            
            6,750
            
            
            
            6,000
            
            (2
            )Nationwide
      Health Properties, Inc.
            April
      2008
            
            
            24
            
            
            
            1,672
            
            
            
            313,954
            
            
            
            279,140
            
            (4
            )Nationwide
      Health Properties, Inc.
            January
      2008
            
            
            1
            
            
            
            38
            
            
            
            -
            
            
            
            -
            
            (5
            )Individual
      community
            January
      2008
            
            
            1
            
            
            
            104
            
            
            
            -
            
            
            
            -
            
            (3
            )76
            
            
            
            6,441(1)
      Excludes closing costs and purchase accounting
adjustments.(2)
      Purchase of community(3)
      Operating leases(4)
      Acquisition of properties previously operated under leases(5)
      Leased community included in April 2008 acquisition





The
following table shows the changes in the Company’s building portfolio from
December 31, 2007 through September 30, 2009, including those transactions
previously described:





20
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Month
            
            Owned
            
            
            Leased
            
            
            Consolidated
            
            
            Managed
            
            
            TotalDecember
      31, 2007
            
            
            
            107
            
            
            
            147
            
            
            
            254
            
            
            
            33
            
            
            
            287Courtyard
      of Loyalton - development
            Jan-08
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1Summerville
      at Hazel Creek
            Jan-08
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1March
      31, 2008
            
            
            
            107
            
            
            
            149
            
            
            
            256
            
            
            
            33
            
            
            
            289NHP
      Purchase
            Apr-08
            
            
            24
            
            
            
            (24
            )
            
            
            –
            
            
            
            –
            
            
            
            –Galleria
      Oaks - disposition
            May-08
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )Meridian
      Oaks - disposition
            May-08
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )Arborwood
            Jun-08
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            –
            
            
            
            1Emeritus
      at Stow - development
            Jun-08
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1
            
            
            
            1HCN
      Purchase
            Jun-08
            
            
            19
            
            
            
            (19
            )
            
            
            –
            
            
            
            –
            
            
            
            –June
      30, 2008
            
            
            
            149
            
            
            
            106
            
            
            
            255
            
            
            
            34
            
            
            
            289No
      activity in the quarter
            
            
            
            -
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –September
      30, 2008
            
            
            
            149
            
            
            
            106
            
            
            
            255
            
            
            
            34
            
            
            
            289HCN
      Purchase
            Oct-08
            
            
            10
            
            
            
            (10
            )
            
            
            –
            
            
            
            –
            
            
            
            –New
      management agreements
            Nov-08
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            4
            
            
            
            4HCP
      Lease
            Dec-08
            
            
            –
            
            
            
            11
            
            
            
            11
            
            
            
            –
            
            
            
            11LTC
      Leases
            Dec-08
            
            
            –
            
            
            
            2
            
            
            
            2
            
            
            
            –
            
            
            
            2Ventas
      5
            Dec-08
            
            
            5
            
            
            
            (5
            )
            
            
            –
            
            
            
            –
            
            
            
            –December
      31, 2008
            
            
            
            164
            
            
            
            104
            
            
            
            268
            
            
            
            38
            
            
            
            306Autumn
      Ridge - disposition
            Jan-09
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )
            
            
            –
            
            
            
            (1
            )Emeritus
      at Northdale
            Jan-09
            
            
            –
            
            
            
            1
            
            
            
            1
            
            
            
            –
            
            
            
            1Emeritus
      at Urbandale - development
            Jan-09
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            –
            
            
            
            1New
      management agreements
            Jan-09
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            2
            
            
            
            2March
      31, 2009
            
            
            
            164
            
            
            
            105
            
            
            
            269
            
            
            
            40
            
            
            
            309Emeritus
      at College Park
            Jun-09
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            (1
            )
            
            
            –June
      30, 2009
            
            
            
            165
            
            
            
            105
            
            
            
            270
            
            
            
            39
            
            
            
            309No
      activity in the quarter
            
            
            
            -
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –September
      30, 2009
            
            
            
            165
            
            
            
            105
            
            
            
            270
            
            
            
            39
            
            
            
            309








Results
of Operations





Two
important factors affecting the Company’s financial results are the rates we
charge our residents and the occupancy levels we achieve in our
communities.  In evaluating the rate component, we rely on the average
monthly revenue per occupied unit, computed by dividing the total community
revenue for a particular period by the average number of occupied units for the
same period.  In evaluating the occupancy component, we rely on an
average occupancy rate, computed by dividing the average units occupied during a
particular period by the average number of units available during the
period.





The table
below shows the average monthly revenue per occupied unit and occupancy rate for
the Company’s consolidated portfolio, which includes the communities the Company
owns and leases, for the three months ended September 30, 2009 and
2008.  Please refer to the completecomparison contained
herein for further analysis of these rate and occupancy statistics.





21
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            %
      DAverage
      monthly revenue per occupied unit
            
            $
            3,673
            
            
            $
            3,459
            
            
            $
            214
            
            
            
            6.2
            %Average
      occupancy rate
            
            
            87.2
            %
            
            
            86.6
            %
            
            
            
            
            
            0.6 ppt*





*
percentage points





We
believe that occupancy rates reflect industry-wide factors and other economic
conditions, as well as our own actions and policies, including the various
acquisitions and development projects we completed in 2009 and
2008.  We continue to evaluate the factors of rate and occupancy to
find the optimum balance in each community.





22
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





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





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





Period-to-Period
      Percentage of Change Fav/ (Unfav)Percentage
      of Revenues
            
            
            Three
            
            
            NineThree
      Months Ended
            
            
            Nine
      Months Ended
            
            
            Months
      Ended
            
            
            Months
      EndedSeptember
      30,
            
            
            September
      30,
            
            
            September
      30,
            
            
            September
      30,2009
            
            
            2008
            
            
            2009
            
            
            2008
            
            
            
            2009-2008
            
            
            
            2009-2008Revenues:
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            100.0
            %
            
            
            16.7
            %
            
            
            17.9
            %Expenses:Community
      operations (exclusive of depreciation and amortization and facility lease
      expense shown separately below)
            
            
            65.9
            
            
            
            64.0
            
            
            
            64.7
            
            
            
            64.2
            
            
            
            (20.1
            )
            
            
            (18.7
            )General
      and administrative
            
            
            7.3
            
            
            
            7.6
            
            
            
            7.2
            
            
            
            7.9
            
            
            
            (11.6
            )
            
            
            (8.2
            )Impairment
      loss on long-lived assets
            
            
            0.8
            
            
            
            -
            
            
            
            0.3
            
            
            
            -
            
            
            
            N/A
            
            
            
            N/ADepreciation
      and amortization
            
            
            8.4
            
            
            
            15.2
            
            
            
            8.8
            
            
            
            15.9
            
            
            
            35.5
            
            
            
            34.6Facility
      lease expense
            
            
            13.2
            
            
            
            11.7
            
            
            
            13.3
            
            
            
            12.0
            
            
            
            (31.4
            )
            
            
            (31.4
            )Total
      operating expenses
            
            
            95.6
            
            
            
            98.5
            
            
            
            94.3
            
            
            
            100.0
            
            
            
            (13.2
            )
            
            
            (11.3
            )Operating
      income (loss) from continuing operations
            
            
            4.4
            
            
            
            1.5
            
            
            
            5.7
            
            
            
            -
            
            
            
            247.4
            
            
            
            12,649.1Other
      income (expense):Interest
      income
            
            
            0.3
            
            
            
            0.3
            
            
            
            0.1
            
            
            
            0.3
            
            
            
            19.8
            
            
            
            (52.8
            )Interest
      expense
            
            
            (11.8
            )
            
            
            (13.0
            )
            
            
            (11.8
            )
            
            
            (12.2
            )
            
            
            (5.2
            )
            
            
            (14.1
            )Change
      in fair value of interest rate swaps
            
            
            (0.1
            )
            
            
            (0.1
            )
            
            
            0.1
            
            
            
            -
            
            
            
            (85.7
            )
            
            
            3,781.3Equity
      earnings (losses) for unconsolidated joint ventures
            
            
            -
            
            
            
            -
            
            
            
            0.2
            
            
            
            (0.2
            )
            
            
            (130.3
            )
            
            
            224.5Others,
      net
            
            
            0.2
            
            
            
            (0.3
            )
            
            
            0.1
            
            
            
            (0.1
            )
            
            
            200.2
            
            
            
            264.7Net
      other expense
            
            
            (11.4
            )
            
            
            (13.1
            )
            
            
            (11.3
            )
            
            
            (12.2
            )
            
            
            (1.9
            )
            
            
            (10.0
            )Loss
      from continuing operations before income taxes
            
            
            (7.0
            )
            
            
            (11.6
            )
            
            
            (5.6
            )
            
            
            (12.2
            )
            
            
            29.1
            
            
            
            45.1Provision
      for income taxes
            
            
            (0.2
            )
            
            
            (0.1
            )
            
            
            (0.1
            )
            
            
            (0.1
            )
            
            
            (33.3
            )
            
            
            (20.0
            )Loss
      from continuing operations
            
            
            (7.2
            )
            
            
            (11.7
            )
            
            
            (5.7
            )
            
            
            (12.3
            )
            
            
            28.3
            
            
            
            44.4Loss
      from discontinued operations
            
            
            (0.1
            )
            
            
            (0.3
            )
            
            
            (0.1
            )
            
            
            (1.1
            )
            
            
            80.2
            
            
            
            86.6Net
      loss
            
            
            (7.3
            )
            
            
            (12.0
            )
            
            
            (5.8
            )
            
            
            (13.4
            )
            
            
            29.7
            
            
            
            48.0Net
      loss attributable to the noncontrolling interest
            
            
            0.1
            
            
            
            -
            
            
            
            0.1
            
            
            
            -
            
            
            
            N/A
            
            
            
            N/ANet
      loss attributable to Emeritus Corporation common
    shareholders
            
            
            (7.2
            %)
            
            
            (0.1
            )
            
            
            (5.7
            %)
            
            
            (13.4
            %)
            
            
            30.7
            %
            
            
            48.9
            %











23
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents


Comparison of the Three
Months EndedSeptember 30, 2009 and
2008





Net
Loss Attributable to Emeritus Corporation Common Shareholders





We
reported a net loss of $16.0 million in the three months ended September 30,
2009, compared to $23.1 million in the prior year period.  As
discussed under Liquidity and
Capital Resources, we have incurred significant losses since our
inception, but for each quarter throughout 2009 and in each of the past three
years, we have generated positive cash flow from operating
activities.





The $7.1
million decrease in our net loss was primarily due to operating income from
continuing operations, which increased by $6.9 million to $9.7 million in the
current period.  The increase in operating income reflects the
acquisition of communities, improvements in operating margins (community
revenues less community operating expenses), and a decrease in amortization
expense.  Interest expense (net of interest income) increased by $1.2
million, which was offset by a decrease in net other expenses and discontinued
operations.  The details of each of the components of net loss are set
forth below.





Since our
inception in 1993, the Company has incurred losses totaling approximately $398.5
million as of September 30, 2009.  We believe that these losses have
resulted from our emphasis on expansion, financing costs arising from multiple
financing and refinancing transactions related to this expansion, administrative
and corporate expenses that we incurred in anticipation of further expansion,
increased emphasis on risk management and financial reporting controls, the
impact in the early years on many of our leases from capital and financing lease
treatments and occupancy rates remaining lower for longer periods than we
anticipated.  Our current emphasis is on maximization of cash flows as
we work toward improvements in occupancy and average rates, selective growth,
and changes in our capital structure, such as acquisition of leased properties
and refinancing of existing debt.





Total
Operating Revenues:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Community
      revenue
            
            $
            221,262
            
            
            $
            189,638
            
            
            $
            31,624
            
            
            
            16.7
            %Management
      fees
            
            
            1,439
            
            
            
            1,266
            
            
            
            173
            
            
            
            13.7
            %Total
      operating revenues
            
            $
            222,701
            
            
            $
            190,904
            
            
            $
            31,797
            
            
            
            16.7
            %








Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % DAverage
      monthly revenue per occupied unit
            
            $
            3,673
            
            
            $
            3,459
            
            
            $
            214
            
            
            
            6.2
            %Average
      occupancy rate
            
            
            87.2
            %
            
            
            86.6
            %
            
            
            
            
            
            0.6 ppt*








Of the
$31.6 million increase in community revenues over the prior year quarter,
approximately $25.1 million was due to the addition of new communities and
expansion of existing communities.  Of the remaining increase of $6.5
million, $4.1 million was due to an increase in the average monthly revenue per
occupied unit and $2.4 million was from the improvement in average
occupancy.  The average monthly revenue per occupied unit increased
6.2% from the prior year period, of which approximately 2.1% was from the same
community group and the balance from the addition of new communities with higher
average revenue per unit.








24
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents


We
continue our efforts to build our occupancy through sales and marketing
initiatives, programs that address resident mix and a focus on property
improvements and other community-level enhancements to attract additional





Management
fee revenues are earned from our management of communities for third parties,
including communities owned by joint ventures in which we have an ownership
interest. Fees are based on a percentage of community revenues.  These
include a joint venture with Blackstone for which we manage 23 communities (the
Blackstone JV) and 16 other communities we manage for third
parties.  The Blackstone JV accounted for management fee revenues of
$876,000 and $864,000 in the three-month periods ended September 30, 2009 and
2008, respectively.  The increase in total management fees in the
current period compared to the prior year period was due to an increase in the
revenue base and the addition of six new management contracts since September of
2008.





Community
Operations:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Community
      operations
            
            $
            146,700
            
            
            $
            122,119
            
            
            $
            24,581
            
            
            
            20.1
            %As
      percentage of revenue
            
            
            65.9
            %
            
            
            64.0
            %
            
            
            
            
            
            1.9 ppt





Of the
$24.6 million increase in community operating expense, $18.3 million was due to
the addition of new communities and expansions at existing
communities.  Of the remaining increase of $6.3 million, $517,000 was
due to an increase in employee compensation and benefits of our existing
communities as well as a $1.2 million increase in health insurance expense and a
$3.0 million increase in workers’ compensation insurance expense.  The
remaining $1.6 million represents an increase in other community expenses of
$2.4 million, offset by an $843,000 decrease in property and professional
liability insurance.  Our workers’ compensation and professional and
general liability accruals are based on actuarial estimates of ultimate
losses.  The change in actuarial estimates resulted in an increase in
workers’ compensation of $1.4 million in the 2009 period and a reduction in
workers’ compensation expense of $1.6 million in 2008, producing a swing of $3.0
million when comparing the periods.  Health insurance expenses
increased primarily from an increase in employee enrollment.  The
increase in workers’ compensation reflects an increase in both the frequency and
severity of claims.





General
and Administrative:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)General
      and administrative
            
            $
            16,429
            
            
            $
            14,725
            
            
            $
            1,704
            
            
            
            11.6
            %As
      percentage of revenue
            
            
            7.3
            %
            
            
            7.6
            %
            
            
            
            
            
            (0.3)
      ppt





The
increase in general and administrative expenses of $1.7 million reflects the
Company’s growth over the past year.  The increase is due primarily to
salaries and benefits for regional and corporate overhead positions, which
increased by $2.1 million, resulting from increases in both the number of
personnel and in average salaries.  In addition, non-cash stock
compensation expense increased by $219,000 to $1.2 millionfor the three months ended
September 30, 2009 from $1.0 millionfor the three months ended
September 30, 2008.  Ongoing stock option expense is approximately
$1.1 millionper
quarter based on the current stock options outstanding.  These
increases were partially offset by a decrease in professional, legal and
accounting fees of $833,000.





25
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents


General
and administrative expense as a percentage of operating revenues for all
communities, including managed communities, may be more meaningful for
comparison with other providers in our industry.  General and
administrative expense as a percentage of community operating revenues for all
managed and consolidated communities decreased to 6.5% for the three months
ended September 30, 2009 from 6.7% for the three months ended September 30,
2008.





Impairment Loss on Long-Lived Assets:





The $1.9
million impairment loss for the three months ended September 30, 2009 represents
adjustments to certain intangible assets and assets held for sale based on our
determination of the ability to recover our investments in these assets from
future cash flows.





Depreciation
and Amortization:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Depreciation
      and amortization
            
            $
            18,643
            
            
            $
            28,925
            
            
            $
            (10,282
            )
            
            
            (35.5
            %)As
      percentage of revenue
            
            
            8.4
            %
            
            
            15.2
            %
            
            
            
            
            
            (6.8)
      ppt





The
decrease in depreciation and amortization expense of $10.3 million represents an
increase in depreciation expense of $745,000 and a decrease in amortization
expense of $11.0 million.  The increase in depreciation expense is
primarily the result of our purchase or opening of 17 communities since the
comparable period last year.





The
decrease in amortization expense is due primarily to the in-place resident
contract intangible asset acquired in our acquisition of Summerville in
September 2007.  This asset was fully amortized in the first quarter
of 2009 and accounted for $11.3 million of the amortization expense recorded in
the prior year period.





Facility
Lease Expense:


Three
      Months Ended September 30,2009
              
              
              2008
              
              
              $D
              
              
              % D(in
      thousands, except percentages)Operating
      lease expense
              
              $
              22,056
              
              
              $
              17,595
              
              
              $
              4,461
              
              
              
              25.4
              %Above/below
      market rent
              
              
              2,457
              
              
              
              2,524
              
              
              
              (67
              )
              
              
              (2.7
              %)Straight-line
      rent
              
              
              4,847
              
              
              
              2,220
              
              
              
              2,627
              
              
              
              118.3
              %Total
      facility lease expense
              
              $
              29,360
              
              
              $
              22,339
              
              
              $
              7,021
              
              
              
              31.4
              %As
      percentage of revenue
              
              
              13.2
              %
              
              
              11.7
              %
              
              
              
              
              
              1.5 ppt




The
increase in facility lease expense of $7.0 million consisted of a $4.5 million
net increase in operating lease payments and a $2.6 million increase in
straight-line rent accruals.  The operating lease expense was
primarily due to the acquisition of 14 communities operated by us under
operating leases and expansions of existing communities, which increased
facility lease expense by $8.4 million.  This increase was offset by
the purchase of communities in the fourth quarter of 2008 that were formerly
accounted for as operating leases.  We leased 79 and 71 communities
under operating leases as of September 30, 2009 and 2008,
respectively.  The increase in straight-line rents was due to the new
community leases discussed above which contain fixed rent escalators in future
years.





26
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Interest
Income:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Interest
      income
            
            $
            575
            
            
            $
            480
            
            
            $
            95
            
            
            
            19.8
            %As
      percentage of revenue
            
            
            0.3
            %
            
            
            0.3
            %
            
            
            
            
            
            - ppt





Interest
income is primarily attributable to interest earned on invested cash balances,
interest earned on collateral paid in advance for workers’ compensation, and
interest earned on restricted deposits.  The increase in interest
income resulted primarily from an increase in the rate of interest earned on the
workers’ compensation collateral.





Interest
Expense:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Interest
      expense
            
            $
            26,170
            
            
            $
            24,874
            
            
            $
            1,296
            
            
            
            5.2
            %As
      percentage of revenue
            
            
            11.8
            %
            
            
            13.0
            %
            
            
            
            
            
            (1.2)
      ppt





The
increase in interest expense of $1.3 million for the third quarter of 2009 as
compared to 2008 was primarily due to the increase in long-term debt during 2008
related to the refinancing of certain mortgages and a net increase in debt
obligations related to the purchase or opening of 17 communities.





Change
in Fair Value of Interest Rate Swaps:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Change
      in fair value of interest rate swaps
            
            $
            (221
            )
            
            $
            (119
            )
            
            $
            (102
            )
            
            
            (85.7
            %)As
      percentage of revenue
            
            
            (0.1
            %)
            
            
            (0.1
            %)
            
            
            
            
            
            - ppt





The
change in fair value of the interest rate swaps is estimated based on market
interest rates and yield curves and therefore fluctuates with changes in
interest rates.





Equity
Losses in Unconsolidated Joint Ventures:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Equity
      losses for unconsolidated joint ventures
            
            $
            (76
            )
            
            $
            (33
            )
            
            $
            (43
            )
            
            
            (130.3
            %)As
      percentage of revenue
            
            
            –
            
            
            
            –
            
            
            
            
            
            
            - ppt








27
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





The
equity losses of $94,000 from the Blackstone JV were partially offset by equity
earnings of $18,000 from the Stow JV for the three months ended September 30,
2009.  The equity losses of $33,000 in the three months ended
September 30, 2008, includes equity losses of $63,000 from the Stow JV, offset
in part by equity earnings of $30,000 from the Blackstone JV.





Equity
earnings and losses related to the Blackstone JV are impacted by changes in the
fair value of its interest rate swap, which is recorded in the Blackstone JV’s
earnings.  Changes in the fair value of this swap resulted in equity
losses of $230,000 in the third quarter of 2009 and $84,000 in the 2008 period.
Excluding the interest rate swap adjustments, equity earnings from the
Blackstone JV were $136,000 and $114,000 for the three months ended September
30, 2009 and 2008, respectively





The
following table sets forth condensed combined statements of operations data for
the Blackstone JV and Stow JV (in thousands):





Three
      Months EndedSeptember
      30,2009
            
            
            2008Total
      revenues
            
            $
            20,611
            
            
            $
            19,857Operating
      income
            
            
            3,376
            
            
            
            3,284Interest
      expense
            
            
            2,643
            
            
            
            2,926Unrealized
      loss on interest rate swaps
            
            
            (1,208
            )
            
            
            (443
            )Net
      loss
            
            
            (463
            )
            
            
            (75
            )





Other,
net:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Other,
      net
            
            $
            441
            
            
            $
            (440
            )
            
            $
            881
            
            
            
            200.2
            %As
      percentage of revenue
            
            
            0.2
            %
            
            
            (0.2
            %)
            
            
            
            
            
            0.4 ppt





Other,
net for 2009 consists primarily of the amortization of deferred gains of
$312,000 and resident late fee finance charges of $125,000.





Other,
net for the 2008 period consists primarily of a loss of $241,000 on short-term
investments, a $250,000 lease restructuring fee and other miscellaneous expenses
totaling $198,000, offset in part by the amortization of deferred gains of
$130,000and resident
late fee finance charges of $119,000.





Income
Taxes:





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Provision
      for income taxes
            
            $
            (360
            )
            
            $
            (270
            )
            
            $
            (90
            )
            
            
            (33.3
            %)As
      a percent of revenue
            
            
            (0.2
            %)
            
            
            (0.1
            %)
            
            
            
            
            
            (0.1)
      ppt





The
income tax provisions in 2009 and 2008 represent estimated state income and
franchise tax liabilities.





28
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Discontinued
Operations:





For the
three months ended September 30, 2009 and 2008, our discontinued operations
recorded losses of $122,000 and $616,000, respectively.  The 2008 loss
includes an impairment charge of $653,000.





Comparison of the Nine
Months EndedSeptember 30, 2009 and
2008





Net
Loss Attributable to Emeritus Corporation Common Shareholders





We
recorded a net loss of $37.9 million in the nine months ended September 30,
2009, compared to $74.3 million in the prior year period.  As
discussed under Liquidity and
Capital Resources, we have incurred significant losses since our
inception, but for each quarter of 2009 and in each of the past three years, we
have generated positive cash flow from operating activities.





The $36.4
million decrease in our net loss is due primarily to improvements in operating
income from continuing operations, which amounted to $37.4 million in the 2009
period compared to $293,000 in the prior year period.  The increase in
operating income reflects the acquisition of communities, improvements in
operating margin (community revenues less community operating expenses) and a
decrease in amortization expense.  Interest expense (net of interest
income) increased by $10.6 million, which was offset by increases in equity
earnings and other income and a decrease in losses from discontinued
operations.  The details of each of the components of net loss are set
forth below.





Total
Operating Revenues:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Community
      revenue
            
            $
            655,411
            
            
            $
            555,925
            
            
            $
            99,486
            
            
            
            17.9
            %Management
      fees
            
            
            4,359
            
            
            
            3,648
            
            
            
            711
            
            
            
            19.5
            %Total
      operating revenues
            
            $
            659,770
            
            
            $
            559,573
            
            
            $
            100,197
            
            
            
            17.9
            %





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % DAverage
      monthly revenue per occupied unit
            
            $
            3,660
            
            
            $
            3,393
            
            
            $
            267
            
            
            
            7.9
            %Average
      occupancy rate
            
            
            86.6
            %
            
            
            86.8
            %
            
            
            
            
            
            (0.2)
      ppt








Of the
$99.5 million in community revenues, approximately $72.2 million was due to the
addition of new communities and $2.5 million resulted from the expansion of
existing communities.  Total units increased by more than the increase
in occupied units causing average occupancy rate to decline by 0.2 percentage
points.  However, both the number of occupied units and the rate per
occupied unit increased.  Of the remaining increase in community
revenues of $24.8 million, $20.4 million was due to an increase in the average
monthly revenue per occupied unit and $4.4 million was from the increase in
occupied units.  The average monthly revenue per occupied unit
increased 7.9% from the prior year period, of which approximately 3.2% was from
the same community group and the balance from the addition of new communities
with higher average revenue per unit.





The
occupancy rate decreased slightly to 86.6% from 86.8% in the prior year
period.  Same community occupancy increased to 87.7% from 87.0% in the
prior year period, which indicates that new acquisitions and developments caused
the overall consolidated decline between the periods.  We continue our
efforts to build our occupancy





29
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CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





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





The
increase in management fee revenue was primarily due to the Blackstone JV, from
which we recognized $2.6 million and $2.5 million in the nine-month periods
ended September 30, 2009 and 2008, respectively, and the addition of six new
management contracts during the past year.





Community
Operations:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Community
      operations
            
            $
            426,832
            
            
            $
            359,504
            
            
            $
            67,328
            
            
            
            18.7
            %As
      percentage of revenue
            
            
            64.7
            %
            
            
            64.2
            %
            
            
            
            
            
            0.5 ppt





Of the
$67.3 million increase in community operating expense, $55.2 million was due to
the addition of new communities and expansion of existing
communities.  Of the remaining increase of $12.1 million, $2.2 million
was due to increases in employee compensation and benefits as well as a $3.9
million increase in health insurance expense and a $1.2 million increase in
workers’ compensation insurance expense.  The remaining increase of
$4.8 million was in other community expenses of $7.1 million, offset in part by
a $2.3 million decrease in property and professional liability
insurance.  Our workers’ compensation and professional and general
liability accruals are based on actuarial estimates of ultimate
losses.  The change in actuarial estimates resulted in an increase in
workers’ compensation of $1.4 million in the 2009 period and a reduction in
workers’ compensation expense of $2.5 million in 2008, producing a swing of $3.9
million when comparing the periods.  Health insurance expenses
increased primarily from an increase in employee enrollment.  The
increase in workers’ compensation reflects an increase in both the frequency and
severity of claims.





General
and Administrative:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)General
      and administrative
            
            $
            47,666
            
            
            $
            44,066
            
            
            $
            3,600
            
            
            
            8.2
            %As
      percentage of revenue
            
            
            7.2
            %
            
            
            7.9
            %
            
            
            
            
            
            (0.7)
      ppt





The
increase in general and administrative expenses of $3.6 million reflects the
Company’s growth over the past year.  Salaries and benefits for
regional and corporate overhead positions increased by $3.8 million, resulting
from increases in both the number of personnel and in average
salaries.  The increase in salaries and benefits was mitigated by a
$536,000 decrease in non-cash stock compensation expense, which amounted to $3.3
millionand $3.8
millionfor the nine
months ended September 30, 2009 and 2008, respectively.  Additionally,
legal, professional and accounting fees decreased by $1.1
million.  The remaining net increase is due to various other general
and administrative expenses.





General
and administrative expense as a percentage of operating revenues for all
communities, including managed communities, may be more meaningful for
comparison with other providers in our industry.  General and
administrative expense as a percentage of community operating revenues for all
managed and consolidated





30
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 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





communities
decreased to 6.4% for the nine months ended September 30, 2009 from 6.8% for the
nine months ended September 30, 2008.





Impairment
Loss on Long-Lived Assets:





The $1.9
million impairment loss for the nine months ended September 30, 2009 represents
adjustments to certain intangible assets and assets held for sale based on our
determination of the ability to recover our investments in these assets from
future cash flows.





Depreciation
and Amortization:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Depreciation
      and amortization
            
            $
            58,031
            
            
            $
            88,742
            
            
            $
            (30,711
            )
            
            
            (34.6
            %)As
      percentage of revenue
            
            
            8.8
            %
            
            
            15.9
            %
            
            
            
            
            
            (7.1)
      ppt





The
decrease in depreciation and amortization expense of $30.7 million represents a
decrease in depreciation expense of $968,000 and a decrease in amortization
expense of $29.7 million.  The decrease in depreciation expense is the
result of our purchase in 2008 of the real estate underlying 52 communities
accounted for as capital leases.  Assets under capital leases are
depreciated over the lease terms, which are generally shorter than the useful
lives.





The
decrease in amortization expense is due primarily to the in-place resident
contract intangible asset acquired in our purchase of Summerville in September
2007.  This asset was fully amortized in the first quarter of 2009;
therefore, amortization expense related to this asset decreased by $30.0 million
from the prior year period.  This decrease was offset in part by a
$275,000 increase in amortization related to the purchase of two
communities.





Facility
Lease Expense:





Nine
      Months Ended September 30,2009
              
              
              2008
              
              
              $D
              
              
              % D(in
      thousands, except percentages)Operating
      lease expense
              
              $
              65,803
              
              
              $
              52,384
              
              
              $
              13,419
              
              
              
              25.6
              %Above/below
      market rent
              
              
              7,430
              
              
              
              7,572
              
              
              
              (142
              )
              
              
              (1.9
              %)Straight-line
      rent
              
              
              14,796
              
              
              
              7,012
              
              
              
              7,784
              
              
              
              111.0
              %$
              88,029
              
              
              $
              66,968
              
              
              
              21,061
              
              
              
              31.4
              %As
      percentage of revenue
              
              
              13.3
              %
              
              
              12.0
              %
              
              
              
              
              
              1.3 ppt





The
increase in facility lease expense of $21.1 million consisted primarily of a
$13.4 million net increase in operating lease payments and a $7.8 million
increase in straight-line rent accruals.  The operating lease expense
increase was due to the acquisition of 14 communities operated by us under
operating leases and expansions of existing communities, which increased
facility lease expense by $24.9 million.  This increase was offset in
part by the 2008 purchases of communities formerly accounted for as operating
leases.  We leased 79 and 71 communities under operating leases as of
September 30, 2009 and 2008, respectively.The increase in
straight-line rents was due to the new community leases discussed above which
contain fixed rent escalators in future years.





31
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 MANAGEMENT’S
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CONTINUED
 September
30, 2009


Table of Contents





Interest
Income:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Interest
      income
            
            $
            902
            
            
            $
            1,913
            
            
            $
            (1,011
            )
            
            
            (52.8
            %)As
      percentage of revenue
            
            
            0.1
            %
            
            
            0.3
            %
            
            
            
            
            
            (0.2)
      ppt





Interest
income is primarily attributable to interest earned on invested cash balances,
interest earned on collateral paid in advance for workers’ compensation, and
interest earned on restricted deposits.  Our average balance of
interest-earning assets and related interest rates were lower in the first nine
months of 2009 as compared to the first nine months of 2008.





Interest
Expense:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Interest
      expense
            
            $
            77,649
            
            
            $
            68,030
            
            
            $
            9,619
            
            
            
            14.1
            %As
      percentage of revenue
            
            
            11.8
            %
            
            
            12.2
            %
            
            
            
            
            
            (0.4)
      ppt





The
increase in interest expense of $9.6 million for the first nine months of 2009
as compared to the 2008 period was primarily due to the increase in long-term
debt during 2008 related to the refinancing of certain mortgages and a net
increase in debt obligations related to the purchase or opening of 61
communities.





Change
in fair value of interest rate swaps:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Change
      in fair value of interest rate swaps
            
            $
            621
            
            
            $
            16
            
            
            $
            605
            
            
            
            3,781.3
            %As
      percentage of revenue
            
            
            0.1
            %
            
            
            –
            
            
            
            
            
            
            0.1 ppt





The fair
value of the interest rate swaps is estimated based on market interest rates and
yield curves and therefore fluctuates with changes in interest
rates.




Equity
Earnings (Losses) in Unconsolidated Joint Ventures:
 
 Nine
      Months Ended September 30,2009
              
              
              2008
              
              
              $D
              
              
              % D(in
      thousands, except percentages)Equity
      earnings (losses) for unconsolidated joint ventures
              
              $
              1,108
              
              
              $
              (890
              )
              
              $
              1,998
              
              
              
              224.5
              %As
      percentage of revenue
              
              
              0.2
              %
              
              
              (0.2
              %)
              
              
              
              
              
              0.4 ppt


32
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents







The
equity earnings for the nine months ended September 30, 2009, were comprised of
equity earnings of $1.2 million from the Blackstone JV, partially offset by
equity losses from the Stow JV.  The equity losses for the nine months
ended September 30, 2008, were comprised of equity losses of $676,000 from the
Blackstone JV and $215,000 from the Stow JV, respectively.





Equity
earnings and losses related to the Blackstone JV are impacted by changes in the
fair value of its interest rate swap, which are recorded in the Blackstone JV’s
earnings.  Changes in the fair value of this swap resulted in equity
earnings of $569,000 for the nine months ended September 30, 2009 and $1,000 in
the 2008 period.Excluding the interest
rate swap adjustments, equity earnings for the Blackstone JV were $592,000 for
2009 and equity losses were $677,000 for 2008.





The
following table sets forth condensed combined statements of operations data for
the Blackstone and Stow joint ventures (in thousands):





Nine
      Months EndedSeptember
      30,2009
            
            
            2008Total
      revenues
            
            $
            61,741
            
            
            $
            56,217Operating
      income
            
            
            10,835
            
            
            
            6,016Interest
      expense
            
            
            8,037
            
            
            
            8,673Unrealized
      gain on interest rate swaps
            
            
            525
            
            
            
            4Net
      income (loss)
            
            
            3,370
            
            
            
            (2,652
            )





Other,
net:





Nine
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % D(in
      thousands, except percentages)Other,
      net
            
            $
            792
            
            
            $
            (481
            )
            
            $
            1,273
            
            
            
            264.7
            %As
      percentage of revenue
            
            
            0.1
            %
            
            
            (0.1
            %)
            
            
            
            
            
            0.2 ppt





Other,
net for 2009 consists primarily of amortization of deferred gains of $460,000
and resident late fee finance charges of $400,000.





Other,
net in 2008 consists primarily of deferred gains of $1.1 million and resident
late fee finance charges of $340,000, offset by debt refinancing expenses of
$1.1 million, a loss of $429,000 on short-term investments, a $250,000 lease
restructuring fee, and other miscellaneous items.




Income
Taxes:
 
 Nine
      Months Ended September 30,2009
              
              
              2008
              
              
              $D
              
              
              % D(in
      thousands, except percentages)Provision
      for income taxes
              
              $
              (900
              )
              
              $
              (750
              )
              
              $
              (150
              )
              
              
              (20.0
              %)As
      a percent of revenue
              
              
              (0.1
              %)
              
              
              (0.1
              %)
              
              
              
              
              
              - ppt
 
 The
income tax provisions in 2009 and 2008 represent estimated state income and
franchise tax liabilities.





33
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Discontinued
Operations:





The loss
from discontinued operations was $849,000 and $6.3 million for the nine months
ended September 30, 2009 and 2008, respectively.  The 2009 and 2008
losses include impairment charges of $1.1 million and $4.9 million,
respectively.





Same
Community Comparison





Of the
270communities
included in our consolidated portfolio at September 30, 2009, we include 241
communities in our “same communities” definition.  For purposes of
comparing the three months ended September 30, 2009 and 2008, same communities
are defined as those communities continuously operated since January 1, 2008,
and does not include properties where new expansion projects were opened during
the comparable periods, and communities accounted for as discontinued
operations.  In addition, the analysis below excludes general and
administrative expenses, unallocated corporate expenses and capital lease
accounting adjustments.





Three
      Months Ended September 30,(In
      thousands)2009
            
            
            2008
            
            
            $D
              Fav/(Unfav)
            
            
            %
      D
              Fav/(Unfav)Revenue
            
            $
            192,108
            
            
            $
            185,809
            
            
            $
            6,299
            
            
            
            3.4
            %Community
      operations expense*
            
            
            (123,334
            )
            
            
            (119,100
            )
            
            
            (4,234
            )
            
            
            (3.6
            )Community
      operating income
            
            
            68,774
            
            
            
            66,709
            
            
            
            2,065
            
            
            
            3.1Depreciation
      and amortization
            
            
            (13,574
            )
            
            
            (12,199
            )
            
            
            (1,375
            )
            
            
            (11.3
            )Facility
      lease expense
            
            
            (21,801
            )
            
            
            (23,338
            )
            
            
            1,537
            
            
            
            6.6Operating
      income
            
            
            33,399
            
            
            
            31,172
            
            
            
            2,227
            
            
            
            7.1Interest
      expense, net
            
            
            (20,178
            )
            
            
            (18,028
            )
            
            
            (2,150
            )
            
            
            (11.9
            )Operating
      income after interest expense
            
            $
            13,221
            
            
            $
            13,144
            
            
            $
            77
            
            
            
            0.6
            %





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





These
same communities represented $192.1million or 86.8% of our
total community revenue of $221.3 million for the third quarter of
2009.  Of the $6.3 million increase in same community revenues, $3.9
million was due to improvements in average revenue per occupied unit and
$2.4million was due
to the increase in the average occupancy rate.





Three
      Months Ended September 30,2009
            
            
            2008
            
            
            $D
            
            
            % DAverage
      monthly revenue per occupied unit
            
            $
            3,543
            
            
            $
            3,469
            
            
            $
            74
            
            
            
            2.1
            %Average
      occupancy rate
            
            
            88.2
            %
            
            
            87.1
            %
            
            
            
            
            
            1.1 ppt






The $4.2
million increase in community operations expenses for our same communities was
primarily related to increases in employee-related expenses,including health insurance
expense increases of $1.2 million and an increase in workers’ compensation
expense of $1.9 million. The increase in health insurance expense was primarily
a result of an increase in enrollment and the increase in workers’ compensation
expense is the result of actuarial estimates of our ultimate losses, reflecting
both an increase in the frequency and severity of claims.  The
remaining net expense increase was primarily related to various categories of
operating expenses such as raw food, supplies, bad debt expense, repairs and
maintenance, and offset by decreases in insurance, utilities, and outside
contracted services.
 
 Property-related
expenses (depreciation and amortization, facility lease expense, and interest
expense, net of interest income) for our same communities increased by
approximately $2.0 million, which is due primarily to the purchase in the fourth
quarter of 2008 of the real estate underlying communities that we previously
operated under leases.





34
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CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009


Table of Contents





Operating
income after interest expense for our same communities increased slightly to
$13.2million in the
current quarter from $13.1million in the prior year
quarter.  We will continue our efforts to build our occupancy through
increased marketing initiatives, programs that address resident mix and a focus
on property improvements and other community-level enhancements to attract
additional long-term residents and increase occupancy while maintaining growth
in average monthly revenue per unit.  We believe that these
initiatives will have a positive impact on operating performance over
time.





Liquidity
and Capital Resources





The
United States economy experienced a significant decline in the housing market
and a related weakness in the availability and affordability of credit during
2007 that continued through 2008 and 2009.  Moreover, leading economic
indicators such as employment levels and income growth indicate that the nation
has been in a recession.  We believe that the need-driven demand for
our services continues to grow and remains resilient, in spite of the overall
housing and economic concerns, as evidenced by the relative stability in
occupancy, improvements in cash flows, and our ability to finance the
acquisition of 15 previously leased properties during the fourth quarter of
2008.





At
September 30, 2009, we had cash and equivalents on hand of $52.1 million
compared to $27.3 million at December 31, 2008.  We had working
capital deficits of $5.5 million and $15.2 million at September 30, 2009 and
December 31, 2008, respectively.





We have
incurred significant operating losses since our inception.  The
working capital deficit as of September 30, 2009 includes $15.1 million of
deferred tax assets and a liability of $29.5 million of deferred revenue and
unearned rental income.  The level of current liabilities is not
expected to increase from year to year in such a way as to require the use of
significant cash, except for debt obligations of $49.9 million scheduled to
mature in the next 12 months, of which $33.7 million is related to properties
held for sale that is due in 2012 but will be payable upon the sale of the
related properties.  We intend to refinance the remaining current debt
obligations prior to their respective due dates.  Given the
unprecedented instability in worldwide credit markets, there can be no assurance
that we will be able to obtain such refinancing or, if so, on terms that are
comparable to current terms.





While we
have reported positive cash flows from operating activities each quarter in 2009
and over the past three years, our cash flows have not always been sufficient to
pay all of our long-term obligations and we have been dependent upon third-party
financing or disposition of assets to fund operations.  We cannot
assure that, if necessary in the future, such transactions will be readily
available to us, or on terms attractive to us, but we believe that we will be
able to sustain positive operating cash flow or have adequate cash reserves and
sources of capital for all necessary investing and financing activities
including required debt service and capital expenditures through at least the
next 12 months.  We have a $25.0 million unsecured revolving line of
credit, described below.




Sources
and Uses of Cash
 
 The
following is a summary of cash flow information for the periods indicated (in
thousands):
 
 Nine
      Months Ended September 30,2009
              
              
              2008Cash
      provided by operating activities
              
              $
              55,110
              
              
              $
              56,457Cash
      used in investing activities
              
              
              (34,470
              )
              
              
              (574,651
              )Cash
      provided by financing activities
              
              
              4,196
              
              
              
              494,125Net
      increase (decrease) in cash and cash equivalents
              
              
              24,836
              
              
              
              (24,069
              )Cash
      and cash equivalents at the beginning of the period
              
              
              27,254
              
              
              
              67,710Cash
      and cash equivalents at the end of the period
              
              $
              52,090
              
              
              $
              43,641
 
 In each
quarter for the first nine months of 2009 and in each of the previous three
years, we reported positive net cash from operating activities in our
consolidated statements of cash flows.  Both the 2009 and 2008 periods
were





35


EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of
Contents


positively
impacted by purchasing the real estate underlying leased facilities, as we
replaced lease payments with lower levels of debt service and, avoided future
scheduled lease escalators





The
decrease in net cash used in investing activities was primarily due to the
number of current year acquisitions as compared to the prior
period.  In the first nine months of 2008, we purchased 43 communities
that we previously operated under lease agreements and purchased one additional
community compared to the first nine months of 2009 in which we purchased one
community.  As a result, cash paid for acquisitions of property and
equipment, including new communities, was $33.0 million in the current period
compared to $575.0 million in the 2008 period.  Cash placed in escrow
for the subsequent acquisition of communities was $6.3 million and $3.2 million
in the 2009 and 2008 periods, respectively.  Cash expenditures in the
current period were offset in part by $2.7 million of proceeds from the sale of
a community, payments from affiliates of $797,000 and distributions from our
joint ventures of $1.6 million.  In the 2008 period, we received cash
proceeds of $6.8 million from the sale of a community and used cash for
investments in marketable equity securities of $3.0 million.





The
decrease in net cash provided by financing activities was related to the
decrease in acquisition activity described in the previous
paragraph.  As a result, proceeds from long-term borrowings, net of
debt issue costs, deposits and repayments (including capital lease obligations),
amounted to $3.6 million in the current period compared to $493.2 million in the
prior year period.  Repayments in the 2008 period included the
redemption of convertible debentures of $10.8 million.





At
September 30, 2009, the Company had payment obligations for long-term debt and
capital leases due in the next 12 months totaling approximately $60.8
million.  In addition, for the year ending December 31, 2009, we
anticipate that we will make investments of approximately $20.0 to $23.0
million for capital expenditures, comprised of approximately $18.0 million to
$20.0 million of net recurring capital expenditures (including corporate capital
expenditures) and approximately $2.0 million to $3.0 million of net capital
expenditures for community expansions.





On
February 8, 2008, the Company entered into a credit agreement with Wells Fargo
Bank, N.A. (“Wells Fargo”), which provides a $25.0 million unsecured revolving
line of credit (see Note 5, Long-Term Debt, for further
details).  The credit agreement requires that we maintain a $20.0
million minimum balance in cash, cash equivalents and/or publicly traded
marketable securities and a fixed charge coverage ratio of 1.1 to
1.0.  In June 2009, Wells Fargo extended the line of credit to June
30, 2010.  There were no outstanding borrowings under the line of
credit as of September 30, 2009.




Payment
Commitments
 
 The
following table summarizes the Company’s contractual obligations at September
30, 2009, (in thousands):
 Principal
      and Lease Payments Due by PeriodAfter
      5Contractual
      Obligations
              
              Total
              
              
              1
      year
              
              
              2-3
      years
              
              
              4-5
      years
              
              
              yearsLong-term
      debt, including current portion
              
              $
              1,385,027
              
              
              $
              49,941
              
              
              $
              380,687
              
              
              $
              33,761
              
              
              $
              920,638Capital
      leases including current portion
              
              
              179,032
              
              
              
              10,838
              
              
              
              25,516
              
              
              
              31,708
              
              
              
              110,970Operating
      leases
              
              
              1,007,316
              
              
              
              91,768
              
              
              
              198,661
              
              
              
              205,542
              
              
              
              511,345Liability
      related to unrecognized tax benefits (1)
              
              
              2,325
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -$
              2,573,700
              
              
              $
              152,547
              
              
              $
              604,864
              
              
              $
              271,011
              
              
              $
              1,542,953
 
 (1)
We have recognized total liabilities related to unrecognized tax benefits of
$2.3 million as of September 30,
2009.  The timing of payments related to these obligations is
uncertain.


36


Table of Contents







The
following table summarizes interest on the Company’s contractual obligations at
September 30, 2009, (in thousands):





Interest
      Due by PeriodAfter
      5Contractual
      Obligations
            
            Total
            
            
            1
      year
            
            
            2-3
      years
            
            
            4-5
      years
            
            
            yearsLong-term
      debt
            
            $
            553,944
            
            
            $
            87,990
            
            
            $
            155,493
            
            
            $
            119,815
            
            
            $
            190,646Capital
      lease obligations
            
            
            104,593
            
            
            
            13,149
            
            
            
            25,013
            
            
            
            22,768
            
            
            
            43,663$
            658,537
            
            
            $
            101,139
            
            
            $
            180,506
            
            
            $
            142,583
            
            
            $
            234,309





The
amounts above do not include our guarantee of the mortgage debt payable to a
bank by the Stow JV in which Emeritus has a 50% ownership
interest.  We account for the Stow JV as an unconsolidated equity
method investment.  As of September 30, 2009, the loan balance was
$8.1 million with variable rate interest at 2.26%.  Emeritus and the
other member of the Stow JV have each provided to the lender an unconditional
guarantee of payment of this mortgage loan.  In the event that the
Company would be required to repay this loan, we would be entitled to recoup 50%
of such payment from the other member of the Stow JV.





Financial
Covenants and Cross Defaults





Many of
the Company’s debt instruments, leases and corporate guarantees contain
financial covenants that require that the Company maintain certain financial
criteria as of the end of each reporting period.  These financial
covenants generally prescribe operating performance metrics such as debt or
lease coverage ratios, operating income yields, fixed-charge coverage ratios
and/or minimum occupancy requirements.  Others are based on financial
metrics such as minimum cash or net worth balances.  Remedies
available to the counterparties to these arrangements in the event of default
vary, but include the requirement to post a security deposit in specified
amounts, acceleration of debt or lease payments, and/or the termination of
related lease agreements.





In
addition, many of the lease and debt instruments contain cross-default
provisions whereby a default under one obligation can cause a default under one
or more other obligations.  Accordingly, an event of default could
have a material adverse effect on our financial condition if a lender or
landlord exercised its rights under an event of default.




·
              Mortgage
      debt financed through Freddie Mac and Fannie Mae of approximately $952.9
      million, or approximately 69% of our total debt
      outstanding.  These obligations were incurred to facilitate
      community acquisitions over the past few years, were issued to single
      purpose entities (SPE) and are secured by the assets of the SPE, which
      consists of the real and personal property and intangible assets of a
      single community.  The debt is generally nonrecourse debt to the
      Company in that only the assets or common stock of the SPE are available
      to the lender in the event of default, with some limited
      exceptions.  These debt obligations do not contain provisions
      requiring ongoing maintenance of specific financial covenants, but do
      contain typical events of default such as nonpayment of monetary
      obligations, failure to maintain insurance
      coverage, fraud and/or misrepresentation of facts, unauthorized sale or
      transfer of assets, and the institution of legal proceedings under
      bankruptcy.  These debt instruments typically contain cross
      default provisions, which are limited to other related loans provided by
      the specific lender.  Remedies under an event of default include
      the acceleration of payment of the related
    obligations.




37
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents


·
            Mortgage
      debt financed primarily through traditional financial lending institutions
      of approximately $302.8 million, or approximately 22% of our total debt
      outstanding.  These obligations were incurred to facilitate
      community acquisitions over the past few years, were typically issued to
      SPEs and are secured by the assets of the SPE, which consists of the real
      and personal property and intangible assets of a single
      community.  The debt is generally recourse debt to the Company
      in that not only are the assets or common stock of the SPE available to
      the lender in the event of default, but the Company has guaranteed
      performance of the SPE’s obligations under the mortgage.  These
      debt obligations generally contain provisions requiring ongoing
      maintenance of specific financial covenants, such as debt service coverage
      ratios, operating income yields, occupancy requirements, and/or net
      operating income thresholds.  The Company guarantees generally
      contain requirements to maintain minimum cash and/or net worth
      balances.  In addition, the mortgages contain other typical
      events of default such as nonpayment of monetary obligations, failure to
      maintain insurance coverage, fraud and/or misrepresentation of facts,
      unauthorized sale or transfer of assets, and the institution of legal
      proceedings under bankruptcy.  These debt instruments may
      contain cross default provisions, but are limited to other loans provided
      by the specific lender.  Remedies under an event of default
      include the acceleration of payment of the related
      obligations.





·
            Mezzanine
      debt financing in the amount of $125.2 million provided by real estate
      investment trusts (REITs) to facilitate community acquisitions, or
      approximately 9% of our total debt outstanding.  These
      obligations are generally unsecured or are secured by mortgages on
      leasehold interests on community lease agreements between the specific
      REIT and the Company, and performance under the debt obligations are
      guaranteed by the Company.  The Company guaranty generally
      contains a requirement to maintain minimum cash and/or net worth
      balances.  Typical events of default under these obligations
      include nonpayment of monetary obligations, events of default under
      related lease agreements, and the institution of legal proceedings under
      bankruptcy.  Remedies under an event of default include the
      acceleration of payments of the related
  obligations.





As of
September 30, 2009, we operated 105 communities under long-term lease
arrangements, of which 77 were leased from publicly traded REITs.  Of
the 105 leased properties, 34 contain provisions requiring ongoing maintenance
of specific financial covenants, such as rent coverage ratios.  Other
typical events of default under these leases include nonpayment of rents or
other monetary obligations, events of default under related lease agreements,
and the institution of legal proceedings under bankruptcy.  Remedies
in these events of default vary, but generally include the requirement to post a
security deposit in specified amounts, acceleration of lease payments, and/or
the termination of the related lease agreements.




As of
September 30, 2009, we were in violation of certain financial covenants in four
debt agreements.  We have obtained waivers from the lenders related to
these defaults and, as such, the Company was in compliance as of September 30,
2009.  The lenders on three of the loans modified the minimum required
coverage ratios and/or occupancy rates and we have a firm commitment to
refinance the fourth loan in the fourth quarter of 2009.  Therefore,
we classified each of these loans as noncurrent in the condensed consolidated
balance sheet at September 30, 2009.
 
 Significant
Accounting Policies and Use of Estimates
 
 Goodwill
Impairment Test
 
 The
Company has determined it has one reporting unit, which is its one operating
segment, for purposes of testing goodwill for impairment.  Our policy
is to estimate the fair value of the Company using a combination of the market
capitalization, discounted cash flows and market comparable
approaches.  We also use market capitalization as a triggering event
that may indicate possible impairment of the reporting unit’s goodwill in
interim periods.
  The
Company’s stock price declined in the first quarter of 2009 such that as of
March 31, 2009, the Company’s market price per share closed at $6.56, which was
less than net book value per share.  We therefore tested goodwill for
impairment as of March 31, 2009.  The concluded fair value estimate of
$9.80 per share at March 31, 2009 was determined using a 50-50 weighted average
of the income approach (discounted cash flows) and the market comparable
approach.  The Company’s book value per share as of March 31, 2009 was
$8.83.  Because the estimated fair value exceeded book value on that
date, we concluded that no goodwill impairment existed at March 31,
2009.  As of September 30, 2009 and June 30, 2009, the Company’s
market capitalization exceeded its book value; therefore, no triggering event
occurred and we did not test goodwill for impairment as of those
dates.




38
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents


For a
description of our other significant accounting policies and estimates, see our
Annual Report on Form 10-K for the year ended December 31, 2008.





Impact of Inflation





Inflation
could affect our cost of doing business, and consequently, our operating income
due to limitations on our ability to increase monthly rates because of our
dependence on the senior resident population, most of whom rely on relatively
fixed incomes to pay for our services.  The monthly charges for the
resident's unit and assisted living services are influenced by the location of
the community and local competition.  Our ability to increase revenues
in proportion to increased operating expenses may be limited.  We
typically do not rely to a significant extent on governmental reimbursement
programs, which accounted for approximately 9.5% of revenues for the nine months
ended September 30, 2009.  In pricing our services, we attempt to
anticipate inflation levels, but there can be no assurance that we will be able
to respond to inflationary pressures in the future.  The near-term
negative economic outlook in the United States may impact our ability to raise
our prices.





Non-GAAP
Measures





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




Definition of Adjusted
EBITDA/EBITDAR
 
 We define
Adjusted EBITDA as net loss adjusted for:
 
 ·
              gains
      or losses, net of tax, in discontinued
  operations,
 ·
              provision
      or benefit for income taxes,
 ·
              equity
      earnings or losses in unconsolidated joint
  ventures,
 ·
              gains
      or losses on sale of assets, termination of leases, or
      investments,
 ·
              write-off
      of terminated development projects
costs,
 ·
              depreciation
      and amortization,
 ·
              straight-line
      rent and above/below market rent
amortization,
 ·
              deferred
      move-in fee revenues,
 ·
              impairment
      losses,
 ·
              amortization
      of deferred gains,
 ·
              non-cash
      stock-based compensation expense,
 ·
              interest
      expense,
 ·
              change
      in fair value of interest rate
swaps,
 ·
              loan
      prepayment fees and debt refinancing
costs,
 ·
              interest
      income, and
 ·
              other
      non-cash unusual adjustments
 
 We define
Adjusted EBITDAR as Adjusted EBITDA plus facility lease expense.
 
 Management's Use of Adjusted
EBITDA/EBITDAR
 
 We use
Adjusted EBITDA/EBITDAR to assess our overall financial and operating
performance.  We believe these non-GAAP measures, as we have defined
them, are useful in identifying trends in our day-to-day performance because
they exclude items that have little or no significance to our day-to-day
operations.  These measures provide an assessment of controllable
expenses and afford management the ability to make decisions that are expected
to facilitate meeting current financial goals, as well as achieve optimal
financial performance.  These measures also provide indicators for
management to determine if adjustments to current spending levels are
needed.




39
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents




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





Limitations of Adjusted
EBITDA/EBITDAR





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





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


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


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




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


40
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents


The table
below shows the reconciliation of net loss to Adjusted EBITDA/EBITDAR for the
periods indicated (in thousands):




Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Net
      loss
              
              $
              (16,221
              )
              
              $
              (23,076
              )
              
              $
              (38,620
              )
              
              $
              (74,278
              )Provision
      for income taxes
              
              
              360
              
              
              
              270
              
              
              
              900
              
              
              
              750Equity
      losses (earnings) in unconsolidated joint ventures
              
              
              76
              
              
              
              33
              
              
              
              (1,108
              )
              
              
              890Depreciation
      and amortization
              
              
              18,643
              
              
              
              28,925
              
              
              
              58,031
              
              
              
              88,742Amortization
      of deferred gains
              
              
              (312
              )
              
              
              (130
              )
              
              
              (460
              )
              
              
              (1,134
              )Non-cash
      stock option compensation expenses
              
              
              1,187
              
              
              
              968
              
              
              
              3,250
              
              
              
              3,786Impairment
      of long-lived assets - continuing operations
              
              
              1,857
              
              
              
              -
              
              
              
              1,857
              
              
              
              -Debt
      refinancing fees
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,090Interest
      expense
              
              
              26,170
              
              
              
              24,874
              
              
              
              77,649
              
              
              
              68,030Straight-line
      rent expense
              
              
              4,847
              
              
              
              2,220
              
              
              
              14,796
              
              
              
              7,012Above/below
      market rent amortization
              
              
              2,457
              
              
              
              2,524
              
              
              
              7,430
              
              
              
              7,572Development
      and transaction costs
              
              
              81
              
              
              
              504
              
              
              
              545
              
              
              
              832Deferred
      revenues
              
              
              460
              
              
              
              432
              
              
              
              475
              
              
              
              2,688Change
      in fair value of interest rate swaps
              
              
              221
              
              
              
              119
              
              
              
              (621
              )
              
              
              (16
              )Interest
      income
              
              
              (575
              )
              
              
              (480
              )
              
              
              (902
              )
              
              
              (1,913
              )Discontinued
      operations
              
              
              122
              
              
              
              616
              
              
              
              849
              
              
              
              6,349Professional
      and workers' compensation liability adjustments
              
              
              818
              
              
              
              (624
              )
              
              
              (908
              )
              
              
              (2,478
              )Adjusted
      EBITDA
              
              
              40,191
              
              
              
              37,175
              
              
              
              123,163
              
              
              
              107,922Facility
      lease expense
              
              
              22,056
              
              
              
              17,595
              
              
              
              65,803
              
              
              
              52,384Adjusted
      EBITDAR
              
              $
              62,247
              
              
              $
              54,770
              
              
              $
              188,966
              
              
              $
              160,306


Three
      Months Ended
                
                
                Nine
      Months EndedSeptember
      30,
                
                
                September
      30,2009
                
                
                2008
                
                
                2009
                
                
                2008Adjusted
      EBITDAR
                
                $
                62,247
                
                
                $
                54,770
                
                
                $
                188,966
                
                
                $
                160,306Provision
      for income taxes
                
                
                (360
                )
                
                
                (270
                )
                
                
                (900
                )
                
                
                (750
                )Debt
      refinancing fees
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,090
                )Interest
      expense
                
                
                (26,170
                )
                
                
                (24,874
                )
                
                
                (77,649
                )
                
                
                (68,030
                )Interest
      income
                
                
                575
                
                
                
                480
                
                
                
                902
                
                
                
                1,913Discontinued
      operations—cash component
                
                
                (121
                )
                
                
                181
                
                
                
                567
                
                
                
                (180
                )Professional
      and workers' compensation liability adjustments
                
                
                (818
                )
                
                
                624
                
                
                
                908
                
                
                
                2,478Facility
      lease expense
                
                
                (22,056
                )
                
                
                (17,595
                )
                
                
                (65,803
                )
                
                
                (52,384
                )Development
      and transaction costs written off
                
                
                (81
                )
                
                
                (504
                )
                
                
                (545
                )
                
                
                (832
                )Amortization
      of loan fees
                
                
                836
                
                
                
                739
                
                
                
                2,363
                
                
                
                1,849Allowance
      for doubtful receivables
                
                
                641
                
                
                
                295
                
                
                
                2,317
                
                
                
                1,096Changes
      in operating assets and liabilities, net
                
                
                7,182
                
                
                
                3,184
                
                
                
                3,772
                
                
                
                11,860Other
                
                
                (114
                )
                
                
                165
                
                
                
                212
                
                
                
                221Net
      cash provided by operating activities
                
                $
                21,761
                
                
                $
                17,195
                
                
                $
                55,110
                
                
                $
                56,457








41
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents    Cash From Facility
Operations





We define
Cash From Facility Operations (CFFO) as net cash provided by operating
activities adjusted for:





·
            changes
      in operating assets and
liabilities,


·
            principal
      amortization of capital lease
obligations


·
            recurring
      routine capital expenditures and


·
            net
      distributions (to) from unconsolidated joint
  ventures.





Recurring
routine capital expenditures include expenditures capitalized in accordance with
GAAP that are funded from CFFO.  Amounts excluded from recurring
routine capital expenditures consist primarily of community purchases and/or
major projects or renovations that are funded using financing
proceeds.





Management’s Use of Cash
From Facility Operations





We use
CFFO to assess our overall liquidity.  This measure provides an
assessment of controllable expenses and affords management the ability to make
decisions that are expected to facilitate meeting current financial and
liquidity goals as well as to achieve optimal financial
performance.  It provides an indicator for management to determine if
adjustments to current spending decisions are needed.





This
metric measures our liquidity based on operational factors that management can
impact in the short-term, namely the cost structure or expenses of the
organization.  CFFO is one of the metrics used by our senior
management and board of directors (i) to assess our ability to service our
outstanding indebtedness (including our credit facilities and long-term leases),
(ii) to assess our ability to make regular recurring routine capital
expenditures to maintain and improve our communities on a period-to-period
basis, (iii) for planning purposes, including preparation of our annual budget
and (iv) in setting various covenants in our credit agreements.  These
agreements generally require us to escrow or spend a minimum of between $250 and
$450 per unit/bed per year.  Historically, we have spent in excess of
these per unit/bed amounts; however, there is no assurance that we will have
funds available to escrow or spend these per unit/bed amounts in the
future.  If we do not escrow or spend the required minimum annual
amounts, we will be in default of the applicable debt or lease agreement, which
could trigger cross-default provisions in our outstanding debt and lease
arrangements.




Limitations of Cash From
Facility Operations
 
 CFFO has
limitations as an analytical tool.  It should not be viewed in
isolation or as a substitute for GAAP measures of cash flow from
operations.  CFFO does not represent cash available for discretionary
expenditures, since we may have mandatory debt service requirements or other
non-discretionary expenditures not reflected in the measure.
 
 We
believe CFFO is useful to investors because it assists in their ability to
meaningfully evaluate (1) our ability to service our outstanding indebtedness,
including our credit facilities and capital and financing leases and (2) our
ability to make regular recurring routine capital expenditures to maintain and
improve our communities.
 
 CFFO is
not an alternative to cash flows provided by or used in operations as calculated
and presented in accordance with GAAP.  You should not rely on CFFO as
a substitute for any such GAAP financial measure.  We strongly urge
you to review the reconciliation of CFFO to GAAP net cash provided by operating
activities, along with our consolidated financial statements included
herein.  We also strongly urge you not to rely on any single financial
measure to evaluate our business.  In addition, because CFFO is not a
measure of financial performance under GAAP and is susceptible to varying
calculations, the CFFO measure as presented in this report may differ from and
may not be comparable to similarly titled measures used by other
companies.




42
 EMERITUS
CORPORATION
 MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –
CONTINUED
 September
30, 2009
 Table of Contents


The
following table shows cash flows from facility operations (in
thousands):




Three
      Months Ended
              
              
              Nine
      Months EndedSeptember
      30,
              
              
              September
      30,2009
              
              
              2008
              
              
              2009
              
              
              2008Net
      cash provided by operating activities
              
              $
              21,761
              
              
              $
              17,195
              
              
              $
              55,110
              
              
              $
              56,457Adjust
      for changes in operating assets and liabilities
              
              
              (7,182
              )
              
              
              (3,184
              )
              
              
              (3,772
              )
              
              
              (11,860
              )Recurring
      capital expenditures, net
              
              
              (5,793
              )
              
              
              (4,080
              )
              
              
              (14,039
              )
              
              
              (11,544
              )Repayment
      of capital lease and financing obligations
              
              
              (2,495
              )
              
              
              (2,365
              )
              
              
              (7,003
              )
              
              
              (11,743
              )Distributions
      from unconsolidated joint ventures, net
              
              
              571
              
              
              
              -
              
              
              
              1,589
              
              
              
              -Cash
      From Facility Operations
              
              $
              6,862
              
              
              $
              7,566
              
              
              $
              31,885
              
              
              $
              21,310








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Item 3.  Quantitative And Qualitative Disclosures About
Market Risk





Our
earnings are affected by changes in interest rates as a result of our short-term
and long-term borrowings.  At September 30, 2009, we had approximately
$173.4 million of variable rate borrowings based on monthly LIBOR.  Of
the total variable rate debt of $173.4 million, $46.8 million varies with
monthly LIBOR with no LIBOR floors or ceilings.  For every 1% change
in the monthly LIBOR on this $46.8 million in variable rate debt, interest
expense will either increase or decrease by $468,000.  As of September
30, 2009, the weighted average variable rate is 3.11% in excess of the monthly
LIBOR on $46.8 million of the variable rate debt, and the monthly LIBOR rate was
0.24563%.  In addition, we have variable rate debt of $126.6 million
that has LIBOR floors at a weighted average floor of 2.58% and a weighted
average spread of 3.89%, for a total weighted average rate of
6.47%.  The LIBOR floors effectively make this debt fixed rate debt as
long as the monthly LIBOR rate is less than the 2.58% weighted average
floor.  Increases or decreases to the monthly LIBOR rate do not change
interest expense on this variable rate debt until the monthly LIBOR rate rises
above the floor, and conversely, interest expense does not decrease when the
monthly LIBOR rates falls below the floor.  This analysis does not
consider changes in the actual level of borrowings or operating lease
obligations that may occur subsequent to September 30, 2009.  This
analysis also does not consider the effects of the reduced level of overall
economic activity that could exist in such an environment, nor does it consider
actions that management might be able to take with respect to our financial
structure to mitigate the exposure to such a change.





We
currently have two interest rate swap contracts with a combined notional amount
of $32.0 million.  A 100-basis point increase in interest rates would
increase the fair value of these swaps by approximately $571,000 and a 100-basis
point decrease in interest rates would decrease the fair value of these swap
contracts by approximately $574,000.





Item 4.  Controls And Procedures





(a)  Evaluation
of disclosure controls and procedures.





Our
co-chief executive officers and our chief financial officer, after evaluating
the effectiveness of our “disclosure controls and procedures” (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the Exchange Act)) as of the end of the period covered by this
quarterly report, have concluded that, as of that date, our disclosure controls
and procedures were effective to ensure that information required to be
disclosed by an issuer in the reports that it files or submits under the
Exchange Act is accumulated and communicated to our management, including our
principal executive and principal financial officers, or persons performing
similar functions, as appropriate to allow timely decisions regarding required
disclosure.





(b)  Changes
in internal controls





During
the third quarter of 2009, we completed the first phase of our conversion to the
Agresso Business World enterprise resource planning computer software platform,
which included our general ledger, accounts payable and financial reporting
systems.  This implementation was done to increase the efficiency of
our systems and to accommodate future growth and not as a result of any
deficiencies identified in the evaluation of our co-chief executive officers or
our chief financial officer of our disclosure controls and
procedures.  We believe these changes have not materially affected,
and are not reasonably likely to materially affect, our internal controls over
financial reporting.





Management
has evaluated the effectiveness of the Company's internal controls through
September 30, 2009.  There were no changes in our internal controls
over financial reporting,except as noted in the
preceding paragraph, that have materially affected, or are reasonably likely to
materially affect, such controls, except as noted in the preceding
paragraph.








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Table of Contents


PART II.  OTHER INFORMATION





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





Item 1.  Legal Proceedings





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





Item 1A.  Risk Factors





In
addition to the other information set forth in this report, you should carefully
consider the factors discussed in Part I, Item 1A., Risk Factors in our Annual
Report on Form 10-K for the year ended December 31, 2008, which could materially
affect our business, financial condition or future results.  The risks
described in our Annual Report on Form 10-K are not the only risks facing our
Company.  Additional risks and uncertainties not currently known to us
or that we currently deem to be immaterial may also materially adversely affect
our business, financial condition and/or operating results.





Item 6.  Exhibits





See Index
to Exhibits, which is incorporated by reference.





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SIGNATURE





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








Dated:  November
      9, 2009
            EMERITUS
      CORPORATION(Registrant)/s/
      Raymond R. BrandstromRaymond
      R. Brandstrom, Executive Vice President—Finance, Chief Financial Officer,
      and Secretary





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Table of Contents





Index to Exhibits





FootnoteNumber
            
            
            Description
            
            Number3.1
            
            
            Restated Articles of Incorporation of
      registrant as of September 14, 2009
            
            
            (1
            )3.2
            
            
            Amended and Restated Bylaws of
      registrant
            
            
            (1
            )10.65
            
            
            Documents
      Relating to Purchase of Communities from Health Care Properties Investors,
      Inc.(9
      Communities) Dated 2009.10.65.21
            
            First Amendment to Loan Agreement dated June 30, 2009
      between certain subsidiaries of registrant,
            
            
            (1
            )as
      borrowers, and Capmark Bank, as lender, in the principal amount of $23.6
      million.10.65.22
            
            Second Amendment to Loan Agreement dated June 30, 2009
      between certain subsidiaries of registrant,
            
            
            (1
            )as
      borrowers, and Capmark Bank, as lender, in the principal amount of $23.6
      million.10.65.31
            
            First Amendment to Promissory Note of Emeri-Sky dated
      June 30, 2009 in the principal amount of
            
            
            (1
            )$13.12 million
      payable to Capmark Bank.10.65.41
            
            First Amendment to Promissory Note of Emeriville SC
      LLC dated June 30, 2009 in the principal amount
            
            
            (1
            )of
      $6.0 million payable to Capmark Bank.10.65.51
            
            First Amendment Promissory Note of Emeripark SC LLC
      dated June 30, 2009 in the principal amount
            
            
            (1
            )of
      $4.48 million payable to Capmark Bank.10.70
            
            
            Updating
      Debt Financing Documents Relating to the Purchase of communities from
      NationwideHealth
      Properties, Inc. (NHP)(24 communities) Dated 200910.70.07
            
            First Amendment to the Promissory Note of Emeritus
      Corporation dated May 1, 2009 in the principal
            
            
            (1
            )amount
      of $8 million payable to Capmark Bank (for PHNTUS LO Joliet SCU
      LLC)31.1
            
            
            Certification
      of Periodic Reports31.1.1
            
            Certification Pursuant to 18 U.S.C. Section
      1350, as Adopted Pursuant to Section 302
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for Daniel R. Baty dated November 9,
      2009.31.1.2
            
            Certification Pursuant to 18 U.S.C. Section
      1350, as Adopted Pursuant to Section 302
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for L. Granger Cobb dated November 9,
      2009.31.1.3
            
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 302
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for Raymond R. Brandstrom dated November 9,
      2009.32.1
            
            
            Certification
      of Periodic Reports32.1.1
            
            Certification Pursuant to 18 U.S.C. Section
      1350, as Adopted Pursuant to Section 906
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for Daniel R. Baty dated November 9,
      2009.32.1.2
            
            Certification Pursuant to 18 U.S.C. Section
      1350, as Adopted Pursuant to Section 906
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for L. Granger Cobb dated November 9,
      2009.32.1.3
            
            Certification Pursuant to 18 U.S.C.
      Section 1350, as Adopted Pursuant to Section 906
            
            
            (1
            )of
      the Sarbanes-Oxley Act of 2002 for Raymond R. Brandstrom dated November 9,
      2009.








Footnotes:(1)
            Filed
      herewith.











47