**SECURITIES
        AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549


______________________





**FORM
      10-Q**


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





For
      the
      quarterly period ended June 30, 2007





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





Commission
      file number   1-14012











**EMERITUS
      CORPORATION**


(Exact
      name of registrant as specified in its charter)





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





3131
      Elliott Avenue, Suite 500


Seattle,
      WA 98121


(Address
      of principal executive offices)





(206)
      298-2909


(Registrant’s
      telephone number, including area code)


____________________________





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





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





Large
      accelerated fileroAccelerated
      filerþNon-accelerated
      filero





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





As
      of
      July 31, 2007, there were29,572,008 shares of the Registrant’s Common Stock, par
      value $.0001, outstanding.








**EMERITUS
                CORPORATION****Table
                of Contents****Part
                I.  Financial
                Information**Page
                No.**Item
                1.  Financial Statements
                (unaudited):**
            1Condensed
                Consolidated Balance Sheets as of June 30, 2007, and
                December 31, 2006
            2Condensed
                Consolidated Statements of Operations for the Three
                Months and Six Months ended June 30, 2007 and 2006
            3Condensed
                Consolidated Statements of Cash Flows for the Six
                Months ended June 30, 2007 and 2006
            4Notes
                to Unaudited Condensed Consolidated Financial
                Statements
            5**Item
                2.**
            **Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations**
            14**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**
            36**Item
                4.**
            **Controls
                and Procedures**
            36**Part
                II.  Other
                Information**Note:
            Items
                2, 3, and 4 of Part II are omitted because they are not
                applicable.**Item
                1.**
            **Legal
                Proceedings**
            37**Item
                1A.**
            **Risk
                Factors**
            37**Item
                5.**
            **Other
                Information**
            37**Item
                6.**
            **Exhibits**
            38**Signature**
            39**Index
                to Exhibits**
            40








**Table
      of Contents**




**PART
      I. Financial Information**





**Item
      1.  Financial Statements
      (unaudited)**








[The
      rest
      of this page is intentionally left blank]





**1**


**Table
        of Contents**


**EMERITUS
                  CORPORATION****CONDENSED
                  CONSOLIDATED BALANCE SHEETS****(unaudited)****(In
                  thousands, except share data)****ASSETS****June
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006**Current
                  Assets:Cash
                  and cash equivalents
              
              $
              26,524
              
              
              $
              14,049Short-term
                  investments
              
              
              2,406
              
              
              
              1,883Trade
                  accounts receivable, net of allowance of $720 and $348
              
              
              5,099
              
              
              
              5,115Other
                  receivables
              
              
              4,539
              
              
              
              3,488Tax
                  and maintenance escrows
              
              
              5,752
              
              
              
              7,067Prepaid
                  workers' compensation
              
              
              11,165
              
              
              
              11,112Other
                  prepaid expenses
              
              
              8,326
              
              
              
              8,457Total
                  current assets
              
              
              63,811
              
              
              
              51,171Long-term
                  investments
              
              
              6,673
              
              
              
              7,504Property
                  and equipment, net of accumulated depreciation of  $171,016 and
                  $151,919
              
              
              835,450
              
              
              
              600,693Property
                  held for development
              
              
              1,661
              
              
              
              599Restricted
                  deposits
              
              
              7,596
              
              
              
              12,601Lease
                  and contract acquisition costs, net of amortization of $17,906
                  and
                  $14,515
              
              
              22,370
              
              
              
              25,762Other
                  assets, net
              
              
              12,903
              
              
              
              4,730Total
                  assets
              
              $
              950,464
              
              
              $
              703,060**LIABILITIES
                  AND SHAREHOLDERS' DEFICIT**Current
                  Liabilities:Current
                  portion of long-term debt
              
              $
              35,071
              
              
              $
              2,645Current
                  portion of capital lease and financing obligations
              
              
              22,851
              
              
              
              22,472Trade
                  accounts payable
              
              
              3,869
              
              
              
              6,718Accrued
                  employee compensation and benefits
              
              
              22,366
              
              
              
              21,012Accrued
                  interest
              
              
              2,514
              
              
              
              1,407Accrued
                  real estate taxes
              
              
              4,783
              
              
              
              6,225Accrued
                  professional and general liability
              
              
              10,417
              
              
              
              10,761Accrued
                  income taxes
              
              
              1,015
              
              
              
              233Other
                  accrued expenses
              
              
              7,177
              
              
              
              6,469Deferred
                  revenue
              
              
              9,037
              
              
              
              8,951Unearned
                  rental income
              
              
              6,508
              
              
              
              6,155Total
                  current liabilities
              
              
              125,608
              
              
              
              93,048Long-term
                  debt, less current portion
              
              
              333,568
              
              
              
              83,335Capital
                  lease and financing obligations, less current portion
              
              
              556,097
              
              
              
              586,174Convertible
                  debentures
              
              
              10,455
              
              
              
              26,575Deferred
                  gain on sale of communities
              
              
              22,693
              
              
              
              23,795Deferred
                  rent
              
              
              6,707
              
              
              
              6,389Other
                  long-term liabilities
              
              
              6,820
              
              
              
              2,776Total
                  liabilities
              
              
              1,061,948
              
              
              
              822,092Commitments
                  and contingenciesShareholders'
                  Deficit:Preferred
                  stock, $.0001 par value. Authorized 5,000,000 shares, none
                  issuedCommon
                  stock, $.0001 par value. Authorized 40,000,000 shares; issued and
                  outstanding19,015,974
                  and 18,165,986 shares at June 30, 2007, and December 31, 2006,
                  respectively
              
              
              2
              
              
              
              2Additional
                  paid-in capital
              
              
              106,852
              
              
              
              87,980Accumulated
                  deficit
              
              
              (218,338
              )
              
              
              (207,014
              )Total
                  shareholders' deficit
              
              
              (111,484
              )
              
              
              (119,032
              )Total
                  liabilities and shareholders' deficit
              
              $
              950,464
              
              
              $
              703,060







See
      accompanying Notes to Unaudited Condensed Consolidated Financial Statements
      and
      Management’s


Discussion
      and Analysis of Financial Condition and Results of Operations.





**2**


**Table
        of Contents**






**EMERITUS
                  CORPORATION****CONDENSED
                  CONSOLIDATED STATEMENTS OF OPERATIONS****(unaudited)****(In
                  thousands, except per share data)****Three
                  Months ended June 30,**
              
              
              **Six
                  Months ended June 30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**Revenues:Community
                  revenue
              
              $
              109,845
              
              
              $
              103,189
              
              
              $
              219,345
              
              
              $
              203,798Management
                  fees
              
              
              930
              
              
              
              484
              
              
              
              1,807
              
              
              
              941Total
                  operating revenues
              
              
              110,775
              
              
              
              103,673
              
              
              
              221,152
              
              
              
              204,739Expenses:Community
                  operations (exclusive of depreciation and amortizationand
                  facility lease expense shown separately below)
              
              
              69,513
              
              
              
              67,662
              
              
              
              140,011
              
              
              
              134,029Texas
                  lawsuit settlement
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              
              (12,207
              )General
                  and administrative
              
              
              11,222
              
              
              
              8,721
              
              
              
              21,336
              
              
              
              17,452Depreciation
                  and amortization
              
              
              14,606
              
              
              
              12,251
              
              
              
              29,195
              
              
              
              24,401Facility
                  lease expense
              
              
              7,482
              
              
              
              11,092
              
              
              
              17,852
              
              
              
              22,010Total
                  operating expenses
              
              
              102,823
              
              
              
              99,726
              
              
              
              208,394
              
              
              
              185,685Operating
                  income from continuing operations
              
              
              7,952
              
              
              
              3,947
              
              
              
              12,758
              
              
              
              19,054Other
                  income (expense):Interest
                  income
              
              
              601
              
              
              
              681
              
              
              
              1,192
              
              
              
              1,552Interest
                  expense
              
              
              (16,945
              )
              
              
              (12,475
              )
              
              
              (30,560
              )
              
              
              (24,206
              )Equity
                  gains (losses) in unconsolidated joint ventures
              
              
              7,065
              
              
              
              (396
              )
              
              
              6,496
              
              
              
              (492
              )Other,
                  net
              
              
              782
              
              
              
              562
              
              
              
              110
              
              
              
              1,158Net
                  other expense
              
              
              (8,497
              )
              
              
              (11,628
              )
              
              
              (22,762
              )
              
              
              (21,988
              )Loss
                  from continuing operations before income taxes
              
              
              (545
              )
              
              
              (7,681
              )
              
              
              (10,004
              )
              
              
              (2,934
              )Provision
                  for income taxes
              
              
              (1,044
              )
              
              
              100
              
              
              
              (1,320
              )
              
              
              90Loss
                  from continuing operations
              
              
              (1,589
              )
              
              
              (7,581
              )
              
              
              (11,324
              )
              
              
              (2,844
              )Loss
                  from discontinued operations (net of tax)
              
              
              –
              
              
              
              (34
              )
              
              
              –
              
              
              
              (44
              )Net
                  loss
              
              $
              (1,589
              )
              
              $
              (7,615
              )
              
              $
              (11,324
              )
              
              $
              (2,888
              )Basic
                  and diluted loss per common share:Continuing
                  operations
              
              $
              (0.08
              )
              
              $
              (0.42
              )
              
              $
              (0.61
              )
              
              $
              (0.17
              )Discontinued
                  operations
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              
              –$
              (0.08
              )
              
              $
              (0.42
              )
              
              $
              (0.61
              )
              
              $
              (0.17
              )Weighted
                  average common shares outstanding: - basic and diluted
              
              
              18,971
              
              
              
              17,927
              
              
              
              18,674
              
              
              
              17,481







See
      accompanying Notes to Unaudited Condensed Consolidated Financial Statements
      and
      Management’s


Discussion
      and Analysis of Financial Condition and Results of Operations.





**3**


**Table
        of Contents**




**EMERITUS
                  CORPORATION****CONDENSED
                  CONSOLIDATED STATEMENTS OF CASH FLOWS****(unaudited)****(In
                  thousands)****Six
                  Months Ended June 30,****2007**
              
              
              **2006**Cash
                  flows from operating activities:Net
                  loss
              
              $
              (11,324
              )
              
              $
              (2,888
              )Adjustments
                  to reconcile net lossto
                  net cash provided by (used in) operating activities:Depreciation
                  and amortization
              
              
              29,195
              
              
              
              24,401Amortization
                  of deferred gain
              
              
              (1,103
              )
              
              
              (1,107
              )Amortization
                  of loan fees
              
              
              591
              
              
              
              101Convertible
                  debenture conversion costs
              
              
              1,329
              
              
              
              –Allowance
                  for doubtful receivables
              
              
              565
              
              
              
              450Equity
                  investment losses/(gains) and distributions
              
              
              939
              
              
              
              492Stock
                  option compensation
              
              
              1,323
              
              
              
              222Deferred
                  revenue
              
              
              85
              
              
              
              793Deferred
                  rent
              
              
              317
              
              
              
              500Other
              
              
              265
              
              
              
              –Changes
                  in operating assets and liabilities
              
              
              1,368
              
              
              
              (26,986
              )Net
                  cash provided by (used in) operating activities
              
              
              23,550
              
              
              
              (4,022
              )Cash
                  flows from investing activities:Acquisition
                  of property and equipment
              
              
              (195,230
              )
              
              
              (6,439
              )Construction
                  expenditures - leased properties
              
              
              (874
              )
              
              
              (1,982
              )Lease
                  and contract acquisition costs
              
              
              (972
              )
              
              
              (8
              )Payments
                  from affiliates and other managed communities
              
              
              629
              
              
              
              606Investment
                  in affiliates
              
              
              (359
              )
              
              
              (136
              )Funds
                  held in escrow
              
              
              –
              
              
              
              (10,834
              )Collection
                  of notes receivable
              
              
              –
              
              
              
              27Net
                  cash used in investing activities
              
              
              (196,806
              )
              
              
              (18,766
              )Cash
                  flows from financing activities:Proceeds
                  from sale of stock
              
              
              873
              
              
              
              3,829Decrease
                  (increase) in restricted deposits
              
              
              5,005
              
              
              
              (1,210
              )Debt
                  issue and other financing costs
              
              
              (2,981
              )
              
              
              (259
              )Proceeds
                  from long-term borrowings and financings
              
              
              284,334
              
              
              
              8,449Repayment
                  of long-term borrowings and financings
              
              
              (91,674
              )
              
              
              (6,357
              )Repayment
                  of capital lease and financing obligations
              
              
              (10,383
              )
              
              
              (9,078
              )Tax
                  benefit of stock compensation
              
              
              557
              
              
              
              1,074Net
                  cash provided by (used in) financing activities
              
              
              185,731
              
              
              
              (3,552
              )Net
                  increase (decrease) in cash and cash equivalents
              
              
              12,475
              
              
              
              (26,340
              )Cash
                  and cash equivalents at the beginning of the period
              
              
              14,049
              
              
              
              56,413Cash
                  and cash equivalents at the end of the period
              
              $
              26,524
              
              
              $
              30,073Supplemental
                  disclosure of cash flow information -Cash
                  paid during the period for interest
              
              $
              29,453
              
              
              $
              25,211Cash
                  paid during the period for taxes
              
              $
              36
              
              
              $
              4,553Non-cash
                  financing and investing activities:HRT
                  capital lease buyout
              
              $
              20,818
              
              
              $
              –Capital
                  lease and financing obligations
              
              $
              1,503
              
              
              $
              730Conversion
                  of convertible debentures
              
              $
              16,120
              
              
              $
              50Deferred
                  lease acquisition cost
              
              $
              –
              
              
              $
              179Debt
                  assumed in acquisitions
              
              $
              90,000
              
              
              $
              –


See
      accompanying Notes to Unaudited Condensed Consolidated Financial Statements
      and
      Management’s


Discussion
      and Analysis of Financial Condition and Results of Operations





**4**


**Table
        of Contents**











**EMERITUS
      CORPORATION**


**NOTES
      TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**











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





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





Emeritus
      believes that certain critical accounting policies are most significant to
      the
      judgments and estimates used in the preparation of its condensed consolidated
      financial statements.  Revisions in such estimates are charged to
      income in the period in which the facts that give rise to the revision become
      known.  A detailed discussion of the Company’s significant accounting
      policies and use of estimates is contained in the Company’s 2006 Form 10-K filed
      March 16, 2007.





**Basis
      of Presentation**





The
      unaudited interim financial information furnished herein, in the opinion of
      the
      Company’s management, reflects all adjustments, consisting of only normally
      recurring adjustments, which are necessary to state fairly the condensed
      consolidated financial position as of June 30, 2007, the results of operations
      of Emeritus for the three and six months ended June 30, 2007 and 2006, and
      the
      cash flows of Emeritus for the six months ended June 30, 2007 and
      2006.  The results of operations for the period ended June 30, 2007,
      are not necessarily indicative of the operating results for the full
      year.  The Company presumes that those reading this interim financial
      information have read or have access to its 2006 audited consolidated financial
      statements and Management’s Discussion and Analysis of Financial Condition and
      Results of Operations that are contained in the Company’s 2006 Form 10-K filed
      March 16, 2007.  Therefore, the Company has omitted footnotes and
      other disclosures herein, which are disclosed in the Form 10-K.





**Recent
      Accounting Pronouncements**





In
      June
      2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      No. 48 (FIN 48), *Accounting for Uncertainty in Income Taxes*, an
      Interpretation of Statement of Financial Accounting Standards (SFAS) No. 109,
      *Accounting for Income Taxes*.  FIN 48 clarifies the accounting
      for income taxes by prescribing the recognition threshold a tax position is
      required to meet before being recognized in the financial
      statements.  It also provides guidance on de-recognition, measurement,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition.  The Interpretation requires that the
      Company recognize in the financial statements the impact of a tax position
      only
      if that position is more likely than not of being sustained upon examination,
      based on the technical merits of the position.  FIN 48 is effective
      for fiscal years beginning after December 15, 2006.  Differences
      between the amounts recognized in the statements of financial position prior
      to
      the adoption of FIN 48 and the amounts reported after adoption should be
      accounted for as a cumulative-effect adjustment recorded to the beginning
      balance of retained earnings.  The Company adopted FIN 48 effective
      January 1, 2007.  The adoption of this statement did not have any
      significant effect on the Company’s financial condition, results of operations,
      or cash flows.  As of June 30, 2007, the Company identified
      unrecognized tax benefits of $269,000 relating to state tax
      liabilities.  If the unrecognized tax benefits were recognized, it
      would not have a material affect on the Company’s effective tax
      rate.  The Company recognizes interest and/or tax penalties related to
      income tax matters as a component of income tax expense.  The Company
      believes it has appropriate support for the income tax positions taken or to
      be
      taken on tax returns and that the accruals for tax liabilities are adequate
      for
      all open years based on an assessment of relevant factors, including past
      experience and interpretations of tax law applied to the facts of each
      matter.  The Company’s open years for federal tax returns are 2003
      through 2006.





In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      (SFAS) 159, *The Fair Value Option for Financial Assets and Financial
      Liabilities*.  SFAS 159 permits entities to choose to measure
      financial assets and liabilities (except for those that are specifically
      excepted from the Statement) at fair value.  The election





**5**


**Table
        of Contents**
 ****


to
      measure a financial asset or liability at fair value can be made on an
      instrument-by-instrument basis and is irrevocable.  The difference
      between carrying value and fair value at the election date is recorded as a
      transition adjustment to opening retained earnings.  Subsequent
      changes in fair value are recognized in earnings.  The effective date
      for SFAS 159 is as of the beginning of an entity's first fiscal year that begins
      after November 15, 2007.  The Company is evaluating SFAS 159 and has
      not yet determined the impact the adoption will have on its consolidated
      financial statements, but it is not expected to be significant.





**Reclassifications**





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





**Stock-Based
      Compensation**





The
      Company records compensation expense based on fair value for all
      awards.  The Company recorded stock-based compensation expense based
      on the fair value of stock options and shares issued under the Employee Stock
      Purchase (ESP) Plan of approximately $786,000 and $87,000 for the three months
      ended June 30, 2007 and 2006, respectively, and $1.3 million and $222,000 for
      the six months ended June 30, 2007 and 2006, respectively.





Stock-based
      compensation is recognized over the period from the date of grant to the date
      when the award is no longer contingent on the employee providing additional
      services (the “vesting period”).  The Company’s stock incentive plans
      and the non-employee directors’ incentive plan provide that awards generally
      vest over a one to three year period.  Any unexercised options expire
      between seven and ten years.  The fair value of each grant is
      estimated as a single award and amortized into compensation expense on a
      straight-line basis over its vesting period.  During the first two
      quarters of 2007, the Company did not grant any options.





The
      following table summarizes the Company’s stock option activity for the six
      months ended June 30, 2007 and 2006:





**2007**
            
            
            **2006****Weighted-**
            
            
            **Aggregate**
            
            
            
            
            
            **Weighted-**
            
            
            **Aggregate****Average**
            
            
            **Intrinsic**
            
            
            
            
            
            **Average**
            
            
            **Intrinsic****Exercise**
            
            
            **Value**
            
            
            
            
            
            **Exercise**
            
            
            **Value****Shares**
            
            
            **Price**
            
            
            **$(000)**
            
            
            **Shares**
            
            
            **Price**
            
            
            **$(000)**Outstanding
                at beginning of year
            
            
            1,510,189
            
            
            $
            9.09
            
            
            
            
            
            
            
            1,349,381
            
            
            $
            3.81Granted
            
            
            –
            
            
            N/A
            
            
            
            
            
            
            
            45,000
            
            
            $
            21.00Exercised
            
            
            (106,988
            )
            
            $
            5.82
            
            
            $
            (2,996
            )
            
            
            (185,523
            )
            
            $
            3.26
            
            
            $
            (3,531
            )Canceled
            
            
            (9,416
            )
            
            $
            –
            
            
            
            
            
            
            
            (667
            )
            
            $
            3.95Outstanding
                at June 30,
            
            
            1,393,785
            
            
            $
            9.31
            
            
            $
            30,209
            
            
            
            1,208,191
            
            
            $
            4.53
            
            
            $
            17,175Options
                exercisable at June 30,
            
            
            1,037,808
            
            
            $
            6.01
            
            
            $
            25,910
            
            
            
            1,163,191
            
            
            $
            3.90
            
            
            $
            17,276Weighted-average
                fair value of options granted during second quarter
            
            
            
            
            
            N/A
            
            
            
            
            
            
            
            
            
            
            $
            11.67





The
      weighted average remaining contractual life was 6.7 years at June 30, 2007,
      for
      stock options outstanding and exercisable.  As of June 30, 2007, there
      was $1.4 million of total unrecognized compensation expense related to unvested
      share-based compensation arrangements granted under the Plan.  That
      expense is expected to be recognized over a weighted average period of two
      years.





The
      amount of cash received from the exercise of stock options and stock purchased
      through the ESP Plan was $873,000 and $789,000 in the first six months of 2007
      and 2006, respectively.  As of June 30, 2007, there were 171,482
      shares available for purchase under the Employee Stock Purchase Plan, 529,166
      shares available for grant





**6**


**Table
        of Contents**
 ****


under
      the
      2006 Equity Incentive Plan, and 169,000 shares available for grant under the
      1995 Stock Incentive Plan, which includes director stock options.





The
      Company offers eligible employees the option to purchase common stock of the
      Company under the ESP Plan at a 15% discount from the lower of the market price
      on the first trading date at the beginning of the current calendar quarter,
      or
      the last trading date of the current quarter.  The following table
      shows the number of shares and purchase price for the first two quarters of
      2007
      and 2006:








**2007**
            
            
            **2006****Shares**
            
            
            **Price**
            
            
            **Shares**
            
            
            **Price**Quarter
                1
            
            
            4,958
            
            
            $
            22.10
            
            
            
            4,929
            
            
            $
            18.36Quarter
                2
            
            
            5,317
            
            
            $
            26.33
            
            
            
            5,882
            
            
            $
            15.94








The
      following table shows the assumptions used in calculating the compensation
      expense for the ESP Plan shares issued during the three and six months ended
      June 30, 2007 and 2006:





**Three
                Months Ended June 30,**
            
            
            **Six
                Months Ended June 30,****2007**
            
            
            **2006**
            
            
            **2007**
            
            
            **2006**Expected
                life from grant date (in months)
            
            
            3
            
            
            
            3
            
            
            
            3
            
            
            
            3Risk-free
                interest rate
            
            
            4.93
            %
            
            
            4.50
            %
            
            
            4.88%-4.93
            %
            
            
            3.91%-4.50
            %Volatility
            
            
            20.30
            %
            
            
            16.50
            %
            
            
            19.8%-20.3
            %
            
            
            13.5%-16.50
            %








**Proposed
      Merger**





On
      March
      29, 2007, the Company and Summerville Senior Living, Inc. (Summerville)
      announced they had entered into an agreement and plan of merger (the Agreement)
      pursuant to which the Company will acquire all of the outstanding stock of
      Summerville.  Under the terms of the Agreement, up to 8,500,000 shares
      of the Company’s common stock will be issued to Apollo Real Estate Investment
      Funds III and IV (the Apollo Funds), two real estate funds managed by Apollo
      Real Estate Advisors, in satisfaction of certain loans from such entities,
      to
      certain employees of Summerville in satisfaction of certain incentive
      compensation arrangements, and to the stockholders of Summerville, including
      the
      Apollo Funds.  Consummation of the transaction is subject to approval
      by the Company’s shareholders of the issuance of shares of common stock pursuant
      to the Agreement,  The transaction is anticipated to close in the
      third quarter of 2007.  The Company has incurred approximately
      $813,000 in merger-related costs which are recorded in Other assets, net on
      the
      balance sheet at June 30, 2007.





Summerville
      is a San Ramon, California-based operator of 81 communities comprising 7,935
      units in 13 states, which provides independent living, assisted living, and
      Alzheimer’s and dementia-related services to seniors.  Upon completion
      of the merger, Summerville will be a wholly owned subsidiary of the Company
      and
      will retain the brand name in the operation of its
      communities.  Granger Cobb, President and CEO of Summerville, will
      assume the titles of President and Co-CEO of Emeritus.  Mr. Cobb and a
      representative designated by the Apollo Funds will each have a seat on the
      Company’s board of directors, thus, increasing the size of the board from the
      current eight members to ten.





After
      the
      merger, the Company will operate 286 communities in 36 states comprising 24,623
      units with a capacity for over 28,000 residents.  Mr. Baty will
      continue to serve as chairman and Co-CEO of the Company.  The Company
      will continue to be traded on the AMEX under the symbol ESC.





**7**


**Table
        of Contents**





**2007
      HCPI Communities Purchased**





On
      March
      26, 2007, the Company completed the purchase of seven communities consisting
      of
      453 units located in South Carolina for approximately $29.0 million, including
      transaction costs.  Pursuant to the leases described below, the
      Company had operated these facilities as assisted living and dementia care
      communities for seniors.





The
      seven
      acquired properties were part of an Amended and Restated Master Lease agreement
      dated September 18, 2002, between Health Care Property Investors, Inc. (HCPI),
      HCPI affiliates, Emeritus, and Emeritus affiliates.  As a result of
      this asset purchase transaction, the master lease was amended to remove the
      purchased communities from the master lease effective March 26,
      2007.  The amendment also provided for the return of approximately
      $4.5 million in cash security deposits held by HCPI, of which approximately
      $1.2
      million is considered a security deposit advance that is repayable in equal
      monthly installments of $20,000 or more.  The cash security deposits
      were applied against the purchase price for the seven acquired
      properties.  This master lease is accounted for as an operating lease
      by the Company.





Capmark
      Finance, Inc. (Capmark) provided variable rate mortgage financing of $23.6
      million pursuant to a loan agreement dated March 26, 2007, by and among
      affiliated entities of Emeritus and Capmark Bank (the "Capmark Loan
      Facility").  Under the Capmark Loan Facility, the variable rate loan
      has a term of three years and bears interest at 290 basis points over the LIBOR
      rate, adjusted monthly and rounded upwards to the nearest .125%.  The
      interest rate on the closing date was 8.22%.  Monthly interest-only
      payments are required for the first year and, thereafter, monthly payments
      of
      principal and interest are based on a 25-year amortization
      period.  The balance is due in full in April 2010.  The
      Capmark Loan Facility is secured by all real, personal, and intangible assets
      used in the operation of the acquired communities.  The loan may be
      repaid at any time upon written notice, if no events of default are
      continuing.  The Company paid a 1.0% loan fee at closing and will be
      required to pay a 2.0% exit fee upon full payment of the loans, unless the
      loans
      are refinanced with Capmark.  The loan agreement requires maintenance
      of a debt service coverage ratio, an aggregate minimum occupancy percentage,
      and
      payment of annual capital expenditures of at least $300 per unit.





**2007
      HRT Communities Purchased**





On
      March
      15, 2007, the Company purchased 12 communities consisting of 786 units located
      in five states for a price of $100.1 million, including transaction
      costs.  The Company had leased four of these communities from
      Healthcare Realty Trust (HRT) since May 2002 and eight since May
      2003.  The four leases had been accounted for as capital leases and
      the eight leases had been accounted for as operating leases by the
      Company.  As a result of this asset purchase transaction, the HRT
      leases were terminated.  Upon termination of the four capital leases,
      the difference between the carrying amount of the leased assets and the lease
      obligation was recorded as an adjustment to the carrying amount of the assets
      purchased, which represented a $3.5 million reduction to the cost basis of
      the
      purchased assets.  Capmark Finance, Inc. provided fixed rate senior
      mortgage financing of $88.0 million at 6.515% per annum and second mortgage
      financing of $13.6 million at a variable rate equal to the LIBOR rate plus
      325 basis points, rounded up to the nearest .125%, which equaled 8.625% per
      annum at the closing date.  The senior mortgage has a term of five
      years, (with 1% exit fee if the debt is paid off or refinanced by anyone except
      Capmark), and monthly interest-only payments for three years and, thereafter,
      monthly payments of principal and interest based on a 25-year amortization,
      with
      the remaining balance due in full in April 2012.  The second mortgage
      has a term of two years with monthly interest-only payments and is due in full
      in April 2009.  The second mortgage has a 1% exit fee if paid off
      prior to the first anniversary date or a 2% exit fee is paid off after the
      first
      anniversary date, unless it is refinanced with Capmark.  The second
      mortgage of $13.6 million was repaid in July 2007.  The total Capmark
      loan commitment of $101.6 million was used to pay the purchase price,
      transaction and financing costs, and to retire a $600,000 loan, as described
      below.





At
      the
      time of closing, the Company had approximately $32.8 million in loans
      outstanding with Healthcare Realty Trust, of which $11.4 million was secured
      by
      the leases on the 12 communities described above.  Of the $11.4
      million, $10.8 relates to the June 2005 Series B Convertible Preferred Stock
      transaction in which Healthcare Realty





**8**


**Table
        of Contents**


Trust
      loaned such amount to enable us to pay the accumulated dividends due upon
      conversion of the Series B Preferred Stock.  As part of this
      transaction, the $10.8 million loan was acquired by Mr. Baty on similar terms
      and conditions as the original loan, and the remaining $600,000 was paid off
      at
      closing.  The $10.8 million loan was repaid in July 2007.





**2007
      Fretus Communities Purchased**





On
      February 22, 2007, the Company purchased 24 communities consisting of 1,651
      units located in six states for a price of $145.1 million, including
      transaction costs.  The Company had leased these communities from
      Fretus Investors LLC since October 2002.  All leases had been
      accounted for as operating leases.  As a result of this asset purchase
      transaction, the Fretus lease was terminated.  Capmark Finance, Inc.
      provided fixed rate mortgage financing of $132.0 million and variable rate
      mortgage financing of $8.0 million.  The fixed rate component has
      a term of five years and bears interest at 6.55% per annum (with a 1% exit
      fee
      payable if the debt is paid off or refinanced by anyone except Capmark), with
      monthly interest-only payments for two years and thereafter, monthly payments
      of
      principal and interest based on a 25-year amortization.  The remaining
      balance is due in full in February 2012.  The variable rate component
      has a term of three years and interest at 30-day LIBOR plus 1.8%, which was
      7.12% at closing, and the same exit fee and payment schedule as for the fixed
      component.  The variable rate loan of $8.0 million was repaid in July
      2007.





Fretus
      was a private investment joint venture between Fremont Realty Capital, which
      held a 65% interest, and a Baty-related entity, which held a 35% minority
      interest.  Mr. Baty held a 16% indirect interest in the minority
      entity, personally guaranteed $3.0 million of the Fretus mortgage debt
      covering the communities and controlled the administrative member of
      Fretus.  In conjunction with this transaction, the Baty-related entity
      provided $18.0 million in short-term financing to the Company, of which
      approximately $5.1 million, was used to fund the balance of the purchase
      price and the balance is available for general business purposes.  The
      short-term debt is due in February 2009 and bears interest at 9.0% per
      annum.  The $18.0 million short-term financing was repaid in July
      2007.





The
      allocation of the purchase price for the acquisitions discussed above was based
      on property appraisals.  Aggregate purchase cost allocations and
      related financings were as follows (in thousands):





**HCPI**
            
            
            **HRT**
            
            
            **Fretus****Acquisition**
            
            
            **Acquisition**
            
            
            **Acquisition**
            
            
            **Total**Land
            
            
            1,546
            
            
            
            13,128
            
            
            
            31,447
            
            
            
            46,121Building
            
            
            23,715
            
            
            
            80,912
            
            
            
            108,418
            
            
            
            213,045Equipment
            
            
            3,633
            
            
            
            2,581
            
            
            
            3,760
            
            
            
            9,974Properties
                under capital leases, net
            
            
            -
            
            
            
            (17,304
            )
            
            
            -
            
            
            
            (17,304
            )
            (a)Restricted
                deposits
            
            
            (4,543
            )
            
            
            -
            
            
            
            -
            
            
            
            (4,543
            )
            (b)Loan
                fees
            
            
            790
            
            
            
            1,973
            
            
            
            2,344
            
            
            
            5,107Long-term
                debt, net
            
            
            23,600
            
            
            
            101,000
            
            
            
            158,000
            
            
            
            282,600Capital
                lease obligations
            
            
            -
            
            
            
            (20,818
            )
            
            
            -
            
            
            
            (20,818
            )
            (a)Other
                long-term liabilities
            
            
            472
            
            
            
            1,016
            
            
            
            1,400
            
            
            
            2,888
            
            (c)





(a)
            Four
                HRT properties were accounted for as capital leases.  The
                termination of the leases created a $3.5 million difference between
                the
                carrying amount of the leased assets and the lease obligation, which
                was
                offset against the cost basis of the four properties acquired in
                this
                transaction.


(b)
            Restricted
                deposits held by HCPI were refunded and used to pay a portion of
                the
                purchase price.


(c)
            The
                Capmark loans require the payment of exit fees upon retirement or
                maturity
                of the debt.  These were recorded as loan fees with a
                corresponding long-term liability.





**9**


**Table
        of Contents**





**Debenture
      Conversion**





In
      February 2007, the Company offered to pay a cash incentive to debenture holders
      if they elected to convert their debentures into common stock by giving written
      notice by March 8, 2007.  The incentive payment was equal to the
      amount of interest that the holders would have received if the debentures were
      held to the maturity date of July 1, 2008.





Of
      the
      $26.6 million principal amount of debentures outstanding, holders of $16.1
      million principal amount converted their debentures into 732,725 shares of
      common stock at the debentures’ stated conversion rate of $22.00 per
      share.  Of the debentures converted into common stock, $15.8 million
      principal amount was owned by entities controlled by Mr. Baty.  On
      April 16, 2007, the Company paid the incentive fee of $1.3 million in connection
      with this conversion, which amount would have been paid in three installments
      on
      July 1, 2007, January 1, 2008, and July 1, 2008, if the
      debentures were held to maturity.  The incentive payment was expensed
      to “Other, net” in the Condensed Consolidated Statement of Operations in the
      first quarter of 2007.





**2006
      Blackstone Joint Venture**





The
      Company holds a 19.0% interest in a joint venture (Blackstone JV) with
      Blackstone Real Estate Advisors that was organized in December 2006 and acquired
      a portfolio of 25 properties as of June 30, 2007.  The Company
      contributed an additional $970,000 to the Blackstone JV in 2007 and recorded
      equity losses of approximately $450,000 and $845,000 for the three and six
      months ended June 30, 2007, respectively.  The Company recorded
      management fee income of approximately $564,000 and $1.1 million for the three
      and six months ended June 30, 2007, respectively.





**Senior
      Med Transaction**





The
      Company owned a 9.5% indirect interest in Senior Med, a pharmacy services
      provider.  In April 2007, the Company received written notice from
      Walgreens, the majority owner of the entity that owns Senior Med, exercising
      its
      purchase option rights.  The transaction closed on May 31,
      2007.  The Company received approximately $8.8 million in cash for its
      equity share of the business and recorded a gain of approximately $7.7
      million.  The Company has no further ownership interest in Senior
      Med.





Exclusive
      of the equity gain mentioned in the previous paragraph, the Company recognized
      equity losses of $113,000 and $355,000 in its condensed consolidated statements
      of operations for the three months ended June 30, 2007 and 2006, respectively,
      and equity losses of $237,000 and $407,000 for the six months ended June 30,
      2007 and 2006, respectively, which is included in the line item entitled “Equity
      gains (losses) in unconsolidated joint ventures.”





**Emeritrust
      Transactions**





As
      a part
      of a 2003 transaction in which the Company leased a separate group of Emeritrust
      communities that the Company had managed since 1999, the Company issued
      seven-year warrants to purchase 500,000 shares of its common stock at an
      exercise price of $7.60 per share to the owners of the communities, which
      included Mr. Baty.  Warrants to purchase 400,000 shares were exercised
      in February 2006 and the Company received proceeds of
      $3.0 million.  In March 2006, warrants to purchase 100,000 shares
      were exercised pursuant to a “net exercise” provision in which the Company
      issued 69,169 shares to the holders and 30,831 shares were used to pay the
      exercise price of $760,000, based on a price of $24.65 per share.





**Exercise
      of Common Stock Warrants**





On
      March 6, 2006, the Company issued 829,597 shares of common stock pursuant
      to the exercise of warrants for the purchase of 1.0 million common
      shares.  The shares were purchased by the holders of the warrants
      pursuant to a





**10**


**Table
        of Contents**
 ****


“net
      exercise” provision of the warrants in which 170,403 shares subject to the
      warrants were used to pay the exercise price of $4.2 million.  No
      cash proceeds were received from this transaction.





**Loss
      Per Share**





The
      capital structure of Emeritus includes convertible debentures and stock
      options.  In addition, the capital structure included common stock
      warrants in prior periods, which were exercised in February and March
      2006.  Basic loss per share is computed based on the weighted average
      shares outstanding and excludes any potential dilution.  Net loss per
      share is computed based on the weighted average number of shares outstanding
      plus dilutive potential common shares.  Options are included using the
“treasury stock method” to the extent they are dilutive.  Certain
      shares issuable upon the exercise of stock options and conversion of convertible
      debentures have been excluded from the computation because the effect of their
      inclusion would be anti-dilutive.





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





**Three
                Months ended**
            
            **Six
                Months ended****June
                30,**
            
            **June,
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**Convertible
                Debentures (1)
            475
            
            1,208
            
            475
            
            1,208Options
            1,394
            
            1,208
            
            1,394
            
            1,2081,869
            
            2,416
            
            1,869
            
            2,416(1)Approximately $5.4 million principal amount paid at
                maturity
                on January 3, 2006,and
                $16.1 million principal amount converted to common stock on March
                8,
                2007.





**Comprehensive
      Loss**





Comprehensive
      loss is the same as net loss for the three-month and six-month periods ended
      June 30, 2007 and 2006.





**Liquidity**





As
      of
      June 30, 2007, the Company has a working capital deficit of $61.8
      million.  The Company is able to operate in the position of a working
      capital deficit because revenues are collected more quickly, often in advance,
      than obligations are required to be paid.  This can result in a low
      level of current assets to the extent cash has been deployed in business
      development opportunities or to pay down long-term liabilities.  Along
      those lines, the working capital deficit includes, as part of current
      liabilities, $15.5 million of deferred revenue and unearned rental
      income.  The level of current liabilities is not expected to change
      from period to period in such a way as to require the use of significant cash,
      except for the current portion of debt maturities of $35.1 million due by June
      30, 2008, in addition to long-term debt maturities of $46.8 million due after
      June 2008 but prior to June 30, 2009, which the Company plans to refinance
      prior
      to their due dates or pay them off at maturity.





The
      Company has incurred significant losses since its inception and has an
      accumulated deficit of $218.3 million as of June 30, 2007.  The
      Company believes these losses have resulted from its early emphasis on
      expansion, financing costs arising from multiple financing and refinancing
      transactions related to this expansion, occupancy rates remaining lower for
      longer periods than anticipated, and depreciation expense primarily from
      multiple capital leases.





The
      cash
      flows from operating activities have not always been sufficient to pay all
      of
      the Company’s long-term obligations and the Company has been dependent upon
      third party financing or disposition of assets to fund
      operations.  The Company cannot guarantee that, if necessary in the
      future, such transactions will be available timely or at all, or on terms
      attractive to the Company.





**11**


**Table
        of Contents**





Substantially
      all of the Company’s debt obligations mature at various dates beginning in March
      2008, at which time the Company will need to refinance or otherwise repay the
      obligations.  As a consequence of the Company’s property and lease
      transactions in 2007, its long-term debt has increased from $86.0 million at
      December 31, 2006, to $368.6 million****at June 30,
      2007.  The Company’s obligations under operating leases have decreased
      from $299.3 million to $211.2 million, and its capital lease and financing
      obligations have decreased from $608.6 million to $578.9
      million.  Many of the Company’s debt instruments and leases contain
“cross-default” provisions pursuant to which a default under one obligation can
      cause a default under one or more other obligations to the same lender or
      lessor.  Such cross-default provisions affect the majority of the
      Company’s 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.  Defaults can include certain financial
      covenants, which generally relate to lease coverage and cash flow.  In
      addition, the Company is required to maintain the leased properties in a
      reasonable and prudent manner.  For the six months ended June 30,
      2007, the Company was in violation of one or more covenants in certain of its
      leases, but obtained waivers from the owners such that it was still deemed
      to be
      in compliance and thus, were not in default.  The waivers expire on
      July 1, 2008.





Based
      on
      the Company’s current operating initiatives, the public offering completed in
      July 2007 (see “Subsequent Events” below), and the current cash position,
      management believes that the Company will be able to generate positive operating
      cash flow, or will have adequate cash reserves, or the ability to obtain
      adequate financing to cover any potential operating shortfalls and necessary
      investing and financing activities, including required debt service and capital
      expenditures for at least the next twelve months.





**Pending
      Acquisitions**





On
      June 8, 2007, the Company entered into a definitive agreement to acquire,
      for an aggregate purchase price of $88 million (excluding closing costs), a
      total of nine communities, consisting of 711 units located in the State of
      New York, that the Company currently leases.  On June 14, 2007,
      the Company entered into definitive agreements to acquire, for an aggregate
      purchase price of $24.5 million (excluding closing costs), a total of three
      communities, consisting of 431 units in the State of Florida, that the
      Company currently leases.  On June 14, 2007, the Company entered
      into a definitive agreement to acquire, for an aggregate purchase price of
      $482.5 million (excluding closing costs), a total of 40 communities,
      consisting of 3,643 units located in 19 states.  Of these
      communities, the Company currently leases 32 communities and Summerville
      currently leases 8 communities.  The Company intends to complete these
      transactions in the third quarter of 2007.  The Company made deposits
      of approximately $5.2 million related to these proposed acquisitions which
      is
      recorded in Other assets, net on the balance sheet at June 30,
      2007.





**Subsequent
      Events**





On
      July
      3, 2007, the Company closed the public offering of 11,000,000 shares of common
      stock, of which 10,500,000 shares were sold by the Company and 500,000 shares
      were sold by certain selling shareholders.  The Company received net
      proceeds of approximately $305.3 million after closing costs.  The
      Company has incurred approximately $773,000 in offering-related costs which
      are
      recorded in Other assets, net on the balance sheet at June 30,
      2007.





On
      July
      27, 2007, the Company received notice from the underwriters of the public
      offering discussed in the previous paragraph that they have elected to exercise
      the over-allotment option specified in the Underwriting Agreement to purchase
      800,800 additional shares of common stock from the Company.  The
      closing date of the purchase was August 2, 2007, and the Company received net
      proceeds of $23.4 million after closing costs.





On
      August
      6, 2007, the Company closed on the acquisition of the three Florida communities
      mentioned above under “Pending Acquisitions.”  The final purchase
      price was $24.5 million, excluding closing costs.  The Company had
      leased these communities from Health Care REIT, Inc. and affiliates under two
      different master leases dated September 30, 2003, and September 30,
      2004.  The leases have been accounted for as capital
      leases.  The annual base rent for the three communities was
      approximately $2.5 million as of the closing date.  As a result of
      this asset





**12**


**Table
        of Contents**
 ****


purchase
      transaction, the master leases were modified to remove the communities from
      these leases.  Upon termination of the capital lease for the three
      communities, the difference between the carrying amount of the leased assets
      and
      the lease obligation will be recorded as an adjustment to the carrying amount
      of
      the assets purchased, which represents a reduction of approximately $3.2 million
      to the cost basis of the purchased assets.  An affiliate of General
      Electric Capital Corporation (“GECC”) provided variable rate mortgage financing
      of approximately $19.6 million pursuant to a Credit Agreement dated August
      6, 2007, by and between affiiliates of Emeritus Corporation and
      GECC.  The variable rate mortgage has a term of five years with
      interest at 30-day LIBOR plus 1.5%, which was 6.83% at
      closing.  Monthly interest-only payments are due for the first three
      years and thereafter, monthly payments of principal and interest will be based
      on a 25-year amortization schedule.  The balance on the loan is due in
      full in August 2012.  The indebtedness outstanding under the GECC loan
      may be accelerated under customary circumstances, including payment defaults,
      and is secured by all real, personal, and intangible assets used in the
      operation of the three communities.














**13**


**Table
        of Contents**
 ****


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





**Forward-Looking
      Statements**





“Safe
      Harbor” Statement under the Private Securities Litigation Reform Act of
      1995:  A number of the matters and subject areas discussed in this
      report that are not historical or current facts deal with potential future
      circumstances, operations, and prospects, which are "forward-looking statements"
      within the meaning of the Private Securities Litigation Reform Act of
      1995.  The discussion of such matters and subject areas is qualified
      by the inherent risks and uncertainties surrounding future expectations
      generally, and also may materially differ from our actual future experience
      as a
      result of such factors as:  the effects of competition and economic
      conditions on the occupancy levels in our communities; our ability under current
      market conditions to maintain and increase our resident charges in accordance
      with our rate enhancement programs without adversely affecting occupancy levels;
      increases in interest costs as a result of re-financings; our ability to control
      community operation expenses, including insurance and utility costs, without
      adversely affecting the level of occupancy and the level of resident charges;
      our ability to generate cash flow sufficient to service our debt and other
      fixed
      payment requirements; our ability to find sources of financing and capital
      on
      satisfactory terms to meet our cash requirements to the extent that they are
      not
      met by operations, uncertainties related to professional liability claims;
      and
      uncertainties about our ability to successfully integrate our company with
      Summerville Senior Living, Inc. after consummating our pending merger with
      them.  We have attempted to identify, in context, certain of the
      factors that we currently believe may cause actual future experience and results
      to differ from our current expectations regarding the relevant matter or subject
      area.  These and other risks and uncertainties are detailed in our
      reports filed with the Securities and Exchange Commission (SEC), including
“Item
      1A.  Risk Factors” in our Annual Report on Form 10-K for the year
      ended December 31, 2006.





**Overview**





Emeritus
      is a Washington corporation founded by Daniel R. Baty and two other long-time
      associates in 1993.  Mr. Baty is chairman of our board of directors,
      chief executive officer, and one of our largest shareholders.  He is
      also a party to a number of agreements with us and is referred to frequently
      in
      discussions of the business.  In November 1995, we completed our
      initial public offering.





From
      1995
      through 1999, we expanded rapidly through acquisition and internal development
      and by December 31, 1999, operated 129 assisted living communities with
      11,726 units.  We believe, however, that during this expansion, the
      assisted living industry became over-built, creating an environment
      characterized by sluggish or falling occupancy and market resistance to rate
      increases caused by the oversupply.  As a result, in 2000 we began an
      increased focus first on raising our occupancy and later on rate development,
      operating efficiencies, and cost controls.  This focus continues into
      2007.





We
      believe the operating environment of the assisted living industry has been
      improving over the past several years resulting in occupancy gains and increases
      in the average monthly rate.  These operating improvements have also
      resulted in greater access to capital.  We believe these dynamics have
      resulted in the consolidation of smaller local and regional operators into
      the
      larger national operators, and anticipate this consolidation of the industry
      will continue.  Because of these circumstances, we have been able to
      complete several acquisitions or leases in the last several years, although
      at a
      slower pace in 2005 and 2006 than in 2003 and 2004.  So far in 2007,
      we have acquired 43 communities that we previously had
      leased.  Although opportunities for further expansion have been
      available over the past two years, we have been selective in our growth as
      we
      have seen a sharp increase in market prices.  As a result, we have
      focused more on internal growth through expansion of existing properties and
      construction of new communities.  We currently have expansion projects
      underway in ten of our communities and will continue to look at other expansion
      opportunities where the market conditions are favorable.  In addition,
      we have five development projects in various stages of completion in several
      locations.





From
      the
      beginning of 2003 through June 30, 2007, we have increased our owned and leased
      communities by 35 and 51, respectively, for a net increase in our consolidated
      portfolio of 86.  In addition, we have decreased our number of managed
      communities by 61, thereby increasing our total operated portfolio by 25
      communities.  Those communities we own and lease, and which are
      included in our consolidated portfolio, increased from 85 at the





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


**Table
        of Contents**


beginning
      of 2003 to 171 at June 30, 2007, reflecting both our increasing confidence
      in
      the assisted living industry and the availability of capital.





In
      2007,
      we expect to continue our focus on increasing occupancy and rates, as well
      as
      reviewing acquisition opportunities that meet our criteria.





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





**As
                of June 30,**
            
            **As
                of December 31,**
            
            **As
                of June 30,****2007**
            
            **2006**
            
            **2006****Buildings**
            
            **Units**
            
            **Buildings**
            
            **Units**
            
            **Buildings**
            
            **Units**Owned
                (1)
            53
            
            3,698
            
            10
            
            808
            
            9
            
            707Leased
                (2 )
            118
            
            9,931
            
            161
            
            12,821
            
            161
            
            12,821Consolidated
                Portfolio
            171
            
            13,629
            
            171
            
            13,629
            
            170
            
            13,528Managed/Admin
                Services (3)
            9
            
            1,084
            
            11
            
            1,232
            
            11
            
            1,235Joint
                Venture/Partnership (4)
            25
            
            1,975
            
            21
            
            1,652
            
            1
            
            140Operated
                Portfolio
            205
            
            16,688
            
            203
            
            16,513
            
            182
            
            14,903Percentage
                increase (decrease) (5)
            1.0%
            
            1.1%
            
            10.3%
            
            9.4%
            
            (1.1%)
            
            (1.3%)





(1)   Owned
                communities increased from June 30, 2006, due to the acquisition
                of one
                community in Washington acquired in July 2006, 24 communities in
                six
                states acquired in February 2007, and 19 communities in six states
                acquired in March 2007.


(2)   Of
                the 118 leased communities at June 30, 2007, 38 are accounted for
                as
                operating leases, in which the assets and liabilities of the communities
                are not included in our condensed consolidated balance sheet and
                66 are
                accounted for as capital leases, in which a long-term asset and
                corresponding liability is established on our balance
                sheet.  The remaining 14 leased communities are reflected in our
                condensed consolidated financial statements as owned communities
                because
                of accounting requirements related to sale-leaseback accounting,
                notwithstanding the legal sale of the communities and their subsequent
                leasing by us.


(3)   Managed
                communities declined by two from June 30, 2006, because we discontinued
                management of one community in January 2007 and reclassified one
                from
                managed to the joint venture group in March
                2007.


(4)   Since
                June 30, 2006, we have added 24 communities to our joint venture
                managed
                group, 20 from the Blackstone joint venture in December 2006, and
                one
                additional Blackstone community in March 2007 that was formerly managed
                by
                the Company, and an additional three communities acquired by Blackstone
                in
                May 2007.


(5)   The
                percentage increase (decrease) indicates the change from the prior
                year,
                or, in the case of June 30, 2007 and 2006, from the end of the prior
                year.





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





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





**15**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





The
      table
      below shows for our consolidated portfolio our average monthly revenue per
      occupied unit and occupancy rate for the three and six months ended June 30, 2007 and
      2006:





**Three
                Months ended June 30,**
            
            
            **Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D**
            
            
            **2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D**Average
                monthly revenueper
                occupied unit
            
            **$**
            **3,202**
            
            
            $
            3,081
            
            
            $
            121
            
            
            
            3.9
            %
            
            **$**
            **3,189**
            
            
            $
            3,064
            
            
            $
            125
            
            
            
            4.1
            %Average
                occupancy rate
            
            ****
            **85.9**
            **%**
            
            
            84.6
            %
            
            
            
            
            
            
            1.3
            ppt*
            
            ****
            **86.1**
            **%**
            
            
            84.2
            %
            
            
            
            
            
            
            1.9
            ppt*





*
      percentage points





We
      believe that this increase in occupancy rates reflects industry-wide factors,
      such as the declining supply of vacant units, as well as our own actions and
      policies.  We continue to evaluate the factors of rate and occupancy
      to find the optimum balance in each community, as witnessed by the increase
      in
      occupancy rates and average monthly revenue per unit over the past
      year.





Since
      our
      inception in 1993, we have incurred operating losses totaling approximately
      $218.3 million as of June 30, 2007.  We believe that these losses have
      resulted from our early emphasis on expansion, financing costs arising from
      multiple financing and refinancing transactions related to this expansion,
      administrative and corporate expenses that we incurred in anticipation of
      further expansion and increased emphasis on risk management and financial
      reporting controls, the impact in the early years on many of our leases from
      capital and financing lease treatments, and occupancy rates remaining lower
      for
      longer periods than we anticipated.   While we have realized
      growth in both our occupancy and average monthly rates, we anticipate continued
      losses in the near term until our occupancy stabilizes.  Our current
      emphasis is on maximization of cash flows as we work toward improvements in
      occupancy and average rates, selective growth, and changes in our capital
      structure, such as acquisition of leased properties and refinancing of existing
      high-rate debt.








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**16**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





**Significant
      Transactions**





From
      2004
      through 2006, and continuing into 2007, we entered into a number of transactions
      that affected the number of communities we own, lease, and manage; our financing
      arrangements; and our capital structure.  These transactions are
      summarized in the “Notes to Unaudited Condensed Consolidated Financial
      Statements” above.





The
      following table shows the changes in buildings from December 31, 2005, through
      June 30, 2007, including those transactions previously described:





**Month**
            
            **Owned**
            
            
            **Leased**
            
            
            **Consolidated**
            
            
            **Managed**
            
            
            **Total****December
                31, 2005**
            
            
            ****
            **9**
            
            
            ****
            **161**
            
            
            ****
            **170**
            
            
            ****
            **14**
            
            
            ****
            **184**Isle
                at Emerald Court
            Jan-06
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1
            
            
            
            1Park
                Lane – disposition
            Jan-06
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )La
                Villita – disposition
            Mar-06
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )**March
                31, 2006**
            
            
            ****
            **9**
            
            
            ****
            **161**
            
            
            ****
            **170**
            
            
            ****
            **13**
            
            
            ****
            **183**Emerald
                Estates – disposition
            Apr-06
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )**June
                30, 2006**
            
            
            ****
            **9**
            
            
            ****
            **161**
            
            
            ****
            **170**
            
            
            ****
            **12**
            
            
            ****
            **182**Arbor
                Place
            Jul-06
            
            
            1
            
            
            
            –
            
            
            
            1
            
            
            
            (1
            )
            
            
            -**September
                30, 2006**
            
            
            ****
            **10**
            
            
            ****
            **161**
            
            
            ****
            **171**
            
            
            ****
            **11**
            
            
            ****
            **182**JV
                – management agreements
            Dec-06
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            21
            
            
            
            21**December
                31, 2006**
            
            
            ****
            **10**
            
            
            ****
            **161**
            
            
            ****
            **171**
            
            
            ****
            **32**
            
            
            ****
            **203**Walking
                Horse Meadows – disposition
            Jan-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (1
            )
            
            
            (1
            )Fretus
                Purchase
            Feb-07
            
            
            24
            
            
            
            (24
            )
            
            
            –
            
            
            
            –
            
            
            
            –HRT
                Purchase
            Mar-07
            
            
            12
            
            
            
            (12
            )
            
            
            –
            
            
            
            –
            
            
            
            –HCPI
                Purchase
            Mar-07
            
            
            7
            
            
            
            (7
            )
            
            
            –
            
            
            
            –
            
            
            
            –**March
                31, 2007**
            
            
            ****
            **53**
            
            
            ****
            **118**
            
            
            ****
            **171**
            
            
            ****
            **31**
            
            
            ****
            **202**Additional
                JV– management agreements
            May-07
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            3
            
            
            
            3**June
                30, 2007**
            
            
            ****
            **53**
            
            
            ****
            **118**
            
            
            ****
            **171**
            
            
            ****
            **34**
            
            
            ****
            **205**








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**17**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**
 ****


**Results
      of Operations**





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





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





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.  Revisions in such estimates are charged to
      income in the period in which the facts that give rise to the revision become
      known.  A detailed discussion of our significant accounting policies
      and use of estimates is contained in our 2006 Form 10-K filed March 16, 2007,
      and there have been no material changes since then.





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**18**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**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 our
      condensed consolidated statements of operations as a percentage of total
      revenues and the percentage change of the dollar amounts from period to
      period.




**Period-to-Period****Percentage****Change****Percentage
                  of Revenues**
              
              
              **Fav
                  / (Unfav)****Three
                  Months**
              
              
              **Six
                  Months****Three
                  Months ended**
              
              
              **Six
                  Months ended**
              
              
              **ended**
              
              
              **ended****June
                  30,**
              
              
              **June
                  30,**
              
              
              **June
                  30,**
              
              
              **June
                  30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**
              
              
              ****
              **2007-2006**
              
              
              ****
              **2007-2006**Revenues:
              
              
              100.0
              %
              
              
              100.0
              %
              
              
              100.0
              %
              
              
              100.0
              %
              
              
              6.9
              %
              
              
              8.0
              %Expenses:Community
                  operations*
              
              
              62.7
              
              
              
              65.3
              
              
              
              63.3
              
              
              
              65.5
              
              
              
              (2.7
              )
              
              
              (4.5
              )Texas
                  lawsuit settlement
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              
              (6.0
              )
              
              N/A
              
              
              N/AGeneral
                  and administrative
              
              
              10.1
              
              
              
              8.4
              
              
              
              9.6
              
              
              
              8.5
              
              
              
              (28.7
              )
              
              
              (22.3
              )Depreciation
                  and amortization
              
              
              13.2
              
              
              
              11.8
              
              
              
              13.2
              
              
              
              11.9
              
              
              
              (19.2
              )
              
              
              (19.6
              )Facility
                  lease expense
              
              
              6.8
              
              
              
              10.7
              
              
              
              8.1
              
              
              
              10.8
              
              
              
              32.5
              
              
              
              18.9Total
                  operating expenses
              
              
              92.8
              
              
              
              96.2
              
              
              
              94.2
              
              
              
              90.7
              
              
              
              (3.1
              )
              
              
              (12.2
              )Operating
                  income from continuing operations
              
              
              7.2
              
              
              
              3.8
              
              
              
              5.8
              
              
              
              9.3
              
              
              
              101.5
              
              
              
              (33.0
              )Other
                  income (expense)Interest
                  income
              
              
              0.5
              
              
              
              0.7
              
              
              
              0.5
              
              
              
              0.8
              
              
              
              (11.7
              )
              
              
              (23.2
              )Interest
                  expense
              
              
              (15.3
              )
              
              
              (12.0
              )
              
              
              (13.8
              )
              
              
              (11.9
              )
              
              
              (35.8
              )
              
              
              (26.2
              )Equity
                  gains (losses) in unconsolidated joint ventures
              
              
              6.4
              
              
              
              (0.4
              )
              
              
              3.0
              
              
              
              (0.2
              )
              
              N/A
              
              
              N/AOther,
                  net
              
              
              0.7
              
              
              
              0.5
              
              
              
              -
              
              
              
              0.6
              
              
              
              39.1
              
              
              
              (90.5
              )Net
                  other expense
              
              
              (7.7
              )
              
              
              (11.2
              )
              
              
              (10.3
              )
              
              
              (10.7
              )
              
              
              26.9
              
              
              
              (3.5
              )Loss
                  from continuing operationsbefore
                  income taxes
              
              
              (0.5
              )
              
              
              (7.4
              )
              
              
              (4.5
              )
              
              
              (1.4
              )
              
              N/A
              
              
              
              (241.0
              )Provision
                  for income taxes
              
              
              (0.9
              )
              
              
              0.1
              
              
              
              (0.6
              )
              
              
              -
              
              
              N/A
              
              
              N/ALoss
                  from continuing operations
              
              
              (1.4
              )
              
              
              (7.3
              )
              
              
              (5.1
              )
              
              
              (1.4
              )
              
              N/A
              
              
              
              (298.2
              )Loss
                  from discontinued operations (net of tax)
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              N/A
              
              
              
              100.0Net
                  loss
              
              
              (1.4
              %)
              
              
              (7.3
              %)
              
              
              (5.1
              %)
              
              
              (1.4
              %)
              
              N/A
              
              
              
              (292.1
              %)* exclusive
                  of depreciation and amortization and facility lease expense shown
                  separately below





**19**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**
 ****


**Comparison
      of the three months ended June 30, 2007 and 2006**





**Total
      Operating Revenues:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Community
                revenue
            
            **$**
            **109,845**
            
            
            $
            103,189
            
            
            $
            6,656
            
            
            
            6.5
            %Management
                fees
            
            ****
            **930**
            
            
            
            484
            
            
            
            446
            
            
            
            92.1
            %Total
                operating revenues
            
            **$**
            **110,775**
            
            
            $
            103,673
            
            
            $
            7,102
            
            
            
            6.9
            %





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D**Average
                monthly revenue per occupied unit
            
            **$**
            **3,202**
            
            
            $
            3,081
            
            
            $
            121
            
            
            
            3.9
            %Average
                occupancy rate
            
            ****
            **85.9**
            **%**
            
            
            84.6
            %
            
            
            
            
            
            
            1.3
            ppt*





*
      percentage points





Of
      the
      $7.1 million increase in revenues for the three months ended June 30, 2007,
      compared to the three months ended June 30, 2006, approximately $4.0 million
      was
      due to increases in the average monthly revenue per occupied unit and
      approximately $2.6 million was due to an increase in occupancy, including an
      increase of $355,000 from the reopening of our Biloxi community that was
      temporarily closed due to hurricane damage in 2005.





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





The
      increase in management fee revenue is primarily due to the Blackstone joint
      venture, from which we received $564,000 in the three month period ended June
      30, 2007.





**Community
      Operations:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Community
                operations
            
            **$**
            **69,513**
            
            
            $
            67,662
            
            
            $
            1,851
            
            
            
            2.7
            %As
                a percent of revenue
            
            ****
            **62.7**
            **%**
            
            
            65.3
            %
            
            
            
            
            
            
            (2.6
            )ppt





Of
      the
      $1.9 million increase in community operating expense, $2.5 million was primarily
      due to increases in labor-related costs.  The remaining decrease of
      $624,000 was primarily related to decreases in insurance, management fees,
      and
      property taxes, partially offset by increases in food costs, contracted
      services, cable television services, and various other similar operating
      expenses.  Included in this net increase was a $2.8 million decrease
      in professional and general liability insurance expense in 2007 based upon
      an
      actuarial valuation report compared to a similar decrease of $1.7 million in
      the
      comparable period of 2006.





**20**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





**General
      and Administrative:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**General
                and administrative
            
            **$**
            **11,222**
            
            
            $
            8,721
            
            
            $
            2,500
            
            
            
            28.7
            %As
                a percent of revenue
            
            ****
            **10.1**
            **%**
            
            
            8.4
            %
            
            
            
            
            
            
            1.7
            ppt
            t





The
      growth in general and administrative expenses of $2.5 million was primarily
      related to staffing costs for regional and corporate overhead positions, which
      is comprised of increases in the number of personnel andin average salaries,
      increases in incentive compensation expenses, and merger-related severance
      pay.  This increase reflects approximately $1.1 million of
      merger-related severance pay, $864,000 in salaries and benefits, $182,000 in
      incentive compensation expenses, and non-cash stock option compensation expenses
      of approximately $699,000, partially offset by a decrease in legal fees of
      $610,000 in 2007 as compared to 2006, primarily as a result of legal fees
      related to the Texas Medicaid dispute in 2006 as discussed under “Legal
      Proceedings.”





**Depreciation
      and Amortization:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Depreciation
                and amortization
            
            **$**
            **14,606**
            
            
            $
            12,251
            
            
            $
            2,355
            
            
            
            19.2
            %As
                a percent of revenue
            
            ****
            **13.2**
            **%**
            
            
            11.8
            %
            
            
            
            
            
            
            1.4
            ppt





The
      increase in depreciation and amortization expense of $2.4 million resulted
      primarily from an increase in depreciation expense of $2.0 million upon
      completion of the Fretus, HRT, and HCPI acquisitions.  The remainder
      was due to leasehold improvement depreciation on capital expenditures to improve
      our properties.





**Facility
      Lease Expense:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Facility
                lease expense
            
            **$**
            **7,482**
            
            
            $
            11,092
            
            
            $
            (3,610
            )
            
            
            (32.5
            %)As
                a percent of revenue
            
            ****
            **6.8**
            **%**
            
            
            10.7
            %
            
            
            
            
            
            
            (3.9
            )ppt





The
      decrease in facility lease expense of $3.6 million was primarily due to the
      operating lease expense decrease of $3.7 million due to the Fretus, HRT, and
      HCPI acquisitions, partially offset by lease terms that provide for periodic
      increases in rent.  We leased 38 and 77 communities under operating
      leases as of June 30, 2007 and 2006, respectively.





**21**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





**Interest
      Income:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Interest
                income
            
            **$**
            **601**
            
            
            $
            681
            
            
            $
            (80
            )
            
            
            (11.7
            %)As
                a percent of revenue
            
            ****
            **0.5**
            **%**
            
            
            0.7
            %
            
            
            
            
            
            
            (.2
            )ppt





Interest
      income is primarily attributable to interest earned on invested cash balances
      and interest earned on restricted deposits, both of which were lower in the
      second quarter of 2007 as compared to the second quarter of 2006, resulting
      in a
      decline in interest income.





**Interest
      Expense:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Interest
                expense
            
            **$**
            **16,945**
            
            
            $
            12,475
            
            
            $
            4,470
            
            
            
            35.8
            %As
                a percent of revenue
            
            ****
            **15.3**
            **%**
            
            
            12.0
            %
            
            
            
            
            
            
            3.3
            ppt





The
      increase in interest expense of $4.5 million for the second quarter of 2007
      as
      compared to the comparable period in 2006 is primarily due to an increase of
      $4.8 million in interest expense from the Fretus, HRT, and HCPI acquisitions
      and
      the new Washington community acquired in July 2006, partially offset by
      reductions in other interest expense due to normal pay downs on loans and
      mortgages.





**Equity
      Gains (Losses) in Unconsolidated Joint Ventures:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Equity
                gains (losses) inunconsolidated
                joint ventures
            
            **$**
            **7,065**
            
            
            $
            (396
            )
            
            $
            7,461
            
            
            
            (1,884.1
            %)As
                a percent of revenue
            
            ****
            **6.4**
            **%**
            
            
            (0.4
            %)
            
            
            
            
            
            
            6.8
            ppt





The
      increase in equity gains (losses) in unconsolidated joint ventures of $7.5
      million primarily reflects net equity gains of $7.7 million recognized in
      connection with the Company’s divestiture of its investment in Senior Med,
      partially offset by equity losses in Senior Med of $113,000 and the Blackstone
      joint venture of $450,000 for the three months ended  June 30,
      2007.





**Other,
      net:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Other,
                net
            
            **$**
            **782**
            
            
            $
            562
            
            
            $
            220
            
            
            
            39.1
            %As
                a percent of revenue
            
            ****
            **0.7**
            **%**
            
            
            0.5
            %
            
            
            
            
            
            
            .2
            ppt








**22**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**
 ****


Other,
      net primarily reflects $549,000 of amortization of deferred gains in 2007 and
      an
      increase of $189,000 on our investment for our non-qualified compensation
      plan.  The balance in 2006 primarily relates to $553,000 of
      amortization of deferred gains.





**Income
      Taxes:**





**Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            **%
                D****(in
                thousands, except percentages)**Provision
                for income taxes
            
            **$**
            **1,044**
            
            
            $
            (100
            )
            
            $
            1,144
            
            N/AAs
                a percent of revenue
            
            ****
            **0.9**
            **%**
            
            
            (0.1
            %)
            
            
            
            
            1.0
            ppt





The
          provision for income taxes for the quarter ended June 30, 2007, is principally
          due to federal taxes on estimated taxable income, primarily related to
          the gain
          from the Senior Med transaction and without the effect of the tax benefit
          of
          excess stock compensation deductions of $286,000, which has been recorded
          as
          additional paid in capital.  As of June 30, 2007 and 2006, we have a
          100% allowance on our net deferred tax
          assets.


**Net
      Loss and Property-Related Expense:**





In
      comparing the net loss for the three months ended June 30, 2007 and 2006, it
      is
      important to consider our property-related expenses, which include depreciation
      and amortization, facility lease expense, and interest expense that are directly
      related to our communities, and which include capital lease accounting
      treatment, finance accounting treatment, or straight-line accounting treatment
      of rent escalators for many of our leases.  These accounting
      treatments all result in greater property-related expense than actual lease
      payments made in the early years of the affected leases and less
      property-related expense than actual lease payments made in later years, as
      detailed in the tables below.





**Detail
                of property-related expenses from lease accounting
                treatment:****Three
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)****Total
                property-related expense:**Depreciation
                and amortization
            
            **$**
            **14,606**
            
            
            $
            12,251
            
            
            $
            2,355
            
            
            
            19.2
            %Facility
                lease expense
            
            ****
            **7,482**
            
            
            
            11,092
            
            
            
            (3,610
            )
            
            
            (32.5
            %)Interest
                expense
            
            ****
            **16,945**
            
            
            
            12,475
            
            
            
            4,470
            
            
            
            35.8
            %Total
                property-related expense
            
            **$**
            **39,033**
            
            
            $
            35,818
            
            
            $
            3,215
            
            
            
            9.0
            %**Property-related
                expenses from lease accounting treatment:**Depreciation
                and amortization
            
            **$**
            **9,210**
            
            
            $
            9,727
            
            
            $
            (517
            )
            
            
            (5.3
            %)Interest
                expense
            
            ****
            **9,557**
            
            
            
            10,359
            
            
            
            (802
            )
            
            
            (7.7
            %)Straight-line
                lease expense
            
            ****
            **153**
            
            
            
            245
            
            
            
            (92
            )
            
            
            (37.6
            %)Operating
                lease expense
            
            ****
            **7,329**
            
            
            
            10,847
            
            
            
            (3,518
            )
            
            
            (32.4
            %)Total
                property-related lease expense
            
            ****
            **26,249**
            
            
            
            31,178
            
            
            
            (4,929
            )
            
            
            (15.8
            %)Actual
                lease payments
            
            ****
            **(22,025**
            **)**
            
            
            (25,847
            )
            
            
            3,822
            
            
            
            (14.8
            %)Expense
                in excess of lease payments
            
            **$**
            **4,224**
            
            
            $
            5,331
            
            
            $
            (1,107
            )
            
            
            (20.8
            %)








**23**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





Our
      property-related expense associated with our leases exceeded our actual lease
      payments by $4.2 million and $5.3 million for the three months ended June 30,
      2007 and 2006, respectively.  The impact of lease accounting declined
      by $1.1 million in the current year quarter from the comparable quarter last
      year due primarily to the reduction in interest expense on the capital leases
      in
      connection with the normal pay down of the lease obligation and the termination
      of leases from the acquisition of the Fretus, HRT, and HCPI
      communities.  While the lease accounting impact has declined since the
      comparable quarter last year, the total impact in both periods is significant
      to
      our overall operating results.  It should be noted that,
      notwithstanding the effects of lease accounting treatment, the actual lease
      payments required under most of our leases will continue to increase annually
      and, as a result, we will need to improve our results from community operations
      to cover these increases.  However, in the quarter ended June 30,
      2007, the actual lease payments decreased due to the acquisition transactions
      discussed in the “Notes to Unaudited Condensed Consolidated Financial
      Statements” above.








[The
      rest
      of this page is intentionally left blank.]








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


**Table
        of Contents**





**Comparison
      of the six months ended June 30, 2007 and 2006**





**Total
      Operating Revenues:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Total
                community revenues
            
            **$**
            **219,345**
            
            
            $
            203,798
            
            
            $
            15,547
            
            
            
            7.6
            %Management
                fees
            
            ****
            **1,807**
            
            
            
            941
            
            
            
            866
            
            
            
            92.0
            %Total
                operating revenues
            
            **$**
            **221,152**
            
            
            $
            204,739
            
            
            $
            16,413
            
            
            
            8.0
            %





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D**Average
                monthly revenue per occupied unit
            
            **$**
            **3,189**
            
            
            $
            3,064
            
            
            $
            125
            
            
            
            4.1
            %Average
                occupancy rate
            
            ****
            **86.1**
            **%**
            
            
            84.2
            %
            
            
            
            
            
            
            1.9
            ppt*








Of
      the
      $16.4 million increase in revenues for the six months ended June 30, 2007,
      compared to the six months ended June 30, 2006, approximately $8.3 million
      was
      due to increases in the average monthly revenue per occupied unit and
      approximately $7.2 million was due to an increase in occupancy, including an
      increase of $1.0 million from the reopening of our Biloxi community that was
      temporarily closed due to hurricane damage in 2005.





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





The
      increase in management fee revenue is primarily due to the Blackstone joint
      venture, from which we recognized $1.1 million in the six month period ended
      June 30, 2007, partially offset by several other management agreements that
      were
      terminated during and since the six month period ended June 30,
      2006





**Community
      Operations:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Community
                operations
            
            **$**
            **140,011**
            
            
            $
            134,029
            
            
            $
            5,982
            
            
            
            4.5
            %As
                a percent of revenue
            
            ****
            **63.3**
            **%**
            
            
            65.5
            %
            
            
            
            
            
            
            (2.2
            )ppt





Of
      the
      $6.0 million increase in community operating expense, $5.2 million was primarily
      due to increases in labor-related costs.  The remaining increase of
      $809,000 was primarily related to increases in food costs, contracted services,
      and utilities.  Included in this net increase was a $2.8 million
      decrease in professional and general liability insurance expense in 2007 based
      upon an actuarial valuation report compared to a similar decrease of $1.7
      million in the comparable period of 2006.





For
      the
      six months ended June 30, 2006, community operations expense excludes a
      $12.2 million reduction in our professional and general liability insurance
      accrual that resulted from the settlement of a lawsuit for an amount
      less





**25**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





than
      the
      original accrual for the action, which is shown as a separate line item on
      the
      condensed consolidated statement of operations and is further discussed under
      “Legal Proceedings.”





**General
      and Administrative:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**General
                and administrative
            
            **$**
            **21,336**
            
            
            $
            17,452
            
            
            $
            3,884
            
            
            
            22.3
            %As
                a percent of revenue
            
            ****
            **9.6**
            **%**
            
            
            8.5
            %
            
            
            
            
            
            
            1.1
            ppt





The
      increase in general and administrative expenses of $3.9 million was primarily
      related to staffing costs for regional and corporate overhead positions, which
      is comprised of increases in the number of personnel and in average salaries,
      increases in incentive compensation expenses, and merger-related severance
      pay.  This increase reflects approximately $1.3 million of salaries
      and benefits, $896,000 in incentive compensation expenses, $1.1 million of
      merger-related severance pay, and non-cash stock option compensation expenses
      of
      approximately $1.1 million.  These increases were partially offset by
      a decrease in legal fees of $802,000 in 2007 as compared to 2006, primarily
      as a
      result of legal fees related to the Texas Medicaid dispute in 2006 as discussed
      under “Legal Proceedings.”





**Depreciation
      and Amortization:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Depreciation
                and amortization
            
            **$**
            **29,195**
            
            
            $
            24,401
            
            
            $
            4,794
            
            
            
            19.6
            %As
                a percent of revenue
            
            ****
            **13.2**
            **%**
            
            
            11.9
            %
            
            
            
            
            
            
            1.3
            ppt





The
      increase in depreciation and amortization expense of $4.8 million is primarily
      the result of the write off of approximately $1.5 million of unamortized lease
      acquisition costs upon completion of the Fretus, HRT, and HCPI acquisitions
      and
      a $317,000 increase in contract acquisition cost amortization from the July
      2006
      acquisition of one Washington community.  In addition, due to the same
      acquisitions, depreciation expense increased $2.3 million.  The
      remainder was due to leasehold improvement depreciation on capital expenditures
      to improve our properties.





**Facility
      Lease Expense:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Facility
                lease expense
            
            **$**
            **17,852**
            
            
            $
            22,010
            
            
            $
            (4,158
            )
            
            
            (18.9
            %)As
                a percent of revenue
            
            ****
            **8.1**
            **%**
            
            
            10.8
            %
            
            
            
            
            
            
            (2.7
            )ppt





The
      decrease in facility lease expense of $4.2 million was primarily due to the
      operating lease expense decrease of $4.4 million due to the Fretus, HRT, and
      HCPI acquisitions, partially offset by lease terms that provide for periodic
      increases in rent.  We leased 38 and 77 communities under operating
      leases as of June 30, 2007 and 2006, respectively.





**26**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





**Interest
      Income:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Interest
                income
            
            **$**
            **1,192**
            
            
            $
            1,552
            
            
            $
            (360
            )
            
            
            (23.2
            %)As
                a percent of revenue
            
            ****
            **0.5**
            **%**
            
            
            0.8
            %
            
            
            
            
            
            
            (.3
            )ppt





The
      decrease in interest income of $360,000 was primarily attributable to interest
      earned in 2006 on investments of cash that was received in the sale of our
      ownership interest in Alterra.  In 2007, cash balances were lower than
      in 2006 as was interest income earned on restricted deposits, which were also
      lower in 2007 as compared to 2006.





**Interest
      Expense:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Interest
                expense
            
            **$**
            **30,560**
            
            
            $
            24,206
            
            
            $
            6,354
            
            
            
            26.2
            %As
                a percent of revenue
            
            ****
            **13.8**
            **%**
            
            
            11.9
            %
            
            
            
            
            
            
            1.9
            ppt





The
      increase in interest expense of $6.4 million is primarily due to an increase
      of
      $6.1 million in interest expense from the Fretus, HRT, and HCPI acquisitions
      and
      the new Washington community acquired in July 2006, partially offset by
      reductions in other interest expense due to normal pay downs on loans and
      mortgages.  In addition, in 2006 there was a reduction in our interest
      payable accrual of $766,000, which was originally recorded in 2005, due to
      the
      settlement of a lawsuit for less than the anticipated amount.





**Equity
      Gains (Losses) in Unconsolidated Joint Ventures:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Equity
                gains (losses) inunconsolidated
                joint ventures
            
            **$**
            **6,496**
            
            
            $
            (492
            )
            
            $
            6,988
            
            
            
            (1,420.3
            %)As
                a percent of revenue
            
            ****
            **3.0**
            **%**
            
            
            (0.2
            %)
            
            
            
            
            
            
            3.2
            ppt





The
      increase in equity gains (losses) in unconsolidated joint ventures of $7.0
      million is primarily from net equity gains of $7.7 million recognized in
      conjunction with the Company’s divestiture of its investment in Senior Med,
      partially offset by equity losses in Senior Med of $237,000 and in the
      Blackstone joint venture of $845,000 for the six months ended June 30,
      2007.





**Other,
      net:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)**Other,
                net
            
            **$**
            **110**
            
            
            $
            1,158
            
            
            $
            (1,048
            )
            
            
            (90.5
            %)As
                a percent of revenue
            
            ****
            **–**
            
            
            
            0.6
            %
            
            
            
            
            
            
            (.6
            )ppt








**27**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





Other,
      net primarily reflects the incentive payment of $1.3 million related to the
      early conversion of approximately $16.1 million of our convertible debentures
      into common stock, offset by $1.1 million of amortization of deferred gains
      in
      2007.  The balance in 2006 primarily relates to $1.1 million of
      amortization of deferred gains.





**Income
      Taxes:**





**Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            **%
                D****(in
                thousands, except percentages)**Provision
                for income taxes
            
            **$**
            **1,320**
            
            
            $
            (90
            )
            
            $
            1,410
            
            N/AAs
                a percent of revenue
            
            ****
            **0.6**
            **%**
            
            
            –
            
            
            
            
            
            0.6
            ppt




The
      provision for income taxes for the six months ended June 30, 2007, is
      principally due to federal taxes on estimated taxable income, primarily related
      to the gain from the Senior Med transaction and without the effect of the tax
      benefit of excess stock compensation deductions of $557,000, which has been
      recorded as additional paid in capital.  As of June 30, 2007 and 2006,
      we have a 100% allowance on our net deferred tax
      assets.


**Net
        Loss and Property-Related Expense:**





In
      comparing the net loss for the six months ended June 30, 2007 and 2006, it
      is
      important to consider our property-related expenses, which include depreciation
      and amortization, facility lease expense, and interest expense that are directly
      related to our communities, and which include capital lease accounting
      treatment, finance accounting treatment, or straight-line accounting treatment
      of rent escalators for many of our leases.  These accounting
      treatments all result in greater property-related expense than actual lease
      payments made in the early years of the affected leases and less
      property-related expense than actual lease payments made in later years, as
      detailed in the tables below.







**Detail
                of property-related expenses from lease accounting
                treatment:****Six
                Months ended June 30,****2007**
            
            
            **2006**
            
            
            **$
                D**
            
            
            **%
                D****(in
                thousands, except percentages)****Total
                property-related expense:**Depreciation
                and amortization
            
            **$**
            **29,195**
            
            
            $
            24,401
            
            
            $
            4,794
            
            
            
            19.6
            %Facility
                lease expense
            
            ****
            **17,852**
            
            
            
            22,010
            
            
            
            (4,158
            )
            
            
            (18.9
            %)Interest
                expense
            
            ****
            **30,560**
            
            
            
            24,206
            
            
            
            6,354
            
            
            
            26.2
            %Total
                property-related expense
            
            **$**
            **77,607**
            
            
            $
            70,617
            
            
            $
            6,990
            
            
            
            9.9
            %**Property-related
                expenses from lease accounting treatment:**Depreciation
                and amortization
            
            **$**
            **18,753**
            
            
            $
            19,426
            
            
            $
            (673
            )
            
            
            (3.5
            %)Interest
                expense
            
            ****
            **19,649**
            
            
            
            20,759
            
            
            
            (1,110
            )
            
            
            (5.3
            %)Straight-line
                lease expense
            
            ****
            **317**
            
            
            
            512
            
            
            
            (195
            )
            
            
            (38.1
            %)Operating
                lease expense
            
            ****
            **17,535**
            
            
            
            21,498
            
            
            
            (3,963
            )
            
            
            (18.4
            %)Total
                property-related lease expense
            
            ****
            **56,254**
            
            
            
            62,195
            
            
            
            (5,941
            )
            
            
            (9.6
            %)Actual
                lease payments
            
            ****
            **(47,450**
            **)**
            
            
            (51,335
            )
            
            
            3,885
            
            
            
            (7.6
            %)Expense
                in excess of lease payments
            
            **$**
            **8,804**
            
            
            $
            10,860
            
            
            $
            (2,056
            )
            
            
            (18.9
            %)








**28**
 **MANAGEMENT’S
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              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





Our
      property-related expense associated with our leases exceeded our actual lease
      payments by $8.8 million and $10.9 million for the six months ended June 30,
      2007 and 2006, respectively.  The impact of lease accounting declined
      by $2.1 million in the first two quarters of the current year from the
      comparable period last year due primarily to the reduction in interest expense
      on the capital leases in connection with the normal pay down of the lease
      obligation and the termination of leases from the acquisition of the Fretus,
      HRT, and HCPI communities.  While the lease accounting impact has
      declined since the comparable quarter last year, the total impact in both
      periods is significant to our overall operating results.  It should be
      noted that, notwithstanding the effects of lease accounting treatment, the
      actual lease payments required under most of our leases will continue to
      increase annually and, as a result, we will need to improve our results from
      community operations to cover these increases.  However, in the two
      quarters ended June 30, 2007, the actual lease payments decreased due to the
      acquisition transactions discussed in the “Notes to Unaudited Condensed
      Consolidated Financial Statements” above.








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**29**
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              RESULTS OF OPERATIONS -
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        of Contents**




**Same
      Community Comparison**





Of
      our
      171 communities, we have operated 169 communities continuously since January
      1,
      2006, and define these as “Same Communities.”  Generally, in the past,
      there has been a significant difference between our Same Communities portfolio
      and our consolidated portfolio and we provided a separate analysis of the Same
      Communities.  Since this disparity no longer exists, we believe any
      analysis of the Same Communities adds little to the understanding of our
      business and have not included such an analysis in this report.





**Liquidity
      and Capital Resources**





For
      the
      six months ended June 30, 2007, net cash provided by operating activities was
      $23.6 million.  The primary components were depreciation and
      amortization of $29.2 million, a net change in operating assets and liabilities
      of $1.4 million, incentive payment accrual for early conversion of debentures
      of
      $1.3 million, non-cash stock option compensation of $1.3 million, net losses
      in
      equity investments of $939,000, amortization of loan fees of $591,000, and
      allowance for doubtful receivables of $565,000, partially offset by $11.3
      million of net loss from operations and amortization of deferred gain of $1.1
      million.





Net
      cash
      used in operating activities was $4.0 million for the six months ended June
      30,
      2006. The primary components were net increases in operating assets and
      liabilities of $27.0 million, $2.9 million of net loss from operations, and
      amortization of deferred gain of $1.1 million, partially offset by $24.4 million
      of depreciation and amortization.  The $27.0 million use of cash
      related to operating assets and liabilities is primarily comprised of the
      following:





**Significant
                components of changes in operating assets and
                liabilities:****Six
                Months****Ended
                June 30,****2006**Reduction
                of Texas settlement liability accruals, including accrued
                interest
            
            $
            (12,973
            )Payment
                of Texas settlement
            
            
            (5,600
            )Texas
                settlement subtotal
            
            
            (18,573
            )Federal
                tax deposits, principally related to the Alterra transaction
                gain
            
            
            (4,200
            )Payment
                of semi-annual debenture interest
            
            
            (1,000
            )Initial
                payment of annual insurance premiums
            
            
            (6,785
            )Tax
                benefit of stock compensation
            
            
            (1,074
            )Texas
                Medicaid accrual
            
            
            500All
                other activity, net
            
            
            4,146Net
                change in operating assets and liabilities
            
            $
            (26,986
            )





The
      Texas
      settlement impact of $18.6 million and the federal tax deposits of $4.2 million
      related to the Alterra transaction gain, a total of $22.8 million, are
      non-recurring items.





For
      the
      six months ended June 30, 2007, cash used in investing activities was $196.8
      million.  The activities that used cash include $196.1 million for the
      acquisition or construction of property and equipment and $972,000 in lease
      and
      contract acquisition costs, partially offset by a net disinvestment in
      affiliates and other managed communities of $270,000.  For the six
      months ended June 30, 2006, cash used in investing activities was $18.8
      million.  The activities that used cash include $10.8 million held in
      escrow for the Arbor Place acquisition, $6.4 million for the acquisition of
      property and equipment and $2.0 million in construction expenditures for leased
      property, partially offset by net cash provided of $470,000 from affiliates
      and
      other managed communities.








For
      the
      six months ended June 30, 2007, net cash provided by financing activities was
      $185.7 million.  Activities resulting in a net cash increase include
      $284.3 million of proceeds from long-term borrowings and financings, $5.0
      million for the decrease in restricted deposits, $557,000 tax benefit of stock
      compensation, and proceeds from the





**30**
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              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





issuance
      of common stock of approximately $873,000, partially offset by $102.1 million
      for repayment of long-term borrowings and financings, and $3.0 million of debt
      issue and other financing costs.  For the six months ended June 30,
      2006, net cash used in financing activities was $3.6 million, consisting
      primarily of $15.4 million repayment of long-term borrowings and financings
      and
      an increase in restricted deposits of $1.2 million, partially offset by proceeds
      from the issuance of common stock of approximately $3.8 million, long-term
      borrowings of $8.4 million, and a $1.1 million tax benefit of stock
      compensation.





As
      of
      June 30, 2007, we had a working capital deficit of $61.8 million.  We
      are able to operate in the position of a working capital deficit because
      revenues are collected more quickly, often in advance, than obligations are
      required to be paid.  This can result in a low level of current assets
      to the extent cash has been deployed in business development opportunities
      or to
      pay down long-term liabilities.  Along those lines, the working
      capital deficit includes, as part of current liabilities, $15.5 million of
      deferred revenue and unearned rental income.  The level of current
      liabilities is not expected to change from period to period in such a way as
      to
      require the use of significant cash, except for the current portion of debt
      maturities of $35.1 million due by June 30, 2008, in addition to long-term
      debt
      maturities of $46.8 million due after June 2008 but prior to June 30, 2009,
      which the Company plans to refinance prior to their due dates or pay them off
      at
      maturity.





We
      have
      incurred significant losses since our inception and have an accumulated deficit
      of $218.3 million as of June 30, 2007.  We believe these losses have
      resulted from our early emphasis on expansion, financing costs arising from
      multiple financing and refinancing transactions related to this expansion,
      occupancy rates remaining lower for longer periods than anticipated, and
      depreciation expense primarily from multiple capital and financing
      leases.





Substantially
      all of our debt obligations mature at various dates beginning in March 2008,
      at
      which time we will need to refinance or otherwise repay the
      obligations.  As a consequence of our property and lease transactions
      in 2007, our long-term debt has increased from $86.0 million at December 31,
      2006, to $368.6 million****at June 30, 2007.  Our
      obligations under operating leases have decreased from $299.3 million to $211.2
      million, and our capital lease and financing obligations have decreased from
      $608.6 million to $578.9 million.  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 our financial condition if such debt or leases are
      cross-defaulted.  Defaults can include certain financial covenants,
      which generally relate to lease coverage and cash flow.  In addition,
      we are required to maintain the leased properties in a reasonable and prudent
      manner.  For the six months ended June 30, 2007, we were in violation
      of one or more covenants in certain of our leases, but obtained waivers from
      the
      owners such that we were still deemed to be in compliance and thus, were not
      in
      default.  The waivers expire on July 1, 2008.





Based
      on
      our current operating initiatives, the public offering completed in July 2007
      (see “Subsequent Events” below), and our current cash position, management
      believes that we will be able to generate positive operating cash flow, or
      will
      have adequate cash reserves, or the ability to obtain adequate financing to
      cover any potential operating shortfalls and necessary investing and financing
      activities, including required debt service and capital expenditures for at
      least the next twelve months.








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**31**
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              CONDITION**
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              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





The
      following table summarizes our contractual obligations at June 30, 2007, (in
      thousands):





**Principal
                and Lease Payments Due by Period****After
                5****Contractual
                Obligations**
            
            **Total**
            
            
            **1
                year**
            
            
            **2-3
                years**
            
            
            **4-5
                years**
            
            
            **years**Long-term
                debt, including current portion
            
            $
            368,639
            
            
            $
            35,071
            
            
            $
            89,785
            
            
            $
            137,285
            
            
            $
            106,498Capital
                lease and financing obligations,including
                current portion
            
            
            578,948
            
            
            
            22,851
            
            
            
            55,584
            
            
            
            70,147
            
            
            
            430,366Operating
                leases
            
            
            211,199
            
            
            
            29,421
            
            
            
            57,659
            
            
            
            50,891
            
            
            
            73,228Convertible
                debentures
            
            
            10,455
            
            
            
            -
            
            
            
            10,455
            
            
            
            -
            
            
            
            -$
            1,169,241
            
            
            $
            87,343
            
            
            $
            213,483
            
            
            $
            258,323
            
            
            $
            610,092





The
      following table summarizes interest on our contractual obligations at June
      30,
      2007, (in thousands):








**Interest
                Due by Period****After
                5****Contractual
                Obligations**
            
            **Total**
            
            
            **1
                year**
            
            
            **2-3
                years**
            
            
            **4-5
                years**
            
            
            **years**Long-term
                debt
            
            $
            93,811
            
            
            $
            26,101
            
            
            $
            39,394
            
            
            $
            27,424
            
            
            $
            892Capital
                lease and financing obligations
            
            
            294,653
            
            
            
            37,411
            
            
            
            70,223
            
            
            
            62,504
            
            
            
            124,515Convertible
                debentures
            
            
            980
            
            
            
            653
            
            
            
            327
            
            
            
            -
            
            
            
            -$
            389,444
            
            
            $
            64,165
            
            
            $
            109,944
            
            
            $
            89,928
            
            
            $
            125,407








**Recent
      Accounting Pronouncements**





In
      June
      2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation
      No. 48 (FIN 48), *Accounting for Uncertainty in Income Taxes*, an
      Interpretation of Statement of Financial Accounting Standards (SFAS) No. 109,
      *Accounting for Income Taxes*.  FIN 48 clarifies the accounting
      for income taxes by prescribing the recognition threshold a tax position is
      required to meet before being recognized in the financial
      statements.  It also provides guidance on de-recognition, measurement,
      classification, interest and penalties, accounting in interim periods,
      disclosure and transition.  The Interpretation requires that we
      recognize in the financial statements the impact of a tax position only if
      that
      position is more likely than not of being sustained upon examination, based
      on
      the technical merits of the position.  FIN 48 is effective for fiscal
      years beginning after December 15, 2006. Differences between the amounts
      recognized in the statements of financial position prior to the adoption of
      FIN
      48 and the amounts reported after adoption should be accounted for as a
      cumulative-effect adjustment recorded to the beginning balance of retained
      earnings.  We adopted FIN 48 effective January 1, 2007.  The
      adoption of this statement did not have any significant effect on our financial
      condition, results of operations, or cash flows.





In
      February 2007, the FASB issued Statement of Financial Accounting Standards
      (SFAS) 159, *The Fair Value Option for Financial Assets and Financial
      Liabilities*.  SFAS 159 permits entities to choose to measure
      financial assets and liabilities (except for those that are specifically
      excepted from the Statement) at fair value.  The election to measure a
      financial asset or liability at fair value can be made on an
      instrument-by-instrument basis and is irrevocable.  The difference
      between carrying value and fair value at the election date is recorded as a
      transition adjustment to opening retained earnings.  Subsequent
      changes in fair value are recognized in earnings.  The effective date
      for SFAS 159 is as of the beginning of an entity's first fiscal year that begins
      after November 15, 2007.  We are evaluating SFAS 159 and have not yet
      determined the impact the adoption will have on our consolidated financial
      statements, but it is not expected to be significant.





**32**
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              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





**Impact
      of Inflation**





To
      date,
      inflation has not had a significant impact on us.  However, inflation
      could affect our future revenues and operating income due to our dependence
      on
      the senior resident population, most of whom rely on relatively fixed incomes
      to
      pay for our services.  The monthly charges for a resident’s unit and
      assisted living services are influenced by the location of the community and
      local competition.  Our ability to increase revenues in proportion to
      increased operating expenses may be limited.  To the extent we rely
      upon governmental reimbursement programs, we have a limited ability to increase
      rates.  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.





**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, as set forth below:





Definition
      of Adjusted EBITDA:





We
      define
      Adjusted EBITDA as  net loss to common shareholders
      before:








·
            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 or
                investments,


·
            depreciation
                and amortization,


·
            impairment
                losses,


·
            amortization
                of deferred gains,


·
            non-cash
                stock option compensation expense,


·
            interest
                expense,


·
            interest
                income, and


·
            other
                non-cash unusual adjustments





Management's
      Use of Adjusted EBITDA:





We
      use
      Adjusted EBITDA to assess our overall financial and operating
      performance.  We believe this non-GAAP measure, as we have defined it,
      is useful in identifying trends in our day-to-day performance because it
      excludes items that have little or no significance on our day-to-day
      operations.  This measure provides an assessment of controllable
      expenses and affords management the ability to make decisions, which are
      expected to facilitate meeting current financial goals, as well as achieve
      optimal financial performance.  It provides an indicator for
      management to determine if adjustments to current spending levels are
      needed.





Adjusted
      EBITDA provides us with a measure of financial performance, independent of
      items
      that are beyond the control of management in the short-term, such as
      depreciation and amortization, taxation, and interest expense associated with
      our capital structure.  This metric measures 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 is one of the metrics used by senior management to review the financial
      performance of the business on a monthly basis and is used by research analysts
      and investors to evaluate the performance and value of the companies in our
      industry.





**33**
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              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**




Limitations
      of Adjusted EBITDA:





Adjusted
      EBITDA has limitations as an analytical tool.  It should not be viewed
      in isolation or as a substitute for GAAP measures of
      earnings.  Material limitations in making the adjustments to our
      earnings (losses) to calculate Adjusted EBITDA and using this non-GAAP financial
      measure as compared to GAAP net loss includes:





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


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


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





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





Adjusted
      EBITDA is not an alternative to net loss, income 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 as a substitute for any such GAAP financial measure.  We
      strongly urge you to review the reconciliation of GAAP net loss to Adjusted
      EBITDA presented below, along with our consolidated balance sheets, statements
      of operations, and cash flows.  In addition, because Adjusted EBITDA
      is not a measure of financial performance under GAAP and is susceptible to
      varying calculations, this measure as presented may differ from and may not
      be
      comparable to similarly titled measures used by other companies.





The
        table
        below shows the reconciliation of net loss to Adjusted EBITDA for the three
        and
        six months ended June 30, 2007 and 2006:
 **Three
                  Months ended June 30,**
              
              
              **Six
                  Months ended June 30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006****Net
                  loss**
              
              $
              (1,589
              )
              
              $
              (7,615
              )
              
              $
              (11,324
              )
              
              $
              (2,888
              )Provision
                  for income taxes
              
              
              1,044
              
              
              
              (100
              )
              
              
              1,320
              
              
              
              (90
              )Equity
                  losses (gains) in unconsolidated joint ventures
              
              
              (7,065
              )
              
              
              396
              
              
              
              (6,496
              )
              
              
              492Depreciation
                  and amortization
              
              
              14,606
              
              
              
              12,251
              
              
              
              29,195
              
              
              
              24,401Amortization
                  of deferred gains
              
              
              (549
              )
              
              
              (553
              )
              
              
              (1,103
              )
              
              
              (1,107
              )Non-cash
                  stock option compensation expenses
              
              
              786
              
              
              
              87
              
              
              
              1,323
              
              
              
              222Convertible
                  debentures conversion costs
              
              
              –
              
              
              
              –
              
              
              
              1,329
              
              
              
              –Interest
                  expense
              
              
              16,945
              
              
              
              12,475
              
              
              
              30,560
              
              
              
              24,206Interest
                  income
              
              
              (601
              )
              
              
              (681
              )
              
              
              (1,192
              )
              
              
              (1,552
              )Other
                  non-cash unusual activity:Reversal
                  of Texas settlement accrued in 2004
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (12,207
              )**Adjusted
                  EBITDA**
              
              $
              23,577
              
              
              $
              16,260
              
              
              $
              43,612
              
              
              $
              31,477


**Pending
      Acquisitions**





On
      June 8, 2007, we entered into a definitive agreement to acquire, for an
      aggregate purchase price of $88 million (excluding closing costs), a total
      of nine communities, consisting of 711 units located in the State of New
      York, that we currently lease.  On June 14, 2007, we entered into
      definitive agreements to acquire, for an aggregate purchase price of
      $24.5 million (excluding closing costs), a total of three communities,
      consisting of 431 units in the State of Florida, that we currently
      lease.  On June 14, 2007, we entered into a definitive agreement
      to acquire, for an aggregate purchase price of $482.5 million (excluding
      closing costs), a total of 40 communities, consisting of





**34**
 **MANAGEMENT’S
              DISCUSSION AND ANALYSIS OF FINANCIAL
              CONDITION**
 **AND
              RESULTS OF OPERATIONS -
              CONTINUED**


**Table
        of Contents**





3,643 units
      located in 19 states.  Of these communities, we currently lease
      32 communities and Summerville currently leases 8 communities.  We
      intend to complete these transactions in the third quarter of 2007 since we
      have
      now completed the public offering discussed in the paragraph below, using
      approximately $181.4 million of the net proceeds from this offering to pay
      a portion of the aggregate purchase price for these communities.  We
      intend to finance the remaining $413.7 million of the aggregate purchase
      price for these communities through secured borrowings.  We have not
      yet entered into definitive agreements for these secured borrowings and cannot
      assure the terms of such borrowings.





**Subsequent
      Events**





On
      July
      3, 2007, we closed the public offering of 11,000,000 shares of common stock,
      of
      which 10,500,000 shares were sold by us and 500,000 shares were sold by certain
      selling shareholders.  We received net proceeds of approximately
      $305.3 million after closing costs.  The proceeds from the offering
      will be used to retire approximately $82.3 million in long-term debt and to
      pay
      $181.4 million of the purchase price of approximately $595.1 million (excluding
      closing costs) for the acquisition of 52 properties discussed in the previous
      paragraph.  The balance of $41.6 million will be used to finance
      facility development, facility acquisitions and capital expenditures, and also
      for other general corporate purposes.





On
      July
      27, 2007, we received notice from the underwriters of the public offering
      discussed in the previous paragraph that they have elected to exercise the
      over-allotment option specified in the Underwriting Agreement to purchase
      800,800 additional shares of common stock from us.  The closing date
      of the purchase was August 2, 2007, and we received net proceeds of $23.4
      million after closing costs.





On
      August
      6, 2007, we closed on the acquisition of the three Florida communities mentioned
      above under “Pending Acquisitions.”  The final purchase price was
      $24.5 million, excluding closing costs.  We had leased these
      communities from Health Care REIT, Inc. and affiliates under two different
      master leases dated September 30, 2003, and September 30, 2004.  The
      leases have been accounted for as capital leases.  The annual base
      rent for the three communities was approximately $2.5 million as of the closing
      date.  As a result of this asset purchase transaction, the master
      leases were modified to remove the communities from these
      leases.  Upon termination of the capital lease for the three
      communities, the difference between the carrying amount of the leased assets
      and
      the lease obligation will be recorded as an adjustment to the carrying amount
      of
      the assets purchased, which represents a reduction of approximately $3.2 million
      to the cost basis of the purchased assets.  An affiliate of General
      Electric Capital Corporation (“GECC”) provided variable rate mortgage financing
      of approximately $19.6 million pursuant to a Credit Agreement dated August
      6, 2007, by and between affiiliates of  Emeritus Corporation and
      GECC.  The variable rate mortgage has a term of five years with
      interest at 30-day LIBOR plus 1.5%, which was 6.83% at
      closing.  Monthly interest-only payments are due for the first three
      years and thereafter, monthly payments of principal and interest will be based
      on a 25-year amortization schedule.  The balance on the loan is due in
      full in August 2012.  The indebtedness outstanding under the GECC loan
      may be accelerated under customary circumstances, including payment defaults,
      and is secured by all real, personal, and intangible assets used in the
      operation of the three communities.








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      rest
      of this page is intentionally left blank.]











**35**


**Table
        of Contents**





**Item
      3.  Quantitative and Qualitative Disclosures About
      Market Risk**





Our
      earnings are affected by changes in interest rates as a result of our short-term
      and long-term borrowings.  At June 30, 2007, we had approximately
      $45.1 million of variable rate borrowings based on the LIBOR rate.  As
      of June 30, 2007, our weighted average variable rate is 2.81% in excess of
      the
      LIBOR rate.  For every 1% change in the LIBOR rate, our interest
      expense will change by approximately $451,000 annually.  In July 2007,
      $21.6 million of variable rate debt was paid off.  This analysis does
      not consider changes in the actual level of borrowings or operating lease
      obligations that may occur subsequent to June 30, 2007.  This analysis
      also does not consider the effects of the reduced level of overall economic
      activity that could exist in such an environment, nor does it consider actions
      that management might be able to take with respect to our financial structure
      to
      mitigate the exposure to such a change.





**Item
      4.  Controls and
      Procedures**





(a)  *Evaluation
      of disclosure controls and procedures.*





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





*(b)*
            *Changes
                in internal controls*





We
      also
      carried out an evaluation of the internal control over financial reporting
      to
      determine whether any changes occurred during the period covered by this
      report.  Based on such evaluation, there has been no change in our
      internal control over financial reporting that occurred during the most recently
      completed fiscal quarter ended June 30, 2007, that materially affected, or
      is
      reasonably likely to materially affect, our internal control over financial
      reporting.











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      rest
      of this page is intentionally left blank]





**36**


**Table
        of Contents**


**PART
      II.  OTHER INFORMATION**





**Items
      2, 3, and 4 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,
      except as noted below, we do not believe that any liability from any such
      lawsuits or other matters will have a material effect on our financial position,
      results of operations, or liquidity.





In
      February 2005, a San Antonio, Texas, jury found one of our assisted living
      communities negligent in the care of a resident.  The jury awarded a
      verdict against us in the amount of $1.5 million in compensatory damages and
      $18.0 million in punitive damages.  We appealed the verdict but
      recorded a liability accrual of $18.7 million in the fourth quarter of 2004
      and
      accrued interest of $766,000 on the unpaid judgment at the rate of 5% per annum
      during 2005.  In March 2006, we settled the action for $5.6
      million.  In the first quarter of 2006, we reduced the accrued
      interest by $766,000 and the liability accrual recorded in 2004 by $12.2
      million.





In
      March
      2006, the Texas attorney general’s office began an inquiry into compliance with
      certain Medicaid regulations at six of our communities in Texas that participate
      in the Community Based Alternative program of the Texas Department of Aging
      and
      Disability.  Participation in the program requires eligible rooms to
      have an area equipped with a sink, refrigerator, cooking appliance, adequate
      space for food preparation, and storage space for utensils and
      supplies.  An audit by the department revealed that some of the rooms
      used for residents in the program did not have some or all of those
      items.  We addressed the State's concerns raised in the audits and all
      rooms were equipped with the above regulatory requirements as of April
      2006.





The
      attorney general’s office originally sought $6.6 million related to the
      compliance issue, which equates to three times the total amount of all payments
      made to us by the State of Texas since the inception of our Medicaid contract,
      plus interest and attorney fees.  We took the position with the State
      that all services for which Medicaid lawfully paid us were provided to the
      program residents despite the absence of some of the kitchen items and
      therefore, recovery of the total of all payments made to us was
      unjustified.  As a result of continuing settlement discussions with
      the attorney general’s office, there is a tentative agreement to settle the
      claim for approximately $1.9 million.





We
      recorded a liability of $1.9 million in 2006, as our best estimate of the
      ultimate outcome based on this tentative agreement.  We will assess
      our liability as final agreements are negotiated and will make adjustments,
      if
      any, to our recorded liability as more information becomes available to
      us.





**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, 2006, which could materially
      affect our business, financial condition or future results. The risks described
      in our Annual Report on Form 10-K are not the only risks facing our
      Company.  Additional risks and uncertainties not currently known to us
      or that we currently deem to be immaterial also may materially adversely affect
      our business, financial condition and/or operating results.





**Item
      5. Other Information**





On
      August
      6, 2007, we closed on the acquisition of the three Florida communities mentioned
      above under “Pending Acquisitions.”  The final purchase price was
      $24.5 million, excluding closing costs.  We had leased these
      communities from Health Care REIT, Inc. and affiliates under two different
      master leases dated September 30, 2003, and September 30, 2004.  The
      leases have been accounted for as capital leases.  The annual base
      rent for the three communities was approximately $2.5 million as of the closing
      date.  As a result of this asset purchase transaction, the master
      leases were modified to remove the communities from these
      leases.  Upon termination of the





**37**


**Table
        of Contents**





capital
      lease for the three communities, the difference between the carrying amount
      of
      the leased assets and the lease obligation will be recorded as an adjustment
      to
      the carrying amount of the assets purchased, which represents a reduction of
      approximately $3.2 million to the cost basis of the purchased
      assets.  An affiliate of General Electric Capital Corporation (“GECC”)
      provided variable rate mortgage financing of approximately $19.6 million
      pursuant to a Credit Agreement dated August 6, 2007, by and between affiiliates
      of Emeritus Corporation and GECC.  The variable rate mortgage has a
      term of five years with interest at 30-day LIBOR plus 1.5%, which was 6.83%
      at
      closing.  Monthly interest-only payments are due for the first three
      years and thereafter, monthly payments of principal and interest will be based
      on a 25-year amortization schedule.  The balance on the loan is due in
      full in August 2012.  The indebtedness outstanding under the GECC loan
      may be accelerated under customary circumstances, including payment defaults,
      and is secured by all real, personal, and intangible assets used in the
      operation of the three communities.





**Item
      6.  Exhibits**





See
                Index to Exhibits, which is incorporated by
                reference.








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      rest
      of this page is intentionally left blank.]











**38**


**Table
        of Contents**








**SIGNATURE**





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








Dated:  August
                9, 2007
            EMERITUS
                CORPORATION(Registrant)/s/
                Raymond R. BrandstromRaymond
                R. Brandstrom, Vice President of Finance,Chief
                Financial Officer, and Secretary





**39**


**Table
        of Contents**


**Index
      to Exhibits**


**Footnote****Number**
              
              **Description**
              
              **Number****10.12**
              
              **Purchase
                  of 12 communities consisting of 786 units in five states from Healthcare
                  Realty Trust (HRT)**10.12.1
              Agreement
                  of Sale and Purchase entered into by Sellers HR Acquisition I Corporation,
                  HR Acquisition forPennsylvania,
                  Inc., HR Acquisition of San Antonio LTD., Healthcare Acquisition
                  of Texas,
                  Inc. HRTand
                  Emeritus Corporation Holdings, Inc., and Healthcare Reality Trust
                  Incorporated
              
              (2)10.12.2
              Loan
                  Agreement by and among 12 Delaware limited liability companies
                  or limited
                  partnerships listed onSchedule
                  A together with their respective successors (borrowers) and Capmark
                  Bank
                  (lender) for $88.0 million
              (2)10.12.3
              Loan
                  Agreement by and among 12 Delaware limited liability companies
                  or limited
                  partnerships listed onSchedule
                  A together with their respective successors (borrowers) and Capmark
                  Bank
                  (lender) for $13.6 million
              (2)10.12.4
              Promissory
                  Note for $88,000,000;the undersigned limited liability companies
                  and
                  limited partnerships(borrower)
                  promises to pay to Capmark Bank (Lender) principal amount
              
              (2)10.12.5
              Promissory
                  Note for $13,600,000;the undersigned limited liability companies
                  and
                  limited partnerships(borrower)
                  promises to pay to Capmark Bank (Lender) principal amount
              
              (2)10.12.6
              Assisgnment
                  and Assumption of Loan and Loan Documents by and between Healthcare
                  Reality TrustIncorporated
                  and Columbia Pacific Opportunity Fund, LP
              
              (2)**10.14**
              
              **Purchase
                  of 3 communities consisting of 453 units located in South Carolina
                  from
                  Health Care Property****Investors,
                  Inc. (HCPI)**10.14.1
              Purchase
                  and Sale Agreement and Joint Escrow Instructions by and Between
                  HCPI Trust
                  "Seller" andEmeritus
                  Corporation "Buyer"
              
              (2)10.14.2
              Loan
                  Agreement by and among Emeri-Sky SC LLC, Emerivell SC LLC, and
                  Emeripark
                  SC LLC "Borrowers"and
                  CAPMARK BANK
              
              (2)10.14.3
              Promissory
                  Note $13.12 million Emeri-Sky (Skylyn) promises to pay to the order
                  of
                  CAPMARK BANK
              
              (2)10.14.4
              Promissory
                  Note $6.0 million Emerivill SC LLC (Village) promises to pay to
                  the order
                  of CAPMARK BANK
              (2)10.14.5
              Promissory
                  Note $4.48 million Emeripark SC LLC (Park) promises to pay to the
                  order of
                  CAPMARK BANK
              (2)**10.15**
              
              **Executive
                  Separation Agreements**10.15.1
              Frank
                  Ruffo
              
              (2)10.15.2
              Gary
                  Becker
              
              (2)**10.5**
              
              **Agreement
                  and Plan of Merger dated as of March 29, 2007, by and among Emeritus
                  Corporation,****Boston
                  Project Acquisition Corp., Summerville Senior Living, Inc. AP Summerville,
                  LLC,****AP
                  Summerville II, LLC, Daniel R. Baty, and Saratoga Partners IV,
                  L.P.**
              
              (1)**10.6**
              
              **Amended
                  and Restated Shareholders Agreement dated as of March 29, 2007,
                  by and
                  among****Emeritus
                  Corporation, AP Summerville, LLC, AP Summerville II, LLC, Apollo
                  Real
                  Estate****Investment
                  Fund III, L.P., Apollo Real Estate Investment Fund IV, L.P., Daniel
                  R.
                  Baty,****Catalina
                  General Partnership, L.P., Columbia Select, L.P., B.F., Limited
                  Partnership, Saratoga****Partners
                  IV, L.P., Saratoga Coinvestment Company, LLC and Saratoga Management
                  Company, LLC.**
              
              (1)**10.68**
              
              10.68.29
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
              
              (2)10.68.30
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Roanoke
              
              (2)10.68.31
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Ravenna
              
              (2)10.68.32
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Harrisburg
              
              (2)10.68.33
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Danville
              
              (2)10.68.34
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Harrisonburg
              
              (2)
   **40**
 **Table
          of Contents**
  **Footnote****Number**
              
              **Description**
              
              **Number**
 10.68.35
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Mechanicsburg
              
              (2)10.68.36
              Lease
                  Termination Agreement by and among HR Acquisition I Corporation,
                  HR
                  Acquisition ofPennsylvania,
                  Inc., and HRT Holdings, Inc. and Emeritus Corporation
                  Bloomsburg
              
              (2)10.68.37
              Lease
                  Termination Agreement by HR Acquisition of San Antonio, LTD, and
                  ESC IV,
                  LPKingsley
                  Place Oakwell
              
              (2)10.68.38
              Lease
                  Termination Agreement by HR Acquisition of San Antonio, LTD, and
                  ESC IV,
                  LPKingsley
                  Place Oakwell Medical Center
              
              (2)10.68.39
              Lease
                  Termination Agreement by HR Acquisition of San Antonio, LTD, and
                  ESC IV,
                  LPKingsley
                  Place McKinney
              
              (2)10.68.40
              Lease
                  Termination Agreement by HR Acquisition of San Antonio, LTD, and
                  ESC IV,
                  LPKingsley
                  Place Henderson
              
              (2)**10.7**
              
              **Registration
                  Rights Agreement dated as of March 29, 2007, by and among Emeritus
                  Corporation,****AP
                  Summerville, LLC, AP Summerville II, LLC, Apollo Real Estate Investment
                  Fund III, L.P.,****Apollo
                  Real Estate Investment Fund IV, L.P., Daniel R. Baty, Catalina
                  General
                  Partnership, L.P.,****Columbia
                  Select, L.P., B.F., Limited Partnership, Saratoga Partners IV,
                  L.P.,
                  Saratoga Coinvestment****Company,
                  LLC, Saratoga Management Company, LLC and Granger
                  Cobb.**
              
              (1)**10.82**
              
              10.82.5
              Sixth
                  Amendment to Amended and Restated Master Lease is among Health
                  Care
                  Property Investors, Inc.HCPI
                  Trust, Emeritus Realty V, LLC, ESC-LA Casa Grande, LLC, and Texas
                  HCP
                  Holding, LP and togetherwith
                  HCP, HCP Trust, ER-V and La Casa Gande "Lessor on the one hand,
                  and
                  Emeritus CorporationESC
                  III, LP, Emeritus Properties II Inc., Emeritus Properties III,
                  Inc.,
                  Emeritus Properties V, IncEmeritus
                  Properties XIV, LLC, ESC-Bozeman, LLC, ESC-New Port Richey, LLC
                  "Lessee"on
                  the other hand
              
              (2)31.1
              
              
              Certification
                  of Periodic Reports31.1.1
              Certification
                  Pursuant to 18 U.S.C. Section 1350, as
                  Adopted Pursuant to Section 302of
                  the Sarbanes-Oxley Act of 2002 for Daniel R. Baty
                  dated August 8, 2007.
              
              (3)31.1.2
              Certification
                  Pursuant to 18 U.S.C. Section 1350, as
                  Adopted Pursuant to Section 302of
                  the Sarbanes-Oxley Act of 2002 for Raymond R.
                  Brandstrom dated August 8, 2007.
              
              (3)32.1
              
              
              Certification
                  of Periodic Reports32.1.1
              Certification
                  Pursuant to 18 U.S.C. Section 1350, as
                  Adopted Pursuant to Section 906of
                  the Sarbanes-Oxley Act of 2002 for Daniel R. Baty
                  dated August 8, 2007.
              
              (3)32.1.2
              Certification
                  Pursuant to 18 U.S.C. Section 1350, as
                  Adopted Pursuant to Section 906of
                  the Sarbanes-Oxley Act of 2002 for Raymond R.
                  Brandstrom dated August 8, 2007.
              
              (3)


**Footnotes:**(1)
            Incorporated
                by reference to the indicated exhibit filed with the Company’s Form 8-K
                (File No. 1-14012)on
                April 2, 2007.(2)
            Incorporated
                by reference to the indicated exhibit filed with the Company's First
                Quarter Report on Form 10-Q(File
                No. 1-14012) on May 10, 2007.(3)
            Filed
                herewith.








**41**