Attached files

file filename
EX-31.1.1 - EX-31.1.1 SECTION 302 CERT BATY - EMERITUS CORP\WA\ex3111sectn302certbaty.htm
EX-31.1.2 - EX-31.1.2 SECTION 302 CERT COBB - EMERITUS CORP\WA\ex3112sectn302certcobb.htm
EX-32.1.2 - EX-32.1.2 SECTION 906 CERT COBB - EMERITUS CORP\WA\ex3212sectn906certcobb.htm
EX-32.1.1 - EX-32.1.1 SECTION 906 CERT BATY - EMERITUS CORP\WA\ex3211sectn906certbaty.htm
EX-31.1.3 - EX-31.1.3 SECTION 302 CERT BATEMAN - EMERITUS CORP\WA\ex3113sectn302certbateman.htm
EX-10.8.1 - EX-10.8.1 OFFICE LEASE RENEWAL SEATTLE 062910 - EMERITUS CORP\WA\ex1081officeleasesea062910.htm
EX-10.22.5 - EX-10.22.5 AMENDMENT 1 SHAREHOLDER AGREEMENT 043010 - EMERITUS CORP\WA\ex10225amend1sharehldragrmt.htm
EX-10.9.3 - EX-10.9.3 AMENDMENT 1 EMPLOYMENT AGREEMENT RAY BRANDSTROM 62310 - EMERITUS CORP\WA\ex1093amend1employagrmtrb623.htm
EX-10.78.05 - EX-10.78.05 3RD AMENDMENT TO PSA SUNWEST 07 2010 - EMERITUS CORP\WA\ex1078053rdamendpsasw.htm
EX-32.1.3 - EX-32.1.3 SECTION 906 CERT BATEMAN - EMERITUS CORP\WA\ex3213sectn906certbateman.htm
EX-10.71.23 - EX-10.71.23 FIRST AMENDED AND RESTATED NOTE $50 MILLION 07 09 2010 - EMERITUS CORP\WA\ex1071231stamendnote50mill.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________________
FORM 10-Q
________________________________

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

For the quarterly period ended June 30, 2010

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

Commission file number   1-14012
logo
EMERITUS CORPORATION
(Exact name of registrant as specified in its charter)
WASHINGTON
91-1605464
(State or other jurisdiction
(I.R.S Employer
of incorporation or organization)
Identification No.)

3131 Elliott Avenue, Suite 500, Seattle, WA 98121
(Address of principal executive offices)

(206) 298-2909
(Registrant’s telephone number, including area code)
____________________________
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. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o           Accelerated filer þ           Non-accelerated filer o Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of August 2, 2010, there were 39,445,684 shares of the Registrant’s Common Stock, par value $0.0001, outstanding.

 
 

 
Table of Contents
       
 
   
Page No.
       
       
   
       
   
       
   
       
   
       
   
       
 
 
       
       
       
Note:
Items 2, 3, 4, and 5 of Part II have been omitted because they are not applicable.
       
     
     
       
 
 
 
     
 

 
 

 



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1

 
EMERITUS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except share data)



ASSETS
  (unaudited)        
 
June 30,
     December 31,
 
 
2010
      2009
 
Current Assets:
       
Cash and cash equivalents
$ 50,912     $ 46,070  
Short-term investments
  2,398       2,208  
Trade accounts receivable, net of allowance of $895 and $1,009
  12,746       10,861  
Other receivables
  7,426       7,251  
Tax, insurance, and maintenance escrows
  20,291       23,565  
Prepaid workers' compensation
  23,045       21,397  
Other prepaid expenses and current assets
  32,644       27,790  
          Total current assets
  149,462       139,142  
Long-term investments
  3,696       4,132  
Property and equipment, net of accumulated depreciation of $261,360 and $222,518
  1,730,105       1,716,472  
Restricted deposits
  15,121       14,349  
Lease acquisition costs, net of accumulated amortization of $2,118 and $1,889
  3,880       3,805  
Goodwill
  74,376       74,755  
Other intangible assets, net of accumulated amortization of $32,744 and $28,883
  110,325       116,418  
Other assets, net
  18,969       20,867  
          Total assets
$ 2,105,934     $ 2,089,940  
               
LIABILITIES, SHAREHOLDERS' EQUITY AND NONCONTROLLING INTEREST
 
               
Current Liabilities:
             
Current portion of long-term debt
$ 41,671     $ 21,324  
Current portion of capital lease and financing obligations
  12,705       11,144  
Trade accounts payable
  5,701       5,928  
Accrued employee compensation and benefits
  44,101       37,624  
Accrued interest
  7,773       8,013  
Accrued real estate taxes
  9,527       10,715  
Accrued professional and general liability
  9,385       8,445  
Accrued income taxes
  194       542  
Other accrued expenses
  14,336       13,491  
Deferred revenue
  12,883       10,729  
Unearned rental income
  17,479       18,669  
          Total current liabilities
  175,755       146,624  
Long-term debt obligations, less current portion
  1,342,627       1,375,088  
Capital lease and financing obligations, less current portion
  201,826       165,372  
Deferred gain on sale of communities
  6,504       7,111  
Deferred straight-line rent
  42,775       34,659  
Other long-term liabilities
  42,051       42,188  
          Total liabilities
  1,811,538       1,771,042  
Commitments and contingencies
             
Shareholders' Equity and Noncontrolling Interest:
             
Preferred stock, $.0001 par value.  Authorized 20,000,000 shares, none issued
  -       -  
Common stock, $.0001 par value.  Authorized 100,000,000 shares, issued and
             
outstanding 39,361,205 and 39,274,590 shares
  4       4  
Additional paid-in capital
  729,300       725,652  
Accumulated other comprehensive income
  788       807  
Accumulated deficit
  (442,509 )     (414,381 )
Total Emeritus Corporation shareholders' equity
  287,583       312,082  
Noncontrolling interest-related party
  6,813       6,816  
Total shareholders' equity
  294,396       318,898  
Total liabilities, shareholders' equity, and noncontrolling interest
$ 2,105,934     $ 2,089,940  
               

See accompanying Notes to Condensed Consolidated Financial Statements

 
2

 
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(In thousands, except per share data)

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues:
                       
Community revenue
  $ 237,787     $ 220,773     $ 470,660     $ 440,404  
Management fees
    1,344       1,453       2,675       2,920  
Total operating revenues
    239,131       222,226       473,335       443,324  
                                 
Expenses:
                               
Community operations (exclusive of depreciation and amortization
                               
    and community lease expense shown separately below)
    157,452       140,935       312,474       284,833  
General and administrative
    17,109       15,932       34,271       30,850  
Acquisitions and development
    309       312       351       387  
Impairments on long-lived assets
    -       36       -       1,132  
Depreciation and amortization
    20,655       17,952       41,101       39,617  
Community leases
    29,716       29,347       58,754       58,416  
Total operating expenses
    225,241       204,514       446,951       415,235  
Operating income from continuing operations
    13,890       17,712       26,384       28,089  
                                 
Other income (expense):
                               
Interest income
    131       189       243       327  
Interest expense
    (27,211 )     (26,416 )     (54,252 )     (52,608 )
Change in fair value of interest rate swaps
    42       752       (12 )     842  
Equity earnings for unconsolidated joint ventures
    302       560       451       1,184  
Other, net
    (22 )     146       456       358  
Net other expense
    (26,758 )     (24,769 )     (53,114 )     (49,897 )
                                 
Loss from continuing operations before income taxes
    (12,868 )     (7,057 )     (26,730 )     (21,808 )
Provision for income taxes
    (326 )     (270 )     (645 )     (540 )
Loss from continuing operations
    (13,194 )     (7,327 )     (27,375 )     (22,348 )
Income (loss) from discontinued operations
    (949 )     23       (1,170 )     (51 )
Net loss
    (14,143 )     (7,304 )     (28,545 )     (22,399 )
Net loss attributable to the noncontrolling interest
    226       229       417       443  
Net loss attributable to Emeritus Corporation common shareholders
  $ (13,917)     $ (7,075 )   $ (28,128)     $ (21,956 )
                                 
Basic and diluted loss per common share attributable to
                               
   Emeritus Corporation common shareholders:
                               
   Continuing operations
  $ (0.33 )   $ (0.18 )   $ (0.69 )   $ (0.56 )
   Discontinued operations
    (0.02 )     0.00       (0.03 )     (0.00 )
    $ (0.35 )   $ (0.18 )   $ (0.72 )   $ (0.56 )
                                 
Weighted average common shares outstanding; basic and diluted
    39,301       39,147       39,290       39,132  



See accompanying Notes to Condensed Consolidated Financial Statements

 
3

 
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)



   
Six Months Ended June 30,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net loss
  $ (28,545 )   $ (22,399 )
Adjustments to reconcile net loss to net cash provided by
               
operating activities:
               
Depreciation and amortization
    41,101       39,617  
Amortization of above/below market rents
    4,347       4,914  
Amortization of deferred gains
    (607 )     (148 )
Loss on sale of assets
    1,179       -  
Impairment of long-lived assets
    320       1,132  
Amortization of loan fees
    1,512       1,572  
Allowance for doubtful receivables
    2,135       1,634  
Equity investment earnings
    (451 )     (1,184 )
Stock based compensation
    2,931       2,063  
Change in fair value of interest rate swaps
    12       (842 )
Other
    (45 )     454  
Changes in operating assets and liabilities
               
Deferred straight-line rent
    7,071       9,931  
Deferred revenue
    2,505       15  
Change in other operating assets and liabilities
    4,458       (3,410 )
Net cash provided by operating activities
    37,923       33,349  
Cash flows from investing activities:
               
Acquisition of property and equipment
    (10,073 )     (16,108 )
Community acquisition
    -       (10,579 )
Sale of property and equipment
    -       2,677  
Lease and contract costs and acquisition deposits
    (4,527 )     (170 )
Payments (to) from affiliates and other managed communities, net
    (1,639 )     699  
Distributions from unconsolidated joint ventures/other
    869       1,018  
Net cash used in investing activities
    (15,370 )     (22,463 )
Cash flows from financing activities:
               
Proceeds from sale of stock and noncontrolling interest contribution
    1,132       257  
Increase in restricted deposits
    (730 )     (256 )
Debt issuance and other financing costs
    (145 )     (274 )
Proceeds from long-term borrowings and financings
    -       10,864  
Repayment of long-term borrowings and financings
    (12,114 )     (2,736 )
Repayment of capital lease and financing obligations
    (5,854 )     (4,508 )
Net cash provided by (used in) financing activities
    (17,711 )     3,347  
Net increase in cash and cash equivalents
    4,842       14,233  
Cash and cash equivalents at the beginning of the period
    46,070       27,254  
Cash and cash equivalents at the end of the period
  $ 50,912     $ 41,487  



 
4

 

EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(In thousands)

   
Six Months Ended June 30,
 
   
2010
   
2009
 
             
Supplemental disclosure of cash flow information:
           
Cash paid during the period for interest
  $ 52,936     $ 49,483  
Cash paid during the period for income taxes
    912       1,694  
Cash received during the period for income tax refunds
    10       83  
Non-cash financing and investing activities:
               
Capital lease and financing obligations
    37,666       295  
Unrealized gain (loss) on investment in marketable equity securities
    (19 )     621  
Purchase and sale-leaseback transaction:
               
Increase in property and equipment
    8,250       968  
Increase in intangible assets
    600       -  
Increase in deferred gain
    -       (5,212 )
Decrease in deferred straight-line rent
    -       129  
Financing lease obligation
    (8,850 )     4,115  
Adjustments related to purchase and sale of leased property:
               
Decrease in capital lease assets
    (2,756 )     -  
Decrease in capital lease obligations
    2,648       -  





See accompanying Notes to Condensed Consolidated Financial Statements



 
5

 
EMERITUS CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(unaudited)
(In thousands, except share data)




   
Emeritus Corporation Shareholders
             
   
Common stock
   
Additional
   
Accumulated
other
               
Total
 
   
Number
         
paid-in
   
comprehensive
   
Accumulated
   
Noncontrolling
   
shareholders'
 
   
of shares
   
Amount
   
capital
   
income
   
deficit
   
interest
   
equity (deficit)
 
Balances at December 31, 2009
    39,274,590     $ 4     $ 725,652     $ 807     $ (414,381 )   $ 6,816     $ 318,898  
Issuances of shares under Employee Stock Purchase Plan
    19,484             293                         293  
Options exercised
    67,131             424                         424  
Stock option compensation expense
                2,931                         2,931  
Capital contribution
                                  414       414  
Components of comprehensive loss:
                                                       
     Net loss
                            (28,128 )     (417 )     (28,545 )
     Unrealized gain (loss) on marketable securities
                      (19 )                 (19 )
Comprehensive loss
                                        (28,564 )
Balances at June 30, 2010
    39,361,205     $ 4     $ 729,300     $ 788     $ (442,509 )   $ 6,813     $ 294,396  



See accompanying Notes to Condensed Consolidated Financial Statements


 
6

 

EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2010

1.  
Description of Business

Emeritus Corporation (“Emeritus” or the “Company”) is an assisted living, Alzheimer’s and dementia care service provider that operates residential style communities located throughout the United States.  Through these communities, Emeritus management (“we”, “our” or “us”) provides a residential housing alternative for senior citizens who need help with the activities of daily living, with an emphasis on assisted living and personal care services.  As of June 30, 2010, the Company owned 167 communities and leased 116 communities.  These 283 communities comprise the communities included in the condensed consolidated financial statements.

We also provide management services to independent and related-party owners of assisted living communities.  As of June 30, 2010, we managed 34 communities, of which 24 are owned by joint ventures in which the Company has a financial interest.  Management agreements typically provide for fees of 5% to 6% of gross revenues.

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

2.  
Summary of Significant Accounting Policies and Use of Estimates

The preparation of condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities.  On an ongoing basis, we evaluate our estimates, including those related to resident move-in fees, bad debts, investments, intangible assets, impairment of long-lived assets and goodwill, income taxes, contingencies, self-insured retention, insurance deductibles, health insurance, inputs to the Black-Scholes option pricing model, and litigation.  We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.

We believe that certain critical accounting policies are most significant to the judgments and estimates used in the preparation of our condensed consolidated financial statements.  We record revisions to such estimates in the period in which the facts that give rise to the revision become known.  A detailed discussion of our significant accounting policies and the use of estimates is contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009, which was filed with the Securities and Exchange Commission (“SEC”) on March 15, 2010.

Basis of Presentation

The unaudited condensed consolidated financial statements reflect all adjustments that are, in our opinion, necessary to state fairly the financial position, results of operations, and cash flows of Emeritus as of June 30, 2010 and for all periods presented.  Except as otherwise disclosed in these Notes, such adjustments are of a normal, recurring nature.  The results of operations for the period ended June 30, 2010 are not necessarily indicative of the operating results that may be achieved for the full year ending December 31, 2010.  We presume that those reading this interim financial information have read or have access to the 2009 audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations that are contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009.  Therefore, we have omitted certain footnotes and other disclosures that are disclosed in the Form 10-K.

 
7

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
Reclassifications and Revisions

We recast the 2009 financial information so that the basis of presentation is consistent with that of the 2010 financial information.  Specifically, in the fourth quarter of 2009, the Company’s Board of Directors approved the sale of one community and, as a result, we reclassified the results of operations for this community as discontinued operations for all periods presented.  Additionally, during the fourth quarter of 2009, we took five communities classified as held for sale (with net assets totaling $28.9 million) off the market and reclassified them as held and used in property and equipment.  As a result, we reclassified the results of operations for these communities from discontinued operations to continuing operations for all periods presented.

3.  
Stock-Based Compensation

We have three equity incentive plans: the 2006 Equity Incentive Plan (the “2006 Plan”), the Amended and Restated Stock Option Plan for Non-employee Directors (the “Directors Plan”) and the 1995 Stock Incentive Plan (the “1995 Plan”).  Employees may also participate in our 2009 Employee Stock Purchase Plan (the “2009 ESP Plan”).  We record compensation expense based on fair value for all stock-based awards, which amounted to approximately $1.5 million and $1.1 million for the three months ended June 30, 2010 and 2009, respectively, and approximately $2.9 million and $2.1 million for the six months ended June 30, 2010 and 2009, respectively.

Stock Incentive Plans

The following table summarizes our stock option activity for the six months ended June 30, 2010:

         
Weighted-
   
Aggregate
 
         
Average
   
Intrinsic
 
         
Exercise
   
Value
 
   
Shares
   
Price
    (in thousands)  
Outstanding at beginning of period
    3,320,976     $ 16.52     $ -  
Granted
    78,500     $ 18.70     $ -  
Exercised
    (67,131 )   $ 6.32     $ 770  
Forfeited/expired
    (37,775 )   $ 13.84     $ -  
Outstanding at end of period
    3,294,570     $ 16.81     $ 10,518  
                         
Options exercisable
    1,485,562     $ 16.65     $ 6,520  
                         
Weighted-average fair value of options granted
          $ 10.67          
                         
Options exercisable in the money
    635,550             $ 6,520  
Options exercisable out of the money
    850,012             $ -  


 
8

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
 
4.  
Acquisitions and Other Significant Transactions

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

2010 HCP, Inc. Lease

In May 2010, we entered into an agreement with HCP, Inc. and Texas HCP Holdings, L.P. (together, “HCP”) for the lease of four senior living communities (collectively, the “HCP Lease”).  The communities, located in Illinois and Texas, consist of 400 assisted living units and 152 skilled nursing units.

The HCP Lease has an initial term of 10 years, commencing on June 1, 2010, with two available extension options of ten years each at our election.  We have the option to purchase the properties upon the expiration of the first extended term.  The purchase option price is calculated at the greater of (i) fair market value, as defined, or (ii) $101.2 million, plus any capital addition costs funded by HCP, increased on each lease anniversary date by the greater of (a) 2.5% or (b) the lesser of the applicable increase in the consumer price index (“CPI”) or 5.0%.

The annual minimum lease payments are fixed for the first five years of the lease term at approximately $8.5 million, $9.1 million, $9.6 million, $10.2 million, and $10.7 million for the first through fifth years, respectively, excluding any additional rent related to capital addition costs funded by HCP.  We are accounting for this lease as an operating lease.

2010 National Health Investors, Inc. Lease

In January 2010, the Company entered into an agreement to lease eight communities from National Health Investors, Inc.  The communities are comprised of 336 units.  The term of the agreement is 15 years with two five-year renewal options available.  The initial annual base rent is $3.4 million with annual scheduled increases.  We are accounting for these leases as capital leases and therefore recorded a capital lease asset and obligation in the aggregate amount of $37.5 million.  We accrue interest on the capital lease obligation at an annualized rate of 7.1%.

2010 Eastover Lease

In February 2010, we purchased an 88-unit assisted living community located in North Carolina and simultaneously entered into a sale-leaseback agreement.  The lease expires in November 2018 and there are two ten-year renewal options available.  The initial annual base rent is approximately $793,000 with annual scheduled increases.  We are accounting for this lease as a financing lease and recorded property and equipment for $8.3 million, a resident contact intangible asset of $600,000 and a financing lease obligation of $8.9 million.  We expensed transaction costs of approximately $181,000.

2009 Trace Point Acquisition

In October 2009, we purchased Trace Pointe, a 100-unit assisted living and memory care community that we previously managed for an affiliate of Daniel R. Baty, the Company’s Chairman and Co-Chief Executive Officer.  The purchase price was $15.8 million, of which we financed $12.1 million with mortgage debt and $2.0 million with an unsecured note payable to an affiliate of Mr. Baty, with the balance paid in cash.
 
2009 Courtyard at Merced Acquisition

In October 2009, we purchased Courtyard at Merced, an 83-unit assisted living and memory care community from Ventas Realty, LP (“Ventas”) that we previously operated under a management contract.  The purchase price was $6.3 million and was financed with a three-year first mortgage note from Ventas for $5.0 million, with the balance paid in cash.



 
9

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
2009 College Park Acquisition

In June 2009, we purchased College Park, an 85-unit assisted living community that we previously managed for an affiliate of Mr. Baty.  The purchase price was $10.6 million, of which $7.8 million was financed with mortgage debt and $1.2 million was financed with an unsecured note payable to an affiliate of Mr. Baty with the balance of the purchase price paid in cash.

2009 Northdale Lease Agreement

In January 2009, we entered into an agreement to lease an 84-unit assisted living community.  The lease term is ten years with two ten-year renewal options available.  The initial annual minimum rent is approximately $600,000 (less abatements in the first year of $300,000) with fixed annual increases of 3.0%.  We are accounting for this lease as an operating lease.

2009 New Development

In January 2009, we opened a newly constructed community in Urbandale, Iowa.  This 38-unit memory care community had a development cost of $6.6 million and was funded by $5.5 million of short-term construction debt due in July 2010.  We repaid this debt in full as of June 30, 2010.

Sale-Leaseback

In 2003, we sold four communities to Health Care REIT, Inc. (“HCN”) and leased them back.  The sale did not qualify for sale-leaseback accounting because of the Company’s continuing involvement in the form of a guarantee of the underlying mortgage debt, which was assumed by HCN in the sale.  Therefore, we recorded the sale proceeds of $34.6 million as a financing lease obligation and continued to report the real estate and equipment as owned assets.
 
HCN paid the mortgage obligations in June 2009 and the Company’s guarantee terminated.  Therefore, we recorded the sale and we now account for each of the four leases as capital leases.  As a result, in June 2009, we recorded a net increase in property and equipment of $968,000, a net decrease in capital lease and financing obligations of $4.1 million, an increase in deferred gains of $5.2 million and a decrease in deferred rent of $129,000.

5.  
Long-Term Debt

Revolving Line of Credit

The Company is party to a credit agreement with Wells Fargo Bank, N.A. (“Wells Fargo”), which provides a $25.0 million unsecured revolving line of credit.  The line of credit matured on June 30, 2010 and was renewed to June 30, 2011.  The line of credit allows the Company to obtain letters of credit from the lender, if the undrawn amount of any outstanding letters of credit (and any borrowings outstanding under the credit agreement) does not exceed $25.0 million.  The interest rate on the line of credit is our choice of either (a) a fluctuating rate equal to the daily one-month London Interbank Offered Rate (“LIBOR”) plus 2.50% or (b) a fixed rate for a 30-day term equal to the one-month LIBOR plus 2.25%, payable monthly.  We pay a commitment fee of 0.25% on the average daily unused amount of the line of credit, payable quarterly.  In addition, Wells Fargo requires the Company to pay fees equal to 1.0% of the face amount of every letter of credit issued as well as the negotiation fees on each letter.  We must maintain a zero balance on advances for 30 consecutive days during each fiscal year and a fixed charge coverage ratio of 1.1 to 1.0.  In addition, effective July 1, 2010, we must maintain liquid assets (cash, cash equivalents and/or publicly traded marketable securities) with an aggregate fair value of at least $10.0 million in excess of the outstanding balance at any time under the line of credit.  There were no outstanding borrowings under the line of credit at June 30, 2010.

Debt Covenants

The Company’s lease and loan agreements generally include customary provisions related to: (i) restrictions on cash dividends, investments, and borrowings; (ii) cash held in escrow for real estate taxes, insurance and building
 
 
10

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
maintenance; (iii) financial reporting requirements; and (iv) events of default.  Certain loan agreements require the maintenance of debt service coverage or other financial ratios and specify minimum required annual capital expenditures at the related communities.  Many of the Company’s lease and debt instruments contain “cross-default” provisions pursuant to which a default under one obligation can cause a default under one or more other obligations to the same lender or property owner.  Such cross-default provisions affect the majority of the Company’s properties.  Accordingly, an event of default could cause a material adverse effect on the Company’s financial condition if such debts/leases are cross-defaulted.  As of June 30, 2010, the Company was in violation of quarterly financial covenants on two mortgage loans with one lender.  The loans have a combined outstanding principal balance of $9.9 million.  We have obtained a waiver for each of the two loans from the lender for the quarter ended June 30, 2010 and, as such, the Company was not in default as of June 30, 2010.

6.  
Derivative Instruments

In the normal course of business, the Company’s financial results are exposed to the effect of interest rate changes, so we may limit these risks by following risk management policies and procedures, including the use of derivatives.  To address exposure to interest rates, we primarily use interest rate swap agreements to fix the rate on debt based on floating-rate indices and to manage the cost of borrowing obligations.

As of June 30, 2010, Emeritus was a party to an interest rate swap with a notional amount of $19.6 million.  The swap effectively converts the interest rate on the related mortgage debt from a floating rate to fixed rate, thus mitigating the impact of interest rate changes on future interest expense.  A second interest rate swap to which Emeritus was a party, with a notional amount of $12.4 million, expired on January 1, 2010.

Hedges that we report at fair value and present on the balance sheet could be characterized as either cash flow hedges or fair value hedges.  We consider the Company’s interest rate swaps to be cash flow hedges as they address the risk associated with future cash flows of debt transactions.  We did not designate the interest rate swaps as hedging instruments; therefore, we recognize the gain or loss resulting from the change in the estimated fair value of the swaps in current earnings during the period of change.

As of June 30, 2010 and December 31, 2009, the fair value of the interest rate swaps was as follows (in thousands):

     
As of
   
As of
 
     
June 30, 2010
   
December 31, 2009
 
 
Balance Sheet
 
Fair
   
Fair
 
 
Location
 
Value
   
Value
 
Interest rate swaps
Other long-term liabilities
  $ 1,446     $ 1,434  

7.  
Loss Per Share

We compute basic net loss per share based on weighted average shares outstanding and exclude any potential dilution.  We reported a consolidated net loss in each of the periods presented.  As a result, we have excluded shares issuable upon the exercise of stock options from the computation as their effect was antidilutive.  Stock options excluded in each period were as follows (in thousands):

 
 Three Months Ended
 
 Six Months Ended
 
 June 30,
 
 June, 30,
 
2010
 
2009
 
2010
 
2009
Options
         3,295
 
         2,634
 
         3,295
 
         2,634


 
11

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
8.  
Comprehensive Loss

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

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net loss
  $ (14,143 )   $ (7,304 )   $ (28,545 )   $ (22,399 )
Other comprehensive income (loss):
                               
Unrealized holding gains (losses) on
                               
available-for-sale investment securities
    (115 )     835       (19 )     621  
Comprehensive loss
  $ (14,258 )   $ (6,469 )   $ (28,564 )   $ (21,778 )

The following table sets forth amounts attributable to Emeritus Corporation common shareholders, excluding losses attributable to the noncontrolling interest (in thousands):
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Loss from continuing operations
  $ (12,968 )   $ (7,098 )   $ (26,958 )   $ (21,905 )
Income (loss) from discontinued operations
    (949 )     23       (1,170 )     (51 )
Net loss attributable to Emeritus Corporation common shareholders
  $ (13,917 )   $ (7,075 )   $ (28,128 )   $ (21,956 )

9.  
Discontinued Operations

Discontinued operations consist of one community sold in January 2010, one community sold in June 2010, and one community sold in January 2009.  Revenues and expenses related to these communities were not material to the condensed consolidated statements of operations for the three and six months ended June 30, 2010 and 2009.  Loss from discontinued operations for the three and six months ended June 30, 2010 amounting to $949,000 and $1.2 million, respectively, represents the losses recorded on the sale of the communities.

10.  
Liquidity

As of June 30, 2010, the Company has a working capital deficit of $26.3 million.  The Company is able to operate in the position of a working capital deficit because we often convert our revenues to cash more quickly than we are required to pay the corresponding obligations incurred to generate those revenues.  This can result in a low level of current assets to the extent we have used cash for business development expenses or to pay down long-term liabilities.  Additionally, the working capital deficit includes the following non-cash items: a $17.8 million deferred tax asset and, as part of current liabilities, $30.4 million of deferred revenue and unearned rental income.  We do not expect the level of current liabilities to change from period to period in such a way as to require the use of significant cash in excess of normal requirements, except for maturities of long-term debt of $77.8 million in 2011, of which $22.8 million is included in current portion of long-term debt at June 30, 2010.

In the six months ended June 30, 2010 and 2009, the Company reported net cash provided by operating activities of $37.9 million and $33.3 million, respectively, in its condensed consolidated statements of cash flows.  However, the cash flows have not always been sufficient to pay all of the Company’s long-term obligations and we have been dependent upon third-party financing or disposition of assets to fund operations.  We cannot guarantee that, if necessary in the future, such transactions will be available on a timely basis or at all, or on terms attractive to us.
 
In 2009 and 2008, we refinanced and extended the terms of a substantial amount of the Company’s existing debt obligations, extending the maturities of such financings to dates in 2011 through 2019.  Debt maturing in 2011 amounts to $77.8 million, and will be repaid or refinanced.  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
 
 
12

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
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.  As of June 30, 2010, the Company was in violation of quarterly financial covenants on two mortgage loans with one lender.  The loans have a combined outstanding principal balance of $9.9 million.  We have obtained a waiver for each of the two loans from the lender for the quarter ending June 30, 2010 and, as such, the Company was not in default as of June 30, 2010.

We believe the Company will be able to generate sufficient cash flows to support its operating activities and will have adequate sources of cash for all necessary investing and financing activities, including required debt service and capital expenditures, for at least the next twelve months.

11.  
Fair Value Disclosures

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2010, and indicates the fair value hierarchy of the valuation techniques we have utilized to determine such fair value (in thousands):

   
Quoted Prices in
   
Significant
             
   
Active Markets
   
Other
   
Significant
   
Balance at
 
   
for Identical
   
Observable
   
Unobservable
   
June 30,
 
   
Assets (Level 1)
   
Inputs (Level 2)
   
Inputs (Level 3)
   
2010
 
Assets
                       
Investment securities – trading
  $ 2,398     $ -     $ -     $ 2,398  
Investment securities – available-for-sale
    2,023       -       -       2,023  
Liabilities
                               
Interest rate swap agreements
    -       1,446       -       1,446  

In general, fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities that we have the ability to access.
 
Fair values determined by Level 2 inputs utilize inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly.  Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability.

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

The Company has financial instruments other than investment securities consisting of cash and cash equivalents, trade accounts receivable, other receivables, tax and maintenance escrows, workers’ compensation collateral accounts, accounts payable, and long-term debt.  The fair value of these financial instruments at June 30, 2010 and December 31, 2009, based on their short-term nature or current market indicators such as prevailing interest rates, approximates their carrying value with the exception of the following (in thousands):

   
June 30, 2010
   
December 31, 2009
 
   
Carrying
         
Carrying
       
   
Amount
   
Fair Value
   
Amount
   
Fair Value
 
Long-term debt
  $ 1,384,298     $ 1,373,591     $ 1,396,412     $ 1,383,632  

We estimated the fair value of debt obligations using discounted cash flows based on the Company’s assumed incremental borrowing rate of 8.0% for unsecured borrowings and 6.6% for secured borrowings.

 
13

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
Impairment of Long-Lived Assets

The following table presents information about the Company’s assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2010 and indicates the fair value hierarchy of the valuation techniques we have utilized to determine such fair value (in thousands):

   
Quoted Prices in
   
Significant
   
 
   
 
 
   
Active Markets
   
Other
   
Significant
       
   
for Identical
   
Observable
   
Unobservable
   
Impairment
 
   
Assets (Level 1)
   
Inputs (Level 2)
   
Inputs (Level 3)
   
Losses
 
Other long-lived assets
  $     $ 2,800      $     $ 320  

In the second quarter of 2010, we wrote down a long-lived asset held for sale with a carrying amount of $2.8 million to its fair value less costs to sell, resulting in a loss of $320,000, which was included in “Other, net” for the period.  This asset represents an executive’s former house that was sold in July 2010.

In the six months ended June 30, 2009, we recorded impairment losses of $1.1 million related to five communities that were previously held for sale.  We determined the fair value of these communities based on preliminary offers from prospective purchasers.

12.  
Income Taxes

Our income tax accruals include liabilities for unrecognized tax benefits, including penalties and interest, which we recorded in connection with the Summerville merger.  These liabilities, which total $2.5 million, are included in “Other long-term liabilities” and are the result of uncertainty surrounding the deductibility of certain items included in the Summerville tax returns for periods prior to the merger.

13.  
Subsequent Events

Sunwest Joint Venture

In January 2010, we entered into a joint venture agreement with BRE/SW Member LLC, an affiliate of Blackstone Real Estate Advisors VI, L.P (“Blackstone”) and an entity controlled by Mr. Baty (“Columbia Pacific”) (the “Joint Venture Agreement”), pursuant to which the Company, Blackstone and Columbia Pacific formed a joint venture that will operate under the name of BRE/SW Portfolio LLC (the “Sunwest Joint Venture”).  The purpose of the Sunwest Joint Venture is to acquire a portfolio of communities (the “Properties”) operated by an Oregon limited liability company (“Sunwest”).

On January 15, 2010, the Joint Venture entered into a purchase and sale agreement with Sunwest to acquire the Properties.  On May 17, 2010, the U.S. District Court for the District of Oregon (the “Court”) approved the purchase and sale agreement, as amended (the “Purchase Agreement”), and on July 13, 2010, the Court confirmed Sunwest’s plan of reorganization.

On August 5, 2010, the Sunwest JV closed on the purchase of 132 Properties, with an additional 12 Properties deferred until finalization of consents with lenders and other matters.  We expect that we will complete the purchase of the deferred Properties by December 31, 2010.  The aggregate unadjusted purchase price for the 144 Properties is approximately $1.3 billion and the consideration includes (i) approximately $285.0 million in an adjustable combination of cash and membership interests in the Sunwest Joint Venture and (ii) the assumption by the Sunwest Joint Venture of secured debt and other liabilities of approximately $980.2 million.  The Company paid cash at closing of $19.0 million for its initial capital contribution.  Additionally, as of June 30, 2010, the Company had incurred legal fees and other expenses related to the formation of the Sunwest JV totaling $2.8 million, which was reimbursed by the Sunwest JV at closing and is recorded in “Other assets, net” in the condensed consolidated balance sheet at June 30, 2010.

 
14

 
EMERITUS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – CONTINUED
June 30, 2010
 
Pursuant to the Purchase Agreement, among other things, existing Sunwest investors (the “Investors”) had the option to either (1) sell their ownership interests in one or more Properties for cash or (2) exchange their ownership interests in the Properties for indirect equity interests in the Joint Venture.  Investors choosing the second option contributed their interests in the Properties (the “Contributed Interests”) to a newly formed entity owned entirely by such Investors (the “Rollover Member”).  The Rollover Member immediately further contributed the Contributed Interests to the Joint Venture in exchange for, at the election of the Investors, preferred equity interests or common equity interests in the Sunwest Joint Venture.  As of August 5, 2010, common equity interests amounted to approximately 15.9% of the initial equity of the Sunwest JV.  The initial equity interests of Blackstone, Columbia Pacific and Emeritus were 67.3%, 11.0% and 5.8%, respectively.  We expect that the equity interests of the members will change slightly over time as the Sunwest Joint Venture completes the deferred transactions, the final rollover member amounts are determined, and additional anticipated funding for capital expenditures is completed.

The Joint Venture Agreement provides for cash distributions from the Sunwest Joint Venture to the members in accordance with their ownership interests; however, the Company is entitled to distributions at increasing levels in excess of its ownership percentage if certain Sunwest Joint Venture performance criteria are achieved.  The Joint Venture Agreement also provides that in the event Blackstone desires to sell a specified portion of the Properties, all of the Properties or its membership interest in the Sunwest Joint Venture, we will have the right of first opportunity to purchase such Properties or membership interest, as applicable.

The 144 Properties included in the purchase are comprised of approximately 11,759 units and are similar in operating characteristics to our existing portfolio of senior living communities.

As contemplated by the Purchase Agreement, the Company entered into management agreements with the Sunwest Joint Venture to manage the portfolio of communities for a fee equal to 5.0% of gross collected revenues.

HCN Note

On July 9, 2010, we entered into an agreement to extend the maturity date on an existing $50.0 million loan with HCN (the “HCN Note”).  The current loan, due July 1, 2011, has been extended to July 1, 2014.  The current interest rate of 8.5% will increase by 0.15% on each anniversary date beginning July 1, 2011.  Monthly payments of interest-only are due through June 1, 2011, with additional principal payments of $200,000 per month due July 1, 2011 and each month thereafter until maturity.  In the event the Company issues securities with net proceeds to the Company in excess of $150.0 million, then such excess proceeds must be used to reduce the principal balance on the HCN Note.  In addition, if the Company makes any principal payments on its $51.4 million of loans with Nationwide Health Properties due at the end of March 2012, then the Company must make a like payment on the HCN Note.


 
15

 
 

Forward-Looking Statements

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

·  
the effects of competition and economic conditions on the occupancy levels in our communities, including possible excess assisted living capacity;
·  
our ability under current market conditions to maintain or increase our community revenues by increasing resident charges without adversely affecting occupancy levels;
·  
our ability to minimize community operations expense, including our oversight of costs largely beyond our control (such as insurance and utility costs) without adversely affecting community revenues;
·  
our ability to generate cash flow sufficient to service our debt and other fixed payment requirements;
·  
our vulnerability to defaults as a result of noncompliance with various debt and lease covenants, including the effects of cross-default provisions;
·  
our uncertainty related to competition, construction costs, licensing restrictions, environmental regulations, the overall economy, and other matters that affect acquisition, disposition, and development of assisted living communities;
·  
our ability to find sources of financing and capital on satisfactory terms to meet our cash requirements to the extent that they are not met by operations; and
·  
our uncertainty related to professional liability and workers’ compensation claims.

Any or all of our forward-looking statements in this report and in any other public statements we make may prove to be inaccurate.  Please carefully review Item 1A—Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009 for important factors that could cause the Company’s actual results to differ materially from the forward-looking statements included in this report and those that we present elsewhere from time to time.  Incorrect assumptions we might make and known or unknown risks and uncertainties may affect the accuracy of our forward-looking statements.  Forward-looking statements reflect our current expectations or forecasts of future events or results and are inherently uncertain.  Accordingly, you should not place undue reliance on forward-looking statements.

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

Overview

During the first six months of 2010, we continued to focus on the fundamentals of maintaining or increasing occupancy rates and resident charges while simultaneously controlling expenses.  We also continue to pursue selected acquisitions of additional communities.


 
16

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
A summary of activity in the first six months of 2010 compared to the equivalent period in 2009 is as follows:

·  
Total operating revenues increased $30.0 million, or 6.8%, to $473.3 million from $443.3 million in the prior year period.
·  
Operating income from continuing operations was $26.4 million compared to $28.1 million in the prior year period.  Our net loss attributable to Emeritus Corporation common shareholders was $28.1 million compared to $22.0 million in the prior year period.
·  
Average occupancy increased to 87.2% from 86.4% in the prior year period.
·  
Average rate per occupied unit increased 2.5% to $3,719 from $3,629 in the prior year period.
·  
Net cash provided by operating activities was $37.9 million compared to $33.3 million in the prior year period.
·  
We added 13 new leased communities to the Company’s portfolio and disposed of two.

Additionally, in January 2010, the Company entered into the Sunwest Joint Venture with Blackstone and Columbia Pacific.  On August 5, 2010, the Sunwest Joint Venture acquired 132 Properties currently operated by Sunwest with an additional 12 Properties expected to be purchased by December 31, 2010.  The Sunwest communities acquired by the Sunwest Joint Venture are similar in operating characteristics to the Company’s existing portfolio of senior living communities.  We entered into management agreements with the Sunwest Joint Venture to manage the portfolio of communities for a fee equal to 5.0% of gross collected revenues.  For additional information see Note 13, Subsequent Events—Sunwest Joint Venture, in Notes to Condensed Consolidated Financial Statements.

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

 
As of June 30,
 
As of December 31,
 
As of June 30,
 
2010
 
2009
 
2009
 
Buildings
 
Units
 
Buildings
 
Units
 
Buildings
 
Units
Owned
              167
 
    13,363
 
          167
 
      13,363
 
          165
 
   13,180
Leased
              116
 (1)
    11,443
 
          105
 
      10,632
 
          105
 
   10,632
Consolidated Portfolio
              283
 
    24,806
 
          272
 
      23,995
 
          270
 
   23,812
Managed
                10
 
      1,159
 
            12
 
        1,325
 
            15
 
     1,604
Joint Venture
                24
 
      1,818
 
            24
 
        1,818
 
            24
 
     1,818
Operated Portfolio
              317
 
    27,783
 
          308
 
      27,138
 
          309
 
   27,234
                       
Percentage increase  (2)
            2.9%
 
       2.4%
 
        0.7%
 
         0.7%
 
        1.0%
 
     1.0%

(1)   We account for 82 of the 116 leased communities as operating leases and the remaining 34 as capital or financing leases.  We do not include the assets and liabilities of the 82 operating lease communities on our condensed consolidated balance sheets.

(2)   The percentage increase indicates the change from the prior year, or, in the case of June 30, 2010 and 2009, from the end of the prior fiscal year.

The Company’s total consolidated portfolio of 24,806 units at June 30, 2010 consists of the following unit types:

 
Total Units
Independent living
             1,396
Assisted living
           19,220
Memory care
             3,539
Skilled nursing care
                404
Operating units
           24,559
Units taken out of service
                247
Designed capacity units
           24,806

 
 
17

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
The units taken out of service represent rooms that we have converted to alternative uses, such as additional office space, and are not available for immediate occupancy.  We exclude the units taken out of service from the calculation of the average occupancy rate.  We place these units back into service as demand dictates.

Significant Transactions

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

                 
Purchase
   
Amount
   
Portfolio or Community
Date
 
Communities
   
Units
   
Price (1)
   
Financed
   
HCP, Inc.
June 2010
    4       552     $     $ (3 )
National Health Investors, Inc.
January 2010
    8       336             (2 )
Emeritus at Eastover
February 2010
    1       88             (2 )
Emeritus at Merced
October 2009
    1       83       6,250       5,000 (4 )
Emeritus at Trace Pointe
October 2009
    1       100       15,783       14,100 (4 )
Emeritus at College Park
June 2009
    1       85       10,579       9,010 (4 )
Emeritus at Northdale
January 2009
    1       84             (3 )
Emeritus at Urbandale
January 2009
    1       38       6,632       5,461 (5 )
        18       1,366                    
                                     
(1) Excludes closing costs.
                                   
(2) Capital/financing lease
                                   
(3) Operating lease
                                   
(4) Purchase
                                   
(5) New construction
                                   


 
18

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
The following table shows the changes in the Company’s building portfolio from December 31, 2008 through June 30, 2010, including those transactions previously described:

 
Month
 
Owned
   
Leased
   
Consolidated
   
Managed
   
Total
 
December 31, 2008
      164       104       268       38       306  
Autumn Ridge - disposition
Jan-09
    (1 )           (1 )           (1 )
Emeritus at Northdale
Jan-09
          1       1             1  
Emeritus at Urbandale - development
Jan-09
    1             1             1  
New management agreements
Jan-09
                      2       2  
March 31, 2009
      164       105       269       40       309  
Emeritus at College Park
Jun-09
    1             1       (1 )      
June 30, 2009
      165       105       270       39       309  
No activity in the quarter
                               
September 30, 2009
      165       105       270       39       309  
Emeritus at Trace Pointe
Oct-09
    1             1       (1 )      
Isle at Emerald Court
Oct-09
                      (1 )     (1 )
Emeritus at Merced
Oct-09
    1             1       (1 )      
December 31, 2009
      167       105       272       36       308  
Emeritus at Westwind Gardens
Jan-10
    -       (1 )     (1 )     1       -  
National Health Investors, Inc.
Jan-10
    -       8       8       -       8  
Cottonbloom Assisted Living
Feb-10
    -       -       -       (1 )     (1 )
Emeritus at Eastover
Feb-10
    -       1       1       -       1  
March 31, 2010
      167       113       280       36       316  
HCP, Inc.
Jun-10
    -       4       4               4  
South Dayton
Jun-10
    -       (1 )     (1 )     -       (1 )
Peachtree Village Retirement
Jun-10
    -       -       -       (1 )     (1 )
Rainbow Assisted Living
Jun-10
    -               -       (1 )     (1 )
June 30, 2010
      167       116       283       34       317  


Results of Operations

For the second quarter of 2010, the net loss attributable to our common shareholders was $13.9 million compared to $7.1 million in the 2009 period.  Operating income from continuing operations, which excludes interest, equity earnings/losses, and other non-operating items, decreased by $3.8 million to $13.9 million in the second quarter of 2010 compared to $17.7 million in the same 2009 period.  Total operating revenues increased to $239.1 million in the current quarter from $222.2 million in the prior year period.

Two of the important factors affecting the Company’s financial results are the rates we charge to our residents and the occupancy levels we achieve in the Company’s communities.  We rely primarily on our residents’ ability to pay the Company’s charges for services from their own or family 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 the Company’s communities.  In this context, we must be sensitive to our residents' financial circumstances and remain aware that rates and occupancy are interrelated.

In evaluating the rate component, we generally utilize the average monthly revenue per occupied unit, computed by dividing the total operating revenue for a particular period by the average number of occupied units for the same period.  In evaluating the occupancy component, we generally utilize an average occupancy rate, computed by dividing the average units occupied during a particular period by the average number of units available during the
 
 
19

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
period.  We evaluate these and other operating components for the Company’s consolidated portfolio, which includes the communities we own and lease, as well as for the Company’s total operating portfolio, which includes all of the communities we manage.

In the Company’s consolidated portfolio, the average monthly revenue per occupied unit increased to $3,739 in the current quarter from $3,626 in the second quarter of 2009.  The change from 2009 to 2010 represents an increase of $113 per occupied unit, or 3.1%.  This average rate increase reflects a combination of factors, including local market conditions, competition, changes in level of required care provided to residents, acquisitions, and inflationary adjustments.

In the Company’s consolidated portfolio, the average occupancy rate was 87.2% in the second quarter of 2010 compared to 86.6% in the 2009 period.  The occupancy rates increased in 2010 despite the recent general economic downturn.  We continue to evaluate the factors of rate and occupancy to find the optimum balance in each community.

Since Emeritus Corporation’s inception in 1993, it has incurred cumulative operating losses totaling approximately $442.5 million as of June 30, 2010.  We believe that these losses have resulted from our early and continuing emphasis on expansion, financing costs arising from multiple financing and refinancing transactions related to this expansion, administrative and corporate expenses that we incur as the scope and complexity of the Company has grown, the impact in the early years on many of the Company’s leases from capital and financing lease treatments, and occupancy rates remaining lower for longer periods than we anticipated.  While we have generally realized growth in both the Company’s occupancy and average monthly rates, we anticipate continued net operating losses in the near term but expect to continue to generate positive cash flows from operations.  Our current emphasis is on maximizing cash flows and containing costs as we work toward improvements in occupancy and average rates, selective growth, and changes in the Company’s capital structure, such as acquisition of leased properties and refinancing of existing debt.

 
20

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
Statements of Operations as a Percentage of Total Operating Revenues and Period-to-Period Percentage Change

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

                           
Period-to-Period Percentage of Change
Fav/ (Unfav)
 
   
Percentage of Total Operating Revenues
   
Three
   
Six
 
   
Three Months Ended
   
Six Months Ended
   
Months Ended
   
Months Ended
 
   
June 30,
   
June 30,
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
     2010-2009      2010-2009  
Total operating revenues:
    100.0 %     100.0 %     100.0 %     100.0 %     7.6 %     6.8 %
                                                 
Expenses:
                                               
Community operations (exclusive of depreciation and amortization and community leases expense shown separately below)
    65.8       63.4       66.0       64.2       (11.7 )     (9.7 )
General and administrative
    7.3       7.2       7.3       7.0       (7.4 )     (11.1 )
Impairments on long-lived assets
    -       -       -       0.3       100.0       100.0  
Depreciation and amortization
    8.6       8.1       8.7       8.9       (15.1 )     (3.7 )
Community leases
    12.4       13.2       12.4       13.2       (1.3 )     (0.6 )
Total operating expenses
    94.2       92.0       94.5       93.7       (10.1 )     (7.6 )
Operating income from continuing operations
    5.8       8.0       5.6       6.3       (21.6 )     (6.1 )
                                                 
Other income (expense):
                                               
Interest income
    0.1       0.1       0.1       0.1       (30.7 )     (25.7 )
Interest expense
    (11.4 )     (11.9 )     (11.5 )     (11.9 )     (3.0 )     (3.1 )
Change in fair value of interest rate swaps
    -       0.3       -       0.2       (94.4 )     (101.4 )
Equity earnings for unconsolidated joint ventures
    0.1       0.3       0.1       0.3       (46.1 )     (61.9 )
Others, net
    -       0.1       0.1       0.1       (115.1 )     27.4  
Net other expense
    (11.2 )     (11.1 )     (11.2 )     (11.2 )     (8.0 )     (6.4 )
                                                 
Loss from continuing operations before income taxes
    (5.4 )     (3.1 )     (5.6 )     (4.9 )     (82.3 )     (22.6 )
Provision for income taxes
    (0.1 )     (0.1 )     (0.1 )     (0.1 )     (20.7 )     (19.4 )
Loss from continuing operations
    (5.5 )     (3.2 )     (5.7 )     (5.0 )     (80.1 )     (22.5 )
Income (loss) from discontinued operations
    (0.4 )     -       (0.2 )     -       N/M       N/M  
Net loss
    (5.9 )     (3.2 )     (5.9 )     (5.0 )     (93.6 )     (27.4 )
Net loss attributable to the noncontrolling interest
    0.1       0.1       0.1       0.1       (1.3 )     (5.9 )
Net loss attributable to Emeritus Corporation common shareholders
    (5.8 %)     (3.1 %)     (5.8 %)     (4.9 %)     (96.7 )%     (28.1 )%

Note: “N/M” indicates percentages that are not meaningful in the analysis.


 
21

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
Comparison of the Three Months Ended June 30, 2010 and 2009

Net Loss Attributable to Emeritus Corporation Common Shareholders

We reported a net loss of $13.9 million in the three months ended June 30, 2010, compared to $7.1 million in the prior year period.  As discussed under Liquidity and Capital Resources, the Company has incurred significant losses since its inception, but has generated positive cash flow from operating activities since 2001.

Total operating revenues increased $16.9 million, or 7.6%, to $239.1 million from $222.2 million in the prior year period.  However, total operating expenses increased at a greater rate to $225.2 million from $204.5 million, which caused operating income from continuing operations to decrease by $3.8 million to $13.9 million in the current period.  The decrease in operating income reflects a $2.7 million increase in depreciation and amortization expense, a $3.6 million increase in actuarial self-insurance adjustments and a $1.2 million increase in general and administrative expenses, as discussed below.  Our operating margin (community revenues less community operation expenses) increased to $80.3 million in the second quarter of 2010 from $79.8 million in the second quarter of 2009.  Net other expense increased by $2.0 million inclusive of interest expense, which increased by $795,000.

Total Operating Revenues:
   
Three Months Ended June 30,
 
   
2010
   
2009
   
 $ D
   
 % D
 
   
(in thousands, except percentages)
 
Same community
  $ 227,648     $ 219,398     $ 8,250       3.8 %
Acquisitions, development and expansion
    11,585       1,268       10,317       N/M  
Unallocated community revenue
    (1,446 )     107       (1,553 )     N/M  
Community revenue
    237,787       220,773       17,014       7.7 %
Management fees
    1,344       1,453       (109 )     (7.5 %)
Total operating revenues
  $ 239,131     $ 222,226     $ 16,905       7.6 %

   
Three Months Ended June 30,
 
   
2010
   
2009
   
 $ D
   
 % D
 
Average monthly revenue per occupied unit
  $ 3,739     $ 3,626     $ 113       3.1 %
Average occupancy rate
    87.2 %     86.6 %          
0.6 ppt*
 

* percentage point
“N/M” indicates percentages that are not meaningful in the analysis.

The increase of $8.3 million from the 264 same community portfolio consisted of $6.9 million in rate improvement and $1.4 million in occupancy gains.  As further described in the section “Same Community Comparison” below, our same community portfolio consists of those communities that we have continuously operated since January 1, 2009.  Revenue increased by $10.3 million from the acquisition, development, and expansion of 15 communities net of three dispositions since the beginning of 2009.  A decrease in unallocated community revenue of $1.6 million resulted primarily from a decrease in deferred resident move-in fees.

We earn management fee revenues by managing certain communities for third parties, including communities owned by joint ventures in which we have an ownership interest.  We charge fees based on a percentage of community revenues.  These include a joint venture with Blackstone for which we manage 23 communities (the “Blackstone JV”) and 11 other communities that we manage for third parties.  The Blackstone JV accounted for management fee revenues of $893,000 and $871,000 in the three-month periods ended June 30, 2010 and 2009 respectively.  The total decrease in management fees is due to the decrease in the number of managed communities in the current quarter compared to the prior year period.
 

 
 
22

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
Community Operations Expense:
   
Three Months Ended June 30,
 
   
2010
   
2009
   
 $ D
   
 % D
 
   
(in thousands, except percentages)
 
Same community
  $ 146,348     $ 140,658     $ 5,690       4.0 %
Acquisitions, development and expansion
    8,280       1,439       6,841       N/M  
Unallocated community expenses
    2,824       (1,162 )     3,986       343.0 %
Community operations
  $ 157,452     $ 140,935     $ 16,517       11.7 %
As a percentage of total operating revenues
    65.8 %     63.4 %          
2.4 ppt
 

The increase of $5.7 million from the 264 same community portfolio includes a $2.8 million increase in total labor and benefits, of which payroll taxes increased $637,000, workers compensation expense increased $384,000, and salaries and wages expense increased $1.7 million, or 2.6% as compared to the same period in 2009.  The remaining increase of $2.9 million in same community operations expense was due to other general expense increases across various operating expense categories.

Another contributor to the increase in community operations expense was $6.8 million from the acquisition, development, or expansion of 15 communities net of three dispositions since the beginning of 2009.  The largest contributor was an increase in total labor and benefits of $4.3 million.

The $4.0 million increase in unallocated community expenses consists primarily of prior-year self-insurance reserve adjustments.  We periodically adjust our estimated self-insurance liabilities based on actuarial projected losses.  In the second quarter of 2010, we recorded an $829,000 expense for professional and general self-insurance for prior years’ claims exposure while in the same period in 2009 we recorded a $1.7 million expense reduction.  This contributed $2.6 million to the period-over-period increase.  Additionally, we recorded an expense increase of $1.0 million for prior years’ claims exposure, representing our revised estimates of the ultimate exposure under the Company’s workers’ compensation self-insurance programs based upon actuarial valuation reports.  We continue to focus attention on worker safety and active claims management to control these expenses.

General and Administrative Expense:
   
Three Months Ended June 30,
 
   
2010
   
2009
   
 $ D
   
 % D
 
   
(in thousands, except percentages)
 
General and administrative
  $ 17,109     $ 15,932     $ 1,177       7.4 %
As a percentage of total operating revenues
    7.3 %     7.2 %          
0.1 ppt
 

The increase in general and administrative expenses reflects the Company’s growth over the past year.  The increase is due primarily to salaries and benefits for regional and corporate overhead positions, which increased by $1.1 million, resulting from increases in both the number of personnel and in average salaries.  Included in this increase is non-cash stock compensation expense, which increased by $379,000 to $1.5 million for the three months ended June 30, 2010 from $1.1 million for the three months ended June 30, 2009.


 
23

 
EMERITUS CORPORATION
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS – CONTINUED
June 30, 2010
 
General and administrative expense as a percentage of operating revenues for all communities, including managed communities, may be more meaningful for comparison with other providers in our industry.  General and administrative expense as a percentage of community operating revenues for all managed and consolidated communities was 6.4% for the three months ended June 30, 2010 and June 30, 2009.  We compute these percentages as follows:
 
   
Three Months Ended June 30,