ESC - 3.31.2014

10-Q 1 esc-3312014x10q.htm 10-Q ESC - 3.31.2014 - 10Q

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 March 31, 2014

¨ 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 of incorporation or organization)	(I.R.S. Employer 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 x No ¨

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 x No ¨

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	x	Accelerated filer	¨

Non-accelerated filer	¨	Smaller reporting company	¨

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

As of April 30, 2014, 49,017,984 shares of the Registrant’s Common Stock were outstanding.

EMERITUS CORPORATION

Table of Contents

Part I. Financial Information



	Part I. Financial Information
		Page No.

Item 1. Financial Statements (unaudited):

	Condensed Consolidated Balance Sheets as of March 31, 2014 and December 31, 2013	2

	Condensed Consolidated Statements of Operations for the three months ended March 31, 2014 and 2013	3

	Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2014 and 2013	4

	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2014 and 2013	5

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	38

Item 4.	Controls and Procedures	38

Part II. Other Information

Note:	Items 2, 3, 4, and 5 of Part II have been omitted because they are not applicable.

Item 1.	Legal Proceedings	39

Item 1A.	Risk Factors	41

Item 6.	Exhibits	42

	Signature	43

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

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EMERITUS CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

(In thousands, except share data)



	March 31,			December 31,
	2014			2013
ASSETS
Current Assets:
Cash and cash equivalents	$	58,670		$	76,672
Short-term investments	7,692			7,394
Trade accounts receivable, net of allowance of $10,375 and $9,380	56,555			53,714
Other receivables	12,299			10,310
Tax, insurance, and maintenance escrows	29,506			28,067
Prepaid insurance expense	27,676			28,109
Deferred tax asset	48,126			49,203
Other prepaid expenses and current assets	15,803			14,588
Property held for sale	7,714			17,459
Total current assets	264,041			285,516
Investments in unconsolidated joint ventures	2,571			2,720
Property and equipment, net of accumulated depreciation of $746,269 and $701,743	3,840,932			3,875,172
Restricted deposits and escrows	85,677			80,919
Goodwill	189,382			189,626
Other intangible assets, net of accumulated amortization of $42,479 and $40,665	121,743			123,557
Other assets, net	37,228			37,138
Total assets	$	4,541,574		$	4,594,648

LIABILITIES, SHAREHOLDERS’ EQUITY AND NONCONTROLLING INTEREST
Current Liabilities:
Current portion of long-term debt	$	141,848		$	152,989
Current portion of capital lease and financing obligations	35,671			33,565
Trade accounts payable	13,167			30,856
Accrued employee compensation and benefits	48,384			44,603
Accrued interest	7,497			7,529
Accrued real estate taxes	14,471			16,528
Accrued insurance liabilities	40,710			40,482
Other accrued expenses	42,653			39,954
Deferred revenue	26,349			25,822
Unearned rental income	32,654			30,745
Total current liabilities	403,404			423,073
Long-term debt obligations, less current portion	1,336,672			1,345,242
Capital lease and financing obligations, less current portion	2,479,631			2,481,930
Deferred gain on sale of communities	2,561			2,786
Deferred straight-line rent	78,111			74,320
Other long-term liabilities	154,961			153,278
Total liabilities	4,455,340			4,480,629
Commitments and contingencies
Shareholders' Equity and Noncontrolling Interest:
Preferred stock, $0.0001 par value. Authorized 20,000,000 shares, none issued	—			—
Common stock, $0.0001 par value. Authorized 100,000,000 shares, issued and outstanding 48,999,284 and 48,118,623 shares	5			5
Additional paid-in capital	913,542			892,319
Accumulated deficit	(829,100		)	(780,654		)
Total Emeritus Corporation shareholders' equity	84,447			111,670
Noncontrolling interest	1,787			2,349
Total shareholders' equity	86,234			114,019
Total liabilities, shareholders' equity, and noncontrolling interest	$	4,541,574		$	4,594,648

See accompanying Notes to Condensed Consolidated Financial Statements

EMERITUS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

(In thousands, except per share data)



	Three Months Ended
	March 31,
	2014			2013
Revenues:
Community and ancillary services revenue	$	513,817		$	462,719
Management fees	703			785
Reimbursed costs incurred on behalf of managed communities	7,310			8,864
Total operating revenues	521,830			472,368
Expenses:
Community and ancillary services operations (exclusive of depreciation, amortization and lease expense shown separately below)	351,716			323,741
General and administrative	29,644			29,440
Transaction costs	10,366			647
Impairments of long-lived assets	1,023			—
Depreciation and amortization	46,228			45,218
Lease expense	52,225			31,964
Costs incurred on behalf of managed communities	7,310			8,864
Total operating expenses	498,512			439,874
Operating income from continuing operations	23,318			32,494
Other income (expense):
Interest income	109			110
Interest expense	(70,369		)	(72,199		)
Change in fair value of derivative financial instruments	(71		)	5
Net equity losses for unconsolidated joint ventures	(131		)	(12		)
Other, net	370			1,043
Net other expense	(70,092		)	(71,053		)

Loss from continuing operations before income taxes	(46,774		)	(38,559		)
Provision for income taxes	(695		)	(1,106		)
Loss from continuing operations	(47,469		)	(39,665		)
Loss from discontinued operations	(1,539		)	—
Net loss	(49,008		)	(39,665		)
Net loss (income) attributable to the noncontrolling interests	562			(91		)

Net loss attributable to Emeritus Corporation common shareholders	$	(48,446	)	$	(39,756	)
Basic and diluted loss per common share attributable to
Emeritus Corporation common shareholders:
Continuing operations	$	(0.99	)	$	(0.88	)
Discontinued operations	(0.03		)	—
	$	(1.02	)	$	(0.88	)

Weighted average common shares outstanding: basic and diluted	47,633			45,417

See accompanying Notes to Condensed Consolidated Financial Statements

EMERITUS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(unaudited)

(In thousands)



	Three Months Ended
	March 31,
	2014			2013
Net loss	$	(49,008	)	$	(39,665	)
Comprehensive loss (income) attributable to the noncontrolling interests	562			(91		)
Comprehensive loss attributable to Emeritus Corporation common shareholders	$	(48,446	)	$	(39,756	)

See accompanying Notes to Condensed Consolidated Financial Statements

EMERITUS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(In thousands)



	Three Months Ended March 31,
	2014			2013
Cash flows from operating activities:
Net loss	$	(49,008	)	$	(39,665	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities
Depreciation and amortization	46,228			45,218
Amortization of above/below market rents	1,230			1,246
Amortization of deferred gains	(224		)	(248		)
Loss on lease termination	85			—
Loss (gain) on early extinguishment of debt	233			(493		)
Impairment of long-lived assets	2,399			—
Amortization of loan fees	705			790
Allowance for doubtful receivables	2,759			2,172
Net equity losses for unconsolidated joint ventures	131			12
Gain on sale of assets	(131		)	—
Stock-based compensation	3,161			3,331
Change in fair value of derivative financial instruments	71			(5		)
Deferred straight-line rent	5,590			216
Deferred revenue	258			2,088
Non-cash interest expense	7,466			7,975
Other	26			80
Changes in operating assets and liabilities:	(22,991		)	5,044
Net cash (used in) provided by operating activities	(2,012		)	27,761
Cash flows from investing activities:
Purchase of property and equipment	(18,008		)	(15,907		)
Acquisitions	—			(78		)
Proceeds from the sale of assets	13,895			—
Lease acquisition costs and other assets, net	(89		)	(1,029		)
Advances (to) from affiliates and other managed communities, net	(898		)	1,273
Distributions from unconsolidated joint ventures, net	79			14,926
Net cash used in investing activities	(5,021		)	(815		)
Cash flows from financing activities:
Sale of stock and exercise of options, net	17,168			37,826
Purchase and distributions to non-controlling interest, net	—			(3,726		)
Increase in restricted deposits	(159		)	(525		)
Debt issuance and other financing costs	(91		)	(819		)
Proceeds from long-term borrowings and financings	—			50,000
Repayment of long-term borrowings and financings	(19,711		)	(49,972		)
Repayment of capital lease and financing obligations	(8,176		)	(6,001		)
Net cash (used in) provided by financing activities	(10,969		)	26,783
Net (decrease) increase in cash and cash equivalents	(18,002		)	53,729
Cash and cash equivalents at the beginning of the period	76,672			59,795
Cash and cash equivalents at the end of the period	$	58,670		$	113,524

See accompanying Notes to Condensed Consolidated Financial Statements

EMERITUS CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(In thousands)



	Three Months Ended March 31,
	2014		2013

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	62,218	$	63,582
Cash paid during the period for income taxes	204		462
Cash received during the period for income tax refunds	446		19
Cash and non-cash financing and operating activities:
Change in receivable from exercise of stock options	893		793
HCP Transaction:
Increase in property and equipment	—		32,596

See accompanying Notes to Condensed Consolidated Financial Statements

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

Note 1. Description of Business

Emeritus Corporation (“Emeritus,” the “Company,” “we,” “us” or “our”) is a senior living service provider focused on operating residential style communities throughout the United States. Our assisted living and Alzheimer’s and dementia care (“memory care”) communities provide a residential housing alternative for senior citizens who need help with the activities of daily living, with an emphasis on assisted living and personal care services. Many of our communities offer independent living alternatives and, to a lesser extent, skilled nursing care. We also offer a range of outpatient therapy and home health services in Florida, Arizona and Texas. As of March 31, 2014, we owned 183 communities and leased 311 communities. These 494 communities comprise the communities included in the condensed consolidated financial statements and are referred to as our “Consolidated Portfolio.”

We also provide management services to independent and related-party owners of senior living communities. As of March 31, 2014, we managed 14 communities, three of which are owned by joint ventures in which we have a financial interest. The majority of our management agreements provide for fees of 5.0% of gross revenues. The communities that we manage for others, combined with our Consolidated Portfolio, are referred to as our “Operated Portfolio.”

Merger Agreement with Brookdale

On February 20, 2014, Emeritus entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Brookdale Senior Living Inc., a Delaware corporation (“Brookdale”), and Broadway Merger Sub Corporation, a Delaware corporation and wholly owned subsidiary of Brookdale (“Merger Sub”). Pursuant to the terms, and subject to the conditions, of the Merger Agreement, at the closing of the proposed transactions contemplated by the Merger Agreement, Merger Sub will be merged with and into Emeritus (the “Merger”), and Emeritus will continue as the surviving corporation of the Merger and as a wholly owned subsidiary of Brookdale.

The Merger Agreement was unanimously approved by the Board of Directors of each of Emeritus and Brookdale, and Emeritus has agreed to convene a special meeting of its shareholders to consider and vote upon the Merger Agreement and the Merger.

In connection with the Merger, each share of Emeritus common stock outstanding immediately prior to the effective time of the Merger (other than shares in respect of which dissenter’s rights are perfected and other than any shares owned by Brookdale or its subsidiaries) will be automatically canceled and converted into the right to receive consideration equal to 0.95 of a share of Brookdale common stock (the “Exchange Ratio”). The Exchange Ratio is fixed and will not be adjusted for changes in the market value of Emeritus common stock or Brookdale common stock. No fractional shares of Brookdale common stock will be issued in the Merger, and Emeritus shareholders will receive cash in lieu of fractional shares, if any, of Brookdale common stock. Each share of Emeritus restricted stock outstanding immediately prior to the effective time of the Merger, whether or not then vested, will become fully vested and will be treated as a share of Emeritus common stock, to be canceled and converted in the same way as all other outstanding shares of Emeritus common stock, as described above.

Each Emeritus stock option outstanding immediately prior to the effective time of the Merger will be canceled and automatically converted into the right of the holder to receive a number of whole shares of Brookdale common stock, determined by (i) multiplying (A) the total number of shares subject to the Emeritus stock option by (B) an amount equal to the “applicable closing price,” less the exercise price per share for such option, and (ii) dividing such amount by the ten-day volume weighted average closing price of Brookdale common stock (the “VWAP”). The number of shares of Brookdale common stock to be issued to the holder of the Emeritus stock option will be reduced to cover the minimum amount of any applicable tax withholdings. Any Emeritus stock option with an exercise price that is equal to or greater than the “applicable closing price” will terminate and cease to be outstanding, without any payment of consideration. The “applicable closing price” for purposes of the Merger Agreement is calculated by multiplying the VWAP by the Exchange Ratio.

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

(iv) approval by the New York Stock Exchange of the listing of the shares of Brookdale common stock to be issued in the Merger, (v) the receipt of required regulatory approvals and lender consents; (vi) the delivery of opinions from counsel to each of Emeritus and Brookdale to the effect that the Merger will be treated as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended; (vii) Emeritus shareholders holding no more than 7.5% dissenting from the merger; and (viii) the absence of a material adverse effect with respect to Emeritus or Brookdale, as well as other conditions to closing as are customary in transactions such as the Merger.

Emeritus and Brookdale each made customary representations and warranties for a transaction of this type. The Merger Agreement also contains customary covenants, including covenants providing (i) that both parties shall use reasonable best efforts to cause the transactions to be consummated, (ii) both parties shall jointly prepare and file a joint proxy statement and call and hold a special meeting of shareholders for each of Emeritus and Brookdale, and (iii) that neither party will solicit proposals relating to certain alternative transactions or engage in discussions or negotiations in connection with alternative transactions, subject to certain exceptions including in order to comply with fiduciary duties and in the case of Brookdale, certain permitted transactions. The Merger Agreement also requires Emeritus to conduct its operations in the ordinary course during the interim period between execution of the Merger Agreement and the completion of the Merger and to refrain from taking specific actions without Brookdale’s prior written consent.

The Merger Agreement contains certain termination rights for both Emeritus and Brookdale, including, among other things, for the failure to consummate the Merger by November 20, 2014 (which date may be unilaterally extended by either party if certain closing conditions related to regulatory and third party approvals have not been satisfied), and for breaches of representations, warranties or covenants that result in the failure of certain conditions to closing being satisfied. In addition, in the event either Emeritus or Brookdale fails to obtain shareholder approval from their respective shareholders, the other party may terminate the Merger Agreement, upon which Emeritus or Brookdale, as applicable, will be required to pay the terminating party a termination payment of $13.5 million. The Merger Agreement also provides that either Emeritus or Brookdale may terminate the Merger Agreement under specified circumstances, including, among others, a change in the recommendation of the non-terminating party’s board of directors or termination of the Merger Agreement to enter into a definitive agreement for a “superior proposal;” provided, however, that, in the case of Emeritus, Emeritus will be required to pay Brookdale a break-up fee of $53.0 million, and in the case of Brookdale, Brookdale will be required to pay Emeritus a break-up fee of $143.0 million.

Brookdale has agreed to take all action necessary to provide that its board of directors appoint one individual serving on the Emeritus board of directors to Brookdale’s board of directors at the closing of the merger (subject to the approval of such nominee by the Brookdale’s Nominating and Corporate Governance Committee). In connection with the foregoing, Emeritus anticipates that Granger Cobb, President and Chief Executive Officer and a director of Emeritus, will be joining Brookdale’s board of directors and will be serving as a consultant to Brookdale, in each case, following the closing of the Merger. We expect that the Merger will close in the third quarter of 2014.

Note 2. Summary of Significant Accounting Policies and Use of Estimates

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”), management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. 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 have adopted certain significant accounting policies that are critical 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 revisions become known. A detailed discussion of our significant accounting policies and the use of estimates is contained in our Annual Report on Form 10-K for the year ended December 31, 2013 (“Form 10-K”), which we filed with the Securities and Exchange Commission (“SEC”).

Basis of Presentation

The condensed consolidated financial statements include the accounts of Emeritus and its wholly owned subsidiaries. Intercompany balances and transactions have been eliminated.

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

The unaudited condensed consolidated financial statements reflect all adjustments that are, in our opinion, necessary to fairly state our financial position, results of operations, and cash flows as of March 31, 2014 and for all periods presented. Except as otherwise disclosed in these notes to condensed consolidated financial statements, such adjustments are of a normal, recurring nature. Our results of operations for the period ended March 31, 2014 are not necessarily indicative of the results of operations that we may achieve for the full year ending December 31, 2014. We presume that readers of the interim financial information in this Quarterly Report on Form 10-Q have read or have access to our 2013 audited consolidated financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Form 10-K for the year ended December 31, 2013. Therefore, we have omitted certain footnotes and other disclosures that are disclosed in our Form 10-K.

Segment Information

Emeritus is comprised of three operating segments and reporting units, which are: (i) ancillary services, including Nurse On Call, Inc. ("NOC"), our home health care provider; (ii) the 133 communities leased in the HCP Transaction, as defined in Note 4 (the “HCP Leased Communities”); and (iii) the legacy Emeritus communities. See Note 13, Segment Information.

Recent Accounting Pronouncements

In April 2014, the Financial Accounting Standards Board ("FASB") issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. Under the new guidance, a discontinued operation is defined as a component or group of components that is disposed of or is classified as held for sale and “represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results.” The standard states that a strategic shift could include a disposal of: (i) a major geographical area of operations; (ii) a major line of business; (iii) a major equity method investment; or (iv) other major parts of an entity. We are required to adopt this standard in the first quarter of 2015. We do not expect that adoption of ASU 2014-08 will have a material impact on our consolidated financial statements.

In July 2013, the FASB issued ASU No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This new standard requires the netting of unrecognized tax benefits ("UTB"s) against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Under the new standard, UTBs will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the UTBs. We adopted ASU No. 2013-11 at the beginning of the first quarter of 2014, and the adoption did not have a material impact on our financial statements.

Note 3. Stock-Based Compensation

As of March 31, 2014, we have two equity incentive plans under which equity awards are outstanding: the Amended and Restated 2006 Equity Incentive Plan (the “2006 Plan”) and the Amended and Restated Stock Option Plan for Non-employee Directors (the “Directors Plan”).

The Directors Plan is a nonqualified stock option plan that has been in effect since 1995. In May 2013, our shareholders approved an amendment to the 2006 Plan, whereby our board of directors terminated the Directors Plan, and therefore no new grants will be made under the plan. Shares previously available for issuance under the Directors Plan, but not issued under that plan, are available for issuance under the 2006 Plan. Future equity awards to directors will be made under the amended 2006 Plan.

Employees may also participate in our 2009 Employee Stock Purchase Plan (the “2009 ESP Plan”). The 2009 ESP Plan provides eligible employees an opportunity to purchase shares of Emeritus common stock through payroll deductions at a 15.0% discount from the lower of the market price on the first trading day or last trading day of each calendar quarter. In connection with the Merger Agreement, Emeritus has suspended the commencement of any offering periods after March 31, 2014.

We record compensation expense based on the fair value for all stock-based awards, which amounted to $3.2 million and $3.3 million for the three months ended March 31, 2014 and 2013, respectively.

The following table summarizes our stock option activity for the three months ended March 31, 2014:

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013



	Shares Underlying Options		Weighted Average Exercise Price		Aggregate Intrinsic Value ($000)
Outstanding at beginning of period	3,989,814		$	20.27	$	10,977
Exercised	(865,953	)	20.54		4,637
Forfeited/expired	(28,338	)	19.94
Outstanding at end of period	3,095,523		20.19		34,823

Options exercisable	1,966,067		20.45		21,610
Options exercisable in the money	1,966,067				21,610

The following table summarizes our restricted stock activity for the three months ended March 31, 2014:



	Number of Shares		Weighted Average Grant Date Fair Value
Outstanding at beginning of period	1,088,934		$	20.61
Vested	(204,502	)	19.42
Outstanding unvested at end of period	884,432		20.88

Note 4. Acquisitions and Other Significant Transactions

We make acquisitions of certain businesses and complete other transactions from time to time that we believe align with our strategic intent to, among other factors, enhance the overall care of our residents as well as maximize our revenues, operating income and cash flows.

In September 2013, we acquired 38 communities pursuant to an operating lease with Health Care REIT, Inc. ("HCN") (the "Master Lease"). These communities were previously operated by Merrill Gardens (the "Merrill Gardens Communities"). Rent in the first year of the Master Lease is $54.0 million and will increase each year based on the greater of (i) the percentage change in the CPI or (ii) (a) 4.0% in the second year of the lease and (b) 3.25% thereafter. Additional rent may be due beginning in the third year of the lease if gross revenues, as defined therein, exceed certain thresholds. The initial term of the Master Lease is fifteen years, and we have the option to extend the lease for one additional fifteen -year term. HCN and Emeritus have committed to fund up to $10.0 million for capital improvements during the first two years of the Master Lease, and our rent will increase by 6.5% of any such capital improvements funded by HCN. The Company also entered into an operations transfer agreement with Merrill Gardens, pursuant to which we paid to Merrill Gardens a $10.0 million management contract termination fee upon commencement of the Master Lease.

HCP Transaction

In 2010, we entered into a joint venture (the “Sunwest JV”) with an affiliate of Blackstone Real Estate Advisors VI, L.P (“Blackstone”), Columbia Pacific Opportunity Fund (“Columbia Pacific”), which is controlled by Daniel R. Baty, a founder of the Company and the Chairman of our board of directors, and certain other tenant-in-common investors. In 2012, we entered into a purchase and sale agreement with the Sunwest JV and HCP, Inc. ("HCP") whereby (i) the Sunwest JV agreed to sell to HCP 142 of its communities (the "Properties"), of which 139 were included in our Operated Portfolio and we managed for a fee, and (ii) HCP agreed to simultaneously lease 133 of these communities to Emeritus through a sale-leaseback arrangement (the "HCP Leased Communities") and sell the remaining nine to Emeritus outright (the "HCP Transaction"). HCP completed the purchase of 138 of these communities in 2012 and completed its purchase of the remaining four communities in the first quarter of 2013, at which time they were added to our Consolidated Portfolio.

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

Dispositions

In the first quarter of 2014, we sold three communities, representing a total of 235 units. A portion of the aggregate sales proceeds of $13.9 million was used to pay down outstanding mortgage debt on two of the communities.

Note 5. Long-Term Debt

Debt

In January 2014, in connection with the sale of a community, we retired a note payable to Keybank with an outstanding principal balance of $4.0 million and an interest rate of 2.70% .

In March 2014, in connection with the sale of a community, we retired a note payable to GE Capital with an outstanding principal balance of $7.2 million and an interest rate of 5.05% .

Debt and Lease Covenants

Our 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 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 our 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 our properties. Accordingly, an event of default could cause a material adverse effect on our financial condition if such debts/leases are cross-defaulted. As of March 31, 2014, we were in violation of financial covenants in one lease agreement covering four communities. We obtained a waiver from the landlord through March 31, 2014 and we are therefore in compliance with those financial covenants.

At December 31, 2012, we were not in compliance with certain financial covenants required by our master lease agreement with Ventas, Inc. ("Ventas"). In February 2013, we received a waiver of these violations in connection with the modification of the master lease. Such modifications include a resetting of the lease coverage ratios, the ability to cure up to four lease coverage shortfalls with cash deposits, and an extension of the period allowed for us to exercise purchase options. In addition, in accordance with a put option provision in the master lease related to two communities, in April 2013, we purchased one of the communities from Ventas for the option price of $3.9 million. The other community remains subject to a put option if certain financial covenants are not met. For the quarterly test period ended March 31, 2014, the community subject to the put option did not meet the covenants, and in April 2014, Ventas notified us that they are exercising the put option, which requires us to purchase the community for the option price of $7.8 million. We recorded the difference between the purchase price and the estimated fair market value of $6.0 million as lease expense in the amount of $1.8 million, with a corresponding current liability that will be relieved when the transaction closes in the third quarter of 2014.

Note 6. Derivative Financial Instruments

In connection with the refinance of two mortgage loans in December 2013, we purchased two interest rate caps, as required by the lender, for a combined cash payment of $70,000. The caps are for a combined notional amount of $14.3 million and effectively cap LIBOR at 2.74%. The contracts expire in January 2017.

In October 2011, pursuant to the terms of a credit agreement related to the acquisition of 24 communities, in October 2011 we purchased an interest rate cap for a cash payment of $1.6 million. This contract effectively caps LIBOR on a notional amount of $132.0 million at 2.50% over the term of the loan. The contract expires in June 2016.

As of March 31, 2014, the combined fair value of our interest rate caps was $158,000, which is included in other assets, net, in the condensed consolidated balance sheet (Note 9).

Note 7. Loss Per Share

Potential dilutive shares consist of the incremental common shares issuable upon the exercise of outstanding stock options (both vested and unvested) using the treasury stock method. Potential dilutive shares are excluded from the computation of earnings

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

per share if their effect is antidilutive. As of March 31, 2014 and 2013, we had outstanding stock options totaling 3.1 million and 4.0 million, respectively, that were excluded from the computation of net loss per share because they were antidilutive.

Performance-based restricted and unvested shares, totaling 884,432 shares as of March 31, 2014, are included in total outstanding shares but are excluded from the loss per share calculation until the related performance criteria have been met.

Note 8. Liquidity

As of March 31, 2014, we had a working capital deficit of $139.4 million compared to a working capital deficit of $137.6 million at December 31, 2013. We are 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, and we have historically refinanced or extended maturities of debt obligations as they become current liabilities. Our operations 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 as of March 31, 2014 included the following non-cash items: a $48.1 million deferred tax asset and, as part of current liabilities, $59.0 million of deferred revenue and unearned rental income. Additionally, a $61.9 million deferred tax liability is included in other long-term liabilities as of March 31, 2014. 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 (i) fluctuations in the timing of vendor payments and (ii) $94.4 million in final (“balloon”) payments of principal on long-term debt maturing in the next 12 months, which is included in current portion of long-term debt as of March 31, 2014. Also included in the current portion of long-term debt is $3.7 million related to a community that is held for sale as of March 31, 2014 (Note 12), which will be repaid with the proceeds from the sale when completed.

Since 2008, we have refinanced and extended the terms of a substantial amount of our existing debt obligations. Balloon payments of principal on long-term debt maturing in the next 12 months are expected to be repaid, refinanced, or extended. 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. From time to time, we have failed to comply with certain covenants in our financing and lease agreements relating generally to matters such as cash flow, debt, and lease coverage ratios, and certain other performance standards. In the future, we may be unable to comply with these or other covenants. If we fail to comply with any of these requirements and are not able to obtain waivers, our lenders could accelerate the repayment of the related indebtedness so that it becomes due and payable prior to its stated due date, and/or the lessors could terminate lease agreements.

In the three months ended March 31, 2014 and 2013, we reported net cash used by operating activities of $2.0 million and net cash provided by operating activities of $27.8 million, respectively, in our condensed consolidated statements of cash flows. The deficit in the current period is due primarily to the timing of vendor payments. Net cash provided by operating activities has not always been sufficient to pay all of our long-term obligations and we have been dependent upon third-party financing or disposition of assets to fund operations. We cannot guarantee that, if necessary in the future, such transactions will be available on a timely basis or at all, or on terms attractive to us.

As discussed above, we expect to repay, refinance or extend our balloon payments due in the next 12 months. If we are unable to do so, or if additional principal payments are required as a result of covenant violations, we believe the Company would be able to generate sufficient cash flows to support its operating and investing activities for at least the next 12 months by reducing or delaying its capital expenditures and operating expenses, selling communities or a combination thereof. However, we will be required to refinance or extend a portion of our debt in order to meet our financing obligations in the next 12 months.

In connection with Emeritus’ guarantees of certain debt and lease agreements, we are required at all times to maintain a minimum $20.0 million balance of unencumbered liquid assets, defined as cash, cash equivalents and/or publicly traded/quoted marketable securities. As a result, $20.0 million of our cash on hand is not available to fund operations and we take this into account in our cash management activities.

Note 9. Fair Value Disclosures

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

The following table presents information about our assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, 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 as of
	for Identical		Observable		Unobservable		March 31,
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		2014
Assets
Investment securities - trading	$	7,692	$	—	$	—	$	7,692
Interest rate cap agreement	—		158		—		158



	Quoted Prices in		Significant
	Active Markets		Other		Significant		Balance as of
	for Identical		Observable		Unobservable		December 31,
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		2013
Assets
Investment securities - trading	$	7,394	$	—	$	—	$	7,394
Interest rate cap agreement	—		229		—		229

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.

We have financial instruments other than investment securities consisting of cash equivalents, other receivables, tax and maintenance escrows, workers’ compensation collateral accounts, and long-term debt. As of March 31, 2014 and December 31, 2013, the fair values of other receivables, tax and maintenance escrows, and workers’ compensation collateral accounts approximate their carrying values based on their short-term nature as well as current market indicators, such as prevailing interest rates (Level 2 inputs). The fair value of our long-term debt is as follows as of the periods indicated (in thousands):



	March 31, 2014				December 31, 2013
	Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value
Long-term debt	$	1,478,520	$	1,511,755	$	1,498,231	$	1,533,192

We estimated the fair value of debt obligations using discounted cash flows based on our assumed incremental borrowing rate of 10.0% for unsecured borrowings and 5.3% for secured borrowings (Level 2 inputs).

Impairments of Long-Lived Assets

We designate communities as held for sale when it is probable that the properties will be sold. As a result, we may record impairment losses and carry these assets on our balance sheet at fair value less estimated selling costs. Such losses are included in discontinued operations in the condensed consolidated statements of operations. We determine the fair value of the properties based primarily on purchase and sale agreements from prospective purchasers (Level 2 input). In periods prior to designating the properties as held for sale, when a triggering event occurs, we test these properties for recoverability by applying probability

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

weighting to the estimated undiscounted future cash flows of the communities based on the probability of selling the properties versus continuing to operate them.

In the first quarter of 2014, we recorded an impairment charge of $1.0 million on one community, as we determined that the undiscounted future cash flows would not be adequate to recover the carrying value of the long-lived assets. We determined the fair value of the community based on recent offer activity (Level 2 input).

Also in the first quarter of 2014, we recorded impairment charges totaling $1.4 million related to two communities that we designated as held for sale (Note 12). The impairment charges are included in loss from discontinued operations. We determined the fair values of these communities based on purchase and sale agreements (Level 2 input).

Note 10. Income Taxes

Our income tax accruals include liabilities for unrecognized tax benefits, including penalties and interest, that we recorded in connection with our acquisition of Summerville Senior Living, Inc. ("Summerville") in 2007. These liabilities, which totaled $104,000 as of March 31, 2014, 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.

We record deferred income taxes based on the estimated future tax effects of loss carryforwards and temporary differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We record a valuation allowance to reduce the Company’s deferred tax assets to the amount that is more likely than not to be realized. Deferred tax assets are recorded as current assets in the condensed consolidated balance sheets and amounted to $48.1 million and $49.2 million as of March 31, 2014 and December 31, 2013, respectively. Deferred tax liabilities amounted to $61.9 million and $62.9 million as of March 31, 2014 and December 31, 2013, respectively, which are included in other long-term liabilities in the condensed consolidated balance sheets.

Because the Company fully reserves its deferred tax assets, no net tax effects were allocated to the components of other comprehensive loss.

Note 11. Contingencies

The Company has been, is currently, and expects in the future to be involved in claims, lawsuits, and regulatory and other governmental audits, investigations and proceedings arising in the ordinary course of business. These claims, lawsuits and other matters are similar to those to which other companies in the senior living and healthcare industries are subject. The defense of these claims, lawsuits and governmental audits, investigations and proceedings, certain of which allege large damage amounts, may require us to incur significant expense.

We utilize a combination of self-insurance reserves and commercial insurance policies in amounts and with coverage and deductibles that we believe are adequate, based on the nature and risks of our business, historical experience and industry standards. We cannot predict the ultimate outcome of any pending litigation, claims, or regulatory and other governmental audits, investigations and proceedings. Certain of these matters are not covered by insurance and, in any event, there is no assurance that our actual costs or damages related to any such matter will not exceed such self-insurance accruals or applicable insurance policy limits. Payments for self-insurance claims are made from the Company's available cash resources.

Merger Litigation

In connection with the Merger, three purported class action lawsuits have been filed on behalf of Emeritus shareholders in the Superior Court of King County, Washington: Tampa Maritime Association/International Longshoremen’s Association Pension Fund v. Emeritus Corp., et al., Case No. 14-2-06385-7-SEA, filed February 28, 2014; Sciabacucchi v. Emeritus Corp., et al., Case No. 14-2-06946-4-SEA, filed March 6, 2014; and Ellerson v. Emeritus Corp., et al., Case No. 14-2-07502-2-SEA, filed March 14, 2014. It is possible that other related suits could subsequently be filed. Emeritus anticipates that the three pending cases and any related cases that are subsequently filed will be consolidated and proceed as a single, consolidated case.

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

the Merger. Specifically, the complaints allege that the Emeritus Board of Directors undervalued Emeritus in connection with the Merger and that the Emeritus Board of Directors agreed to certain deal protection mechanisms that precluded Emeritus from obtaining competing offers. The Sciabacucchi complaint also alleges that the Emeritus Board of Directors breached its fiduciary duties by failing to disclose all material information concerning the Merger to Emeritus’ shareholders. The three complaints also allege that Brookdale, Emeritus and Merger Sub aided and abetted the Emeritus Board of Directors’ alleged breaches of fiduciary duties. The complaints seek, among other things, injunctive relief, including rescission of the Merger, and damages, including counsel fees and expenses. We are currently unable to predict the outcome of these matters nor a reasonable range of potential losses.

Other Legal Proceedings

On June 4, 2013, in Joan Boice et al. v. Emeritus Corporation et al., the Sacramento County Superior Court entered final judgment in favor of Joan Boice (deceased) and against the Company in the amount of $250,000 in compensatory damages and $23.0 million in punitive damages for alleged elder abuse. Judgment was also entered in favor of Joan Boice’s three adult children for $250,000 and the court awarded the plaintiffs’ lawyer over $4.1 million in attorneys’ fees. On July 8, 2013, we filed a Notice of Appeal. We were required to post a bond in connection with our appeal, and made a cash deposit in the amount of $20.9 million to collateralize the bond, which is included in restricted deposits and escrows in the condensed consolidated balance sheets. This matter has been taken into consideration in our self-insurance accruals.

On July 29, 2013, a claim alleging the failure to provide certain services at our California assisted living communities was filed against the Company in the Alameda County Superior Court and subsequently removed to the United States District Court for the Northern District of California. In this case, the plaintiff is seeking to represent a class of residents at such California communities during the period beginning July 29, 2009. The plaintiff alleges violations of certain laws, including California’s Consumer Legal Remedies Act, Unfair Competition Law and Financial Elder Abuse statute. We believe that the suit is without merit and have filed a motion to dismiss the action in its entirety. At this time we are unable to estimate a possible range of loss.

Governmental Investigation

On March 29, 2013, we received a civil investigative demand (“CID”) from the Western District of the Washington office of the United States Department of Justice (“DOJ”) requesting certain documents related to Emeritus billing to Medicaid programs dating from January 1, 2008. The CID was issued in connection with an investigation undertaken by the DOJ and other agencies into Emeritus bills to Medicaid programs for assisted living facility services provided to Medicaid residents who may have been hospitalized during billed dates of service.

We are cooperating with the DOJ in connection with its investigation. We are currently unable to predict the outcome of this matter nor a reasonable range of potential losses.

Self-Insurance Accruals

As of March 31, 2014 and December 31, 2013, we have recorded a liability related to self-insured professional and general claims, including known claims, incurred but not yet reported claims, and legal fees, of $35.8 million and $36.1 million, respectively. We believe that the range of reasonably possible losses as of March 31, 2014, based on sensitivity testing of the various underlying actuarial assumptions, is approximately $34.2 million to $51.5 million. The high end of the range reflects the potential for high-severity losses.

Communities not in the self-insurance pool are insured under commercial policies that provide for deductibles for each claim ranging from $50,000 to $250,000. As a result, the Company is, in effect, self-insured for claims that are less than the deductibles. The net liability for known claims and incurred but not yet reported claims was $9.8 million and $8.9 million as of March 31, 2014 and December 31, 2013, respectively (the gross liability was $18.8 million and $16.5 million with corresponding estimated amounts receivable from the insurance companies of $9.0 million and $7.6 million, respectively).

The total gross liability for professional and general claims as of March 31, 2014 and December 31, 2013 was $54.6 million and $52.6 million, respectively, of which $17.4 million and $17.2 million is included in accrued insurance liabilities, with the balance recorded in other long-term liabilities. Of the related amounts receivable from insurance companies as of March 31,

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013

2014 and December 31, 2013, $3.6 million and $3.0 million , respectively, is included in other receivables and $5.4 million and $4.6 million, respectively, is included in other assets, net, in the condensed consolidated balance sheets.

We are self-insured for workers’ compensation risk (except in five states) up to $500,000 per claim through a high deductible, collateralized insurance program. The liability for self-insured known claims and incurred but not yet reported claims was $46.0 million and $44.5 million at March 31, 2014 and December 31, 2013, respectively, of which $13.4 million and $13.1 million is included in accrued insurance liabilities as of March 31, 2014 and December 31, 2013, respectively, with the balance recorded in other long-term liabilities. We believe that the range of reasonably possible losses as of March 31, 2014, based on sensitivity testing of the various underlying actuarial assumptions, is approximately $44.2 million to $49.9 million.

For health insurance, we self-insure each participant up to $350,000 per year, above which a catastrophic insurance policy covers any additional costs. The liability for self-insured incurred but not yet reported claims is included in accrued insurance liabilities in the condensed consolidated balance sheets and was $8.7 million and $8.5 million at March 31, 2014 and December 31, 2013, respectively.

Note 12. Discontinued Operations

Net losses from discontinued operations for the three months ended March 31, 2014 represent net losses on the sales of communities and related impairment charges and transaction costs (Note 9). During the three months ended March 31, 2014, we sold three communities and two other communities are classified as held-for-sale as of March 31, 2014. Revenues and expenses related to these communities were not material to the consolidated statements of operations and thus have not been reclassified to discontinued operations.

Note 13. Segment Information

The Company currently has three operating segments, which are ancillary services, the HCP Leased Communities, and the legacy Emeritus communities. Operating segments are defined as components of an enterprise that engage in business activities from which it may earn revenues and incur expenses; for which separate financial information is available; and whose operating results are regularly reviewed by the chief operating decision maker ("CODM") to assess the performance of the individual segment and make decisions about resources to be allocated to the segment.

For financial reporting purposes, the HCP Leased Communities and legacy Emeritus communities meet applicable aggregation criteria and are therefore combined into one reportable segment, which is assisted living and related services ("Senior Living"). The "all other" category includes our ancillary services segment. The accounting policies of our reportable segments are the same as those described in the summary of significant accounting policies in Note 2, except as noted below.

The following table sets forth certain segment financial data and does not include reimbursed costs incurred on behalf of managed communities (in thousands). Further, the segment information corresponds to the level of information regularly reviewed by our CODM. Unallocated amounts include corporate revenues and expenses, capital lease adjustments, and certain unallocated community revenues and expenses.

EMERITUS CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Three Months Ended March 31, 2014 and 2013



	Three Months Ended March 31, 2014
	Senior
	Living			All Other		Unallocated			Totals

Community and ancillary services revenue (a)	$	466,290		$	44,770	$	2,757		$	513,817
Management fees	—			—		703			703
Community and ancillary services operations expenses	315,501			35,540		675			351,716
General and administrative expenses	—			3,957		25,687			29,644
EBITDAR (b)	150,789			5,273		(22,902		)	133,160
Lease expense	92,922			1,345		(42,042		)	52,225
EBITDA (c)	57,867			3,928		19,140			80,935
Interest expense	20,715			—		49,654			70,369
Depreciation and amortization	19,883			—		26,345			46,228
Other (revenue) and expense, net	(137		)	—		11,249			11,112
Segment profit (loss)	$	17,406		$	3,928	$	(68,108	)	$	(46,774	)

	Three Months Ended March 31, 2013
	Senior
	Living			All Other		Unallocated			Totals

Community and ancillary services revenue (a)	$	422,329		$	41,357	$	(967	)	$	462,719
Management fees	—			—		785			785
Community and ancillary services operations expenses	284,937			31,458		7,346			323,741
General and administrative expenses	—			4,258		25,182			29,440
EBITDAR (b)	137,392			5,641		(32,710		)	110,323
Lease expense	74,854			1,134		(44,024		)	31,964
EBITDA (c)	62,538			4,507		11,314			78,359
Interest expense	22,646			—		49,553			72,199
Depreciation and amortization	19,232			—		25,986			45,218
Other (revenue) and expense, net	(309		)	—		(190		)	(499		)
Segment profit (loss)	$	20,969		$	4,507	$	(64,035	)	$	(38,559	)

(a) All revenue is earned from external third parties in the United States.

(b) EBITDAR is defined as earnings before interest, taxes, depreciation, amortization and rent (lease) expense and represents the measure of profitability used by our CODM to evaluate the Senior Living segment. The Senior Living data set forth above do not include adjustments related to capital leases and certain unallocated revenues and expenses.

(c) EBITDA is defined as EBITDAR less lease expense and represents the measure of profitability used by our CODM to evaluate our ancillary services segment, the primary component of the All Other category. Lease expense for Senior Living represents cash rent payments on operating and capital leases.



	As of March 31, 2014
	Senior
	Living		All Other		Totals
Total Assets	$	4,393,980	$	147,594	$	4,541,574
Goodwill	134,694		54,688		189,382

	As of December 31, 2013
	Senior
	Living		All Other		Totals
Total Assets	$	4,448,769	$	145,879	$	4,594,648
Goodwill	134,938		54,688		189,626

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

The disclosure and analysis in this Quarterly Report on Form 10-Q contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. They often include words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “predict,” “seek,” “should,” “will,” or the negative of those terms, or comparable terminology. These forward-looking statements are all based on currently available operating, financial and competitive information and are subject to various risks and uncertainties. Our actual future results and trends may differ materially depending on a variety of factors, including, but not limited to, the risks and uncertainties discussed under Risk Factors and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K filed with the Securities and Exchange Commission.

These statements include those regarding the closing of the Merger transaction, the expected timing of the Merger transaction, the anticipated benefits of the proposed Merger, including future financial and operating results, and the potential effects of the Merger transaction, including if it does not close. Any or all of our forward-looking statements in this report may turn out to be inaccurate. 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 our 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 are including this cautionary note to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for forward-looking statements. We expressly disclaim any obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise. You are advised, however, to consult any further disclosures we make in our quarterly reports on Form 10-Q and current reports on Form 8-K.

Overview

Our Business

We are one of the largest and fastest-growing operators of senior living communities in the United States. We own and operate a portfolio of high-quality, purpose-built communities providing resident services including independent living, assisted living, specialized Alzheimer’s/dementia care (“memory care”), and, to a lesser extent, skilled nursing care. Beginning in the fourth quarter of 2012, we added home healthcare to our service offerings through our acquisition of Nurse On Call, Inc. (“NOC”).

We strive to provide a wide variety of supportive living services in a professionally staffed environment that enables seniors to live with dignity and independence. Our holistic approach enhances every aspect of our residents’ lives by assisting them with life enrichment activities including transportation, socialization and education, housing and 24-hour personal support services, such as medication management, bathing, dressing, personal hygiene and grooming. The average age of our residents is 85. As of March 31, 2014, we owned 183 communities and leased 311 communities. These 494 communities comprise the communities included in the condensed consolidated financial statements and are referred to as our “Consolidated Portfolio.”

We also provide management services to independent and related-party owners of senior living communities. As of March 31, 2014, we managed 14 communities, three of which are owned by joint ventures in which we have a financial interest. The communities we manage for others, combined with our Consolidated Portfolio, are referred to as our “Operated Portfolio.”

Merger Agreement with Brookdale

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

with and into Emeritus (the “Merger”), and Emeritus will continue as the surviving corporation of the Merger and as a wholly owned subsidiary of Brookdale.

The consummation of the Merger is subject to customary closing conditions, including, among others, (i) obtaining approval of the Emeritus shareholders holding a majority of the outstanding shares of Emeritus common stock and approval of the Brookdale shareholders holding a majority of the outstanding shares of Brookdale common stock, (ii) absence of legal impediments preventing consummation of the Merger; (iii) the effectiveness under the Securities Act of 1933, as amended, of the Registration Statement on Form S-4 relating to the issuance of the shares of Brookdale common stock in the Merger, (iv) approval by the New York Stock Exchange of the listing of the shares of Brookdale common stock to be issued in the Merger, (v) the receipt of required regulatory approvals and lender consents; (vi) the delivery of opinions from counsel to each of Emeritus and Brookdale to the effect that the Merger will be treated as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended; (vii) Emeritus shareholders holding no more than 7.5% dissenting from the merger; and (viii) the absence of a material adverse effect with respect to Emeritus or Brookdale, as well as other conditions to closing as are customary in transactions such as the Merger.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

the Merger Agreement under specified circumstances, including, among others, a change in the recommendation of the non-terminating party’s board of directors or termination of the Merger Agreement to enter into a definitive agreement for a “superior proposal;” provided, however, that, in the case of Emeritus, Emeritus will be required to pay Brookdale a break-up fee of $53.0 million, and in the case of Brookdale, Brookdale will be required to pay Emeritus a break-up fee of $143.0 million.

The foregoing description of the Merger Agreement is only a summary, does not purport to be complete, and is qualified in its entirety by reference to the full text of the Merger Agreement which was included as an exhibit to Emeritus' Current Report on Form 8-K dated February 20, 2014, which can be found in Emeritus' SEC filings at www.sec.gov.

Summary of Activity

A summary of activity for the first three months of 2014, compared to the same period for 2013, is as follows:


•	Total operating revenues increased $49.5 million, or 10.5%, to $521.8 million from $472.4 million for the prior-year period, due primarily to the lease acquisition of the 38 Merrill Garden Communities in September 2013 and growth in the NOC business.

•

Operating income from continuing operations decreased $9.2 million to $23.3 million from $32.5 million for the prior-year period. Included in operating income in the 2014 period were transaction costs of $10.4 million (related primarily to the pending Merger) and impairment charges of $1.0 million. Our net loss attributable to Emeritus Corporation common shareholders was $48.4 million compared to $39.8 million for the prior-year period.


•	Average occupancy of the Consolidated Portfolio increased to 88.0% from 86.4% for the prior-year period.


•	Average rate per occupied unit in the Consolidated Portfolio decreased 0.7% to $3,986 from $4,012 for the prior-year period. This is primarily due to the acquisition of the Merrill Gardens Communities, which have a higher proportion of independent living units with lower rates than assisted living units.

Our Portfolios

As of March 31, 2014, we operated 508 senior living communities in 45 states. Our Consolidated Portfolio had a capacity of approximately 52,000 residents and our Operated Portfolio had a capacity of approximately 54,000 residents. The following table sets forth a comparison of our Consolidated and Operated Portfolios:



	March 31, 2014		December 31, 2013		March 31, 2013
	Community Count	Unit Count (b)	Community Count	Unit Count (b)	Community Count	Unit Count (b)
Owned	183	15,241	186	15,476	192	16,157
Leased(a)	311	29,697	311	29,697	274	25,199
Consolidated Portfolio	494	44,938	497	45,173	466	41,356
Managed	11	1,226	12	1,301	13	1,381
Managed - Joint Ventures	3	198	3	198	4	357
Operated Portfolio	508	46,362	512	46,672	483	43,094


(a)	As of March 31, 2014, we accounted for 116 of the 311 leased communities as operating leases and 195 as capital or financing leases. We do not include the assets and liabilities of the 116 operating lease communities on our condensed consolidated balance sheets.


(b)	For skilled nursing, beds are considered a unit.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Our Total Operated Portfolio as of March 31, 2014 consisted of the following unit types:



	Units by Type of Service
	AL (a)	MC (b)	IL (c)	SN (d)	Other (e)	Total
Owned	10,913	2,865	1,063	208	192	15,241
Leased	19,582	3,778	5,087	961	289	29,697
Consolidated Portfolio	30,495	6,643	6,150	1,169	481	44,938
Managed	636	215	247	25	103	1,226
Managed - Joint Ventures	122	76	—	—	—	198
Operated Portfolio	31,253	6,934	6,397	1,194	584	46,362


(a)	Assisted living


(b)	Memory care


(c)	Independent living


(d)	Skilled nursing beds


(e)	Units taken out of service

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

Transactions completed in 2013 and during the first three months of 2014 are summarized below.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013



	Transaction Period	Unit Count	Transaction Type	r in Owned Count		r in Leased Count		r in Managed Count
Count as of December 31, 2012				192		269		22

2013 Activity
Necanicum Village	Feb 2013	80	Disposition	—		—		(1	)
Emeritus at Diablo Lodge	Mar 2013	118	Acquisition	—		1		—
HCP Transaction - delayed close properties	Mar 2013	—	Acquisition	—		4		(4	)
Big Sky	Apr 2013	159	Disposition	—		—		(1	)
Emeritus at Roseville Gardens	Apr 2013	—	Acquisition	1		(1	)	—
Sunshine Village	Apr 2013	84	Disposition	(1	)	—		—
Emeritus at Pinellas Park	May 2013	97	Disposition	—		(1	)	—
Emeritus at Augusta	May 2013	50	Disposition	(1	)	—		—
Emeritus at Fulton Villa	Jun 2013	80	Disposition	—		—		(1	)
Emeritus at Springtree	Jun 2013	—	Sale-leaseback	(1	)	1		—
Emeritus at Halcyon Village	Jul 2013	76	Acquisition	—		1		—
Terrace at Jasper	Jul 2013	62	Disposition	(1	)	—		—
Emeritus at West Park Place	Aug 2013	123	Disposition	(1	)	—		—
HCN - Merrill Gardens	Sep 2013	4,406	Acquisition	—		38		—
Emeritus at Escondido	Nov 2013	84	Disposition	(1	)	—		—
Emeritus at Emerald Estates	Dec 2013	119	Disposition	(1	)	—		—
Emeritus at Silverdale	Dec 2013	46	Disposition	—		(1	)	—

Count as of December 31, 2013				186		311		15

2014 Activity
Emeritus at Olive Grove	Jan 2014	98	Disposition	(1	)	—		—
Emeritus at Fort Myers	Jan 2014	77	Disposition	(1	)	—		—
Emeritus at Beneva Park	Jan 2014	96	Disposition	—		—		(1	)
Emeritus at Canton	Feb 2014	82	Disposition	—		—		(1	)
Emeritus at Decatur	Mar 2014	60	Disposition	(1	)	—		—
Emeritus at Newell Creek	Mar 2014	103	Managed	—		—		1

Count as of March 31, 2014				183		311		14

Results of Operations

Sources of Revenues

We generate revenues by providing senior housing and related healthcare services to the senior population. We are the largest provider of assisted living and memory care services in the United States, with a capacity for approximately 54,000 residents. Assisted living and memory care units comprise 82.4% of our total Operated Portfolio.

The two basic drivers of our community revenues are the rates we charge our residents and the occupancy levels we achieve in our communities. In evaluating the rate component, we 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 track the 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 rely primarily on our residents' ability to pay our charges for senior living services from their own or family resources and expect that we will do so for the foreseeable future. Private pay revenues represented 81.2% of our consolidated community and ancillary services revenues and 88.8% of our senior living revenues in the first three months of 2014. We believe that only

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

residents with income or assets meeting or exceeding the regional median can afford to reside in our communities, and that the rates we charge and our occupancy levels are interrelated. Therefore, we continuously evaluate rate and occupancy in each community to find the optimal balance so that we can benefit from our increasing capacity and anticipated future occupancy increases.

Revenues from government reimbursement programs, which are the federal Medicare and state Medicaid programs, represented 18.8% of our consolidated community and ancillary revenues in the first three months of 2014 compared to 20.4% in the comparable 2013 period. The decrease in government reimbursed revenues is primarily due to our lease acquisition of the Merrill Garden Communities, which consists primarily of private pay revenues. Future changes in revenues from Medicare and Medicaid programs in our existing communities will depend upon factors that include resident mix, levels of acuity among our residents, overall occupancy and government reimbursement rates.

There continue to be various federal and state legislative and regulatory proposals to implement cost containment measures that would limit payments to healthcare providers in the future. For example, on April 1, 2013, the mandated 2.0% reduction in Medicare payments under the Budget Control Act of 2011 went into effect. These cuts cannot be offset through higher co-pays or other charges to patients. Although we can offset a portion of Medicare cuts through targeted expense reductions, the expense reductions did not fully offset the revenue decrease.

In 2013, the Centers for Medicare & Medicaid Services ("CMS") issued a rule to update Medicare payment rates for home health agencies, resulting in rebasing adjustments over a four-year period beginning in January 2014. CMS estimates that net payments to home health agencies will decrease by approximately 1.05% in 2014.

We also earn management fee revenues by managing certain communities for third parties, including communities owned by related parties and by joint ventures in which we have an ownership interest. The majority of our management agreements provide for fees equal to 5.0% of gross revenues.

In addition to our monthly management fee, we receive reimbursement for operating expenses of managed communities. Reimbursed operating expenses for which the Company is the primary obligor are reported as costs incurred on behalf of managed communities and included in total operating expense in our condensed consolidated statements of operations. A corresponding amount of revenue is recognized in the same period in which the expense is incurred and the Company is due reimbursement.

Same Community Portfolio Analysis

Of the 494 communities included in our Consolidated Portfolio as of March 31, 2014, we include 448 communities in our Same Community Portfolio. Our Same Community Portfolio consists of consolidated communities that we have continuously operated since January 1, 2013, and does not include properties where new expansion projects were opened during the comparable periods, communities in which we substantially changed the service category offered, or communities accounted for as discontinued operations.

Selected data from our Same Community Portfolio is as follows:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change ^(a) (b)

	(in thousands, except percentages)
Community revenue	$	420,002		$	414,052		$	5,950		1.4	%
Community operations expense	(284,720		)	(277,854		)	(6,866		)	(2.5	)%
Community operating income	$	135,282		$	136,198		$	(916	)	(0.7	)%

Average monthly revenue per occupied unit	$	4,058		$	4,040		$	18		0.5	%
Average occupancy rate	87.6		%	86.7		%				0.9	ppt


(a)	“N/M” indicates percentages that are not meaningful in this analysis. Applies to all subsequent tables in this section.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013


(b)	“ppt” refers to percentage points. Applies to all subsequent tables in this section.

Revenues from our Same Community Portfolio represented 89.5% of our total community revenue for the first quarter of 2014. The increase in same community revenues was due primarily to improvements in occupancy.

The increase in operating expense from the Same Community Portfolio includes a $2.1 million increase in utilities and maintenance costs as a result of unusually severe winter weather, as well as increases in marketing and insurance expenses.

Comparison of the Three Months Ended March 31, 2014 and 2013

Net Loss Attributable to Emeritus Corporation Common Shareholders

We reported a net loss attributable to Emeritus common shareholders of $48.4 million for the three months ended March 31, 2014, compared to a net loss of $39.8 million in the prior-year period. As further described in the section Liquidity and Capital Resources below, the Company has incurred significant losses since its inception, but has generated annual positive cash flow from operating activities since 2001. The $8.7 million increase in net loss was due primarily to the transaction costs and impairment charges incurred during the first quarter of 2014.

The details of each of the components of net loss are set forth below.

Total Operating Revenues:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Same Community Portfolio	$	420,002		$	414,052		$	5,950		1.4	%
Acquisitions, dispositions, development and expansion	48,380			7,128			41,252			N/M
Ancillary services	44,770			41,357			3,413			8.3	%
Unallocated community revenue (a)	665			182			483			265.3	%
Community and ancillary services revenue	513,817			462,719			51,098			11.0	%
Management fees	703			785			(82		)	(10.4	)%
Reimbursed costs incurred on behalf of managed communities	7,310			8,864			(1,554		)	(17.5	)%
Total operating revenues	$	521,830		$	472,368		$	49,462		10.5	%

Average monthly revenue per occupied unit	$	3,986		$	4,012		$	(26	)	(0.6	)%
Average occupancy rate	88.0		%	86.4		%				1.6	ppt

(a) Comprised primarily of deferred move-in fees.

The increase in revenues of $6.0 million from the Same Community Portfolio was due to increases in both occupancy and average rate compared to the prior-year period. As further described in Same Community Portfolio Analysis above, our Same Community Portfolio consists of those communities that we have continuously operated since January 1, 2013, net of dispositions. Revenues from acquisitions, developments and expansions, which are derived from any communities that we began operating since January 1, 2013 (net of dispositions), increased by $41.3 million due primarily to the September 1, 2013 acquisition of the 38 former Merrill Gardens Communities. The $3.4 million increase in ancillary services revenue was the result of growth in our NOC business over the periods.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Community and Ancillary Services Operating Expense:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Same Community Portfolio	$	284,720		$	277,854		$	6,866		2.5	%
Acquisitions, dispositions, development, and expansion	29,700			7,191			22,509			N/M
Ancillary services	35,540			31,458			4,082			13.0	%
Unallocated community expenses	1,756			7,238			(5,482		)	N/M
Community operations and ancillary services	$	351,716		$	323,741		$	27,975		8.6	%
As a percentage of total operating revenues	67.4		%	68.5		%				(1.1	) ppt

Community operating expense includes direct costs incurred to operate the communities and includes costs such as payroll and benefits, resident activities, marketing, housekeeping, food service, facility maintenance, utilities, taxes, insurance, and licenses.

Community operating expense in our Same Community Portfolio increased by $6.9 million, as described above under Same Community Portfolio Analysis. We focus on providing the appropriate level of care to our residents, while also pursuing overall expense efficiencies.

Expenses related to acquisitions, developments and expansions, which are derived from any communities that we began operating since January 1, 2013 (net of dispositions), increased by $22.5 million, due primarily to the September 1, 2013 acquisition of the 38 former Merrill Gardens Communities.

Ancillary services expense represents the operating expenses incurred by NOC as well as our durable medical equipment subsidiary, which we sold in December 2013. Ancillary services expense increased by $4.1 million and was driven by growth in our NOC home health care business.

Unallocated community expenses are comprised primarily of self-insurance reserve adjustments.

General and Administrative Expense:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Senior living	$	25,687		$	25,182		$	505		2.0	%
Ancillary services	3,957			4,258			(301		)	(7.1	)%
General and administrative	$	29,644		$	29,440		$	204		0.7	%
As a percentage of total operating revenues	5.7		%	6.2		%				(0.5	)

The increase in general and administrative expenses attributable to our senior living operations primarily reflects increases in professional fees and marketing expenses, offset in part by decreases in other expenses Ancillary services represents the general and administrative expenses incurred by NOC as well as our durable medical equipment subsidiary, which we sold in December 2013.

Senior living general and administrative expense as a percentage of community operating revenues for our Operated Portfolio was 5.3% and 5.8% (4.7% and 5.0% excluding stock compensation expense) for the three-month periods ended March 31, 2014 and 2013, respectively. We focus on overhead expense efficiencies, while ensuring adequate infrastructure to support our operational needs.

We computed these percentages as follows:

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013



	Three Months Ended March 31,
	2014					2013

	(in thousands, except percentages)
Senior living general and administrative expenses			$	25,687				$	25,182
Sources of revenue:
Owned and leased	$	469,047				$	421,362
Managed	13,512					16,320
Total revenue for all communities in our Operated Portfolio			$	482,559				$	437,682

General and administrative expenses as a percent of
all Operated Portfolio revenue			5.3		%			5.8		%

General and administrative expenses excluding stock-based
compensation as a percent of Operated Portfolio revenue			4.7		%			5.0		%

Transaction Costs:



	Three Months Ended March 31,
	2014			2013			$ Change		% Change

	(in thousands, except percentages)
Transaction costs	$	10,366		$	647		$	9,719	N/M
As a percentage of total operating revenues	2.0		%	0.1		%			1.9	ppt

The increase in transaction costs primarily relates to costs incurred in connection with the pending Merger.

Impairments of Long-Lived Assets:



	Three Months Ended March 31,
	2014			2013			$ Change		% Change

	(in thousands, except percentages)
Impairments of long-lived assets	$	1,023		$	—		$	1,023	N/M
As a percentage of total operating revenues	0.2		%	—		%			0.2	ppt

Impairments of long-lived assets relate to the impairment charge recorded on a 50-unit community in our Consolidated Portfolio (Note 9, Fair Value Disclosures).

Depreciation and Amortization Expense:



	Three Months Ended March 31,
	2014			2013			$ Change		% Change

	(in thousands, except percentages)
Depreciation and amortization	$	46,228		$	45,218		$	1,010	2.2	%
As a percentage of total operating revenues	8.9		%	9.6		%			(0.7	) ppt

The net increase in depreciation and amortization expense represents an increase in depreciation expense of $1.4 million and a decrease in amortization expense of $384,000. The increased depreciation expense is due to capital improvements to our existing communities. The decrease in amortization expense is the result of resident contract intangible assets acquired in

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

business combinations becoming fully amortized subsequent to March 31, 2013, net of an increase in the amortization of lease acquisition costs related to the Merrill Gardens Communities.

Lease Expense:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Operating lease expense	$	45,405		$	30,502		$	14,903		48.9	%
Above/below market rent amortization	1,230			1,246			(16		)	(1.3	)%
Deferred straight-line rent amortization	5,590			216			5,374			N/M
Community leases	$	52,225		$	31,964		$	20,261		63.4	%
As a percentage of total operating revenues	10.0		%	6.8		%				3.2	ppt

The increase in operating lease expense was due to the acquisition of the operating leases of 38 former Merrill Gardens Communities commencing on September 1, 2013, as well as rent escalators on existing leases. Deferred straight-line rent amortization includes a $1.8 million non-cash adjustment to lease expense related to a community that we lease from Ventas subject to a put option, as described in Note 5, Long-Term Debt. The remaining increase is related to the Merrill Gardens Communities. We leased 116 and 80 communities under operating leases as of March 31, 2014 and 2013, respectively.

Costs Incurred on Behalf of Managed Communities:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Costs incurred on behalf of managed communities	$	7,310		$	8,864		$	(1,554	)	(17.5	)%
As a percentage of total operating revenues	1.4		%	1.9		%				(0.5	) ppt

The decrease in costs incurred on behalf of managed communities was due to a decrease in the number of communities that we manage for third parties, including four former Sunwest JV communities that we began leasing in the first quarter of 2013. See Significant Transactions above.

Interest Expense:



	Three Months Ended March 31,
	2014			2013			$ Change			% Change

	(in thousands, except percentages)
Interest expense	$	70,369		$	72,199		$	(1,830	)	(2.5	)%
As a percentage of total operating revenues	13.5		%	15.3		%				(1.8	) ppt

The decrease in interest expense was due primarily to community dispositions and pay-down of corresponding mortgages, as well as repayment of certain high-rate notes payable in 2013.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Loss from Discontinued Operations:



	Three Months Ended March 31,
	2014			2013			$ D			% D

	(in thousands, except percentages)
Loss from discontinued operations	$	(1,539	)	$	—		$	(1,539	)	N/M
As a percentage of total operating revenues	(0.3		)%	—		%				(0.3	) ppt

Loss from discontinued operations for the three months ended March 31, 2014 primarily consists of impairment losses on communities that were sold or held for sale during the period (see Note 12, Discontinued Operations).

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Liquidity and Capital Resources

As of March 31, 2014, we had cash and cash equivalents of $58.7 million, compared to $76.7 million at December 31, 2013.

The Company has incurred significant operating losses since its inception, and we had working capital deficits of $139.4 million and $137.6 million as of March 31, 2014 and December 31, 2013, respectively. Due to the nature of our business, it is not unusual to operate in the position of a working capital deficit because we collect revenues much more quickly, often in advance, than we are required to pay obligations, and we have historically refinanced or extended maturities of debt obligations as they become current liabilities. Our operations result in a very low level of current assets primarily stemming from our deployment of cash to pursue strategic business development opportunities or to pay down long-term liabilities. Along those lines, the working capital deficit as of March 31, 2014 included a $48.1 million deferred tax asset and, as part of current liabilities, $59.0 million of deferred revenue and unearned rental income. A $61.9 million deferred tax liability is included in other long-term liabilities. 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, except for (i) fluctuations in the timing of vendor payments and (ii) $94.4 in balloon payments of principal on long-term debt maturing during the next 12 months, which is included in current portion of long-term debt as of March 31, 2014. We intend to refinance, extend, or retire these obligations prior to their maturities. There can be no assurance that we will be able to obtain such refinancing or be able to retire the obligations.

Also included in the current portion of long-term debt is $3.7 million related to one community held for sale as of March 31, 2014 (see Note 12, Discontinued Operations). This debt will be repaid with the proceeds from the sale.

Sources and Uses of Cash

We expect to use our cash primarily to invest in our core business as well as other new business opportunities related to our core business. As discussed above, we expect to refinance or extend our balloon payments of debt principal in the next 12 months; however, if we are unable to do so, we believe the Company would be able to generate sufficient cash flows to support its operating and investing activities for at least the next 12 months by reducing or delaying capital expenditures and operating expenses, selling communities or a combination thereof. However, we will be required to refinance or extend a portion of our debt in order to meet our financing obligations in the next 12 months. In connection with Emeritus’ guarantees of certain debt and lease agreements, we are required at all times to maintain a minimum $20.0 million balance of unencumbered liquid assets, defined as cash, cash equivalents and/or publicly traded/quoted marketable securities. As a result, $20.0 million of our cash on hand is not available to fund operations and we take this into account in our cash management activities.

We may use our available cash resources for acquisitions and other investments in support of our growth strategy. Significant acquisitions and/or other new business opportunities will likely require additional outside funding. We do not plan to pay cash dividends to our common shareholders in the foreseeable future.

Other than normal operating expenses and debt payments, we expect that cash requirements for the next 12 months will consist primarily of capital expenditures. We expect to increase expenditures both to preserve and maintain our communities as well as to reposition or otherwise invest in return-generating projects. We also expect to invest in systems and technology in the communities and in our overall support infrastructure.

The following is a summary of cash flow information for the periods indicated (in thousands):



	Three Months Ended March 31,
	2014			2013

Net cash (used in) provided by operating activities	$	(2,012	)	$	27,761
Net cash used in investing activities	(5,021		)	(815		)
Net cash (used in) provided by financing activities	(10,969		)	26,783
Net (decrease) increase in cash and cash equivalents	(18,002		)	53,729
Cash and cash equivalents at the beginning of the period	76,672			59,795
Cash and cash equivalents at the end of the period	$	58,670		$	113,524

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

In the first three months of 2014, cash used in operating activities was $2.0 million, compared to cash provided by operating activities of $27.8 million in the first three months of 2013, a decrease of $29.8 million. This is due primarily to fluctuations in working capital due to the timing of cash receipts and payments to vendors.

Cash used in investing activities during the first three months of 2014 includes capital expenditures totaling $18.0 million used to maintain and improve our communities, partially offset by net proceeds from the sale of three communities totaling $13.9 million. We used cash in investing activities during the first three months of 2013 primarily for capital expenditures totaling $15.9 million, offset by $14.9 million of cash distributions received from unconsolidated joint ventures, primarily the Sunwest JV.

In the first three months of 2014, cash used in financing activities represents payments on long-term debt and capital lease obligations totaling $27.9 million, offset in part by $17.2 million in cash received from the exercise of stock options and sale of stock through our employee stock purchase plan. In the first three months of 2013, financing activities provided $37.8 million in net cash from the sale of stock and exercise of stock options, including $31.3 million from the March 2013 secondary public offering, and $50.0 million of proceeds from the NOC credit facility (net of $3.7 million distributed to the noncontrolling interest holders of NOC). Cash paid for debt and capital lease principal payments totaled $56.0 million, including $42.9 million paid to HCN for early retirement of debt.

As of March 31, 2014, the Company had payment obligations for long-term debt and capital and financing leases due during the next 12 months of approximately $177.5 million.

Payment Commitments

The following table summarizes our contractual obligations as of March 31, 2014 (in thousands):



	Principal Due by Period
									More than
	Total		1 year (a)		2-3 years		4-5 years		5 years
Long-term debt, including current portion	$	1,478,520	$	141,848	$	316,017	$	816,154	$	204,501
Capital and financing leases including current portion	2,515,302		35,671		92,188		123,804		2,263,639
Operating leases	1,870,180		179,912		364,917		361,406		963,945
Liability related to unrecognized tax benefits (b)	104		—		—		—		—
	$	5,864,106	$	357,431	$	773,122	$	1,301,364	$	3,432,085


(a)	Represents all payments due within one year, including balloon payments described elsewhere in this Form 10-Q. Does not include $4.2 million remaining of the $30.0 million capital expenditure commitment for the HCP Leased Communities, which we expect to pay within the next year.


(b)	We have recognized total liabilities related to unrecognized tax benefits of $104,000 as of March 31, 2014. The timing of payments related to these obligations is uncertain; however, we do not expect to pay any of this amount within the next year.

The following table summarizes interest due on our contractual obligations as of March 31, 2014 (in thousands):



	Interest Due by Period
									More than
	Total		1 year		2-3 years		4-5 years		5 years
Long-term debt	$	342,521	$	84,768	$	149,629	$	77,101	$	31,023
Capital and financing lease obligations	4,354,137		162,378		327,393		325,551		3,538,815
	$	4,696,658	$	247,146	$	477,022	$	402,652	$	3,569,838

The amounts above do not include our indirect guarantee of the construction loan payable by one of our Wegman joint ventures ("Vestal"). Emeritus has a 50.0% ownership interest in Vestal which we account for as an unconsolidated equity method

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

investment. As of March 31, 2014, the loan balance for Vestal was $7.2 million, with a variable interest rate at LIBOR (floor of 1.5%) plus 4.0%. Wegman has provided an unconditional guarantee of payment to the lender and is indemnified by Emeritus through a separate agreement. In the event that we would be required to repay this loan, our share of the obligation would be 50.0%.

Financial Covenants and Cross-Defaults

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

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

As of March 31, 2014, the Company had $1.5 billion of mortgage debt and notes payable outstanding, comprised of the following:

•

Mortgage debt financed through Freddie Mac and Fannie Mae of approximately $1.1 billion, or approximately 75.5% of our total debt outstanding. These obligations were incurred to facilitate community acquisitions over the past few years, were issued to single purpose entities (each an “SPE”) and are secured by the assets of each SPE, which consist of the real and personal property and intangible assets of a single community. The debt is generally nonrecourse debt to the Company in that only the assets or common stock of each SPE are available to the lender in the event of default, with some limited exceptions. These debt obligations do not contain provisions requiring ongoing maintenance of specific financial covenants, but do contain typical events of default such as nonpayment of monetary obligations, failure to maintain insurance coverage, fraud and/or misrepresentation of facts, unauthorized sale or transfer of assets, and the institution of legal proceedings under bankruptcy. These debt instruments typically contain cross-default provisions, which are limited to other related loans provided by the specific lender. Remedies under an event of default include the acceleration of payment of the related obligations.

•

Mortgage debt financed primarily through traditional financial lending institutions of approximately $295.9 million, or approximately 20.0% of our total debt outstanding. These obligations were incurred to facilitate community acquisitions over the past few years, and were typically issued to, and secured by, the assets of each SPE, which consist of the real and personal property and intangible assets of a single community. The debt is generally recourse debt to the Company in that not only are the assets or common stock of each SPE available to the lender in the event of default, but the Company has guaranteed performance of each SPE’s obligations under the mortgage. These debt obligations generally contain provisions requiring ongoing maintenance of specific financial covenants, such as debt service coverage ratios, operating income yields, occupancy requirements, and/or net operating income thresholds. Our guarantees generally contain requirements to maintain minimum cash and/or net worth balances. In addition, the mortgages contain other typical events of default such as nonpayment of monetary obligations, failure to maintain insurance coverage, fraud and/or misrepresentation of facts, unauthorized sale or transfer of assets, and the institution of legal proceedings under bankruptcy. These debt instruments may contain cross-default provisions, but are limited to other loans provided by the specific lender. Remedies under an event of default include the acceleration of payment of the related obligations.

•

Mezzanine debt financing in the amount of $21.4 million provided by real estate investment trusts (each a “REIT” and collectively, “REITs") to facilitate community acquisitions, and a $44.4 million loan to NOC, which combined represents approximately 4.5% of our total debt outstanding. The mezzanine debt is unsecured and the NOC credit facility is secured by its personal property and stock. Performance under the NOC credit facility is guaranteed by the Company and includes a requirement to maintain a minimum debt service coverage ratio and cash and net worth balances. Typical events of default under these obligations include nonpayment of monetary obligations, events of default under related lease agreements, and the institution of legal proceedings under bankruptcy. Remedies under an event of default include the acceleration of payments of the related obligations.

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

As of March 31, 2014, we operated 311 communities under long-term lease arrangements, of which 286 were leased from publicly traded REITs. Of the 311 leased properties, 84 contain provisions requiring ongoing maintenance of specific financial covenants, such as rent coverage ratios. Other typical events of default under all of these leases include nonpayment of rents or other monetary obligations, events of default under related lease agreements, and the institution of legal proceedings under bankruptcy. Remedies in these events of default vary, but generally include the requirement to post a security deposit in specified amounts, acceleration of lease payments, and/or the termination of the related lease agreements. As of March 31, 2014, we were in violation of financial covenants in one lease agreement covering four communities. We obtained a waiver from the landlord through March 31, 2014 and therefore are in compliance with those financial covenants.

Off-Balance Sheet Arrangements

We currently have no off-balance sheet arrangements other than community operating leases. For additional information on the community operating leases, see the discussions of Lease Expense contained in the section Results of Operations.

Significant Accounting Policies and Use of Estimates

Significant accounting policies are those that we believe are both most important to the portrayal of our financial condition and results of operations, and require our most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Judgments and uncertainties affecting the application of those policies may result in our reporting materially different amounts under different conditions or using different assumptions.

We believe that our accounting policies regarding asset impairments, goodwill impairment, leases, self-insurance reserves and income taxes are the most critical in understanding the judgments involved in our preparation of our financial statements. Those financial statements reflect our revisions to such estimates in income in the period in which the facts that give rise to the revision become known. For a summary of all of our significant accounting policies, see Note 1, Description of the Business, Basis of Presentation, and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements in our 2013 Annual Report on Form 10-K (“Form 10-K”).

In our Form 10-K, we provide additional analysis of our significant accounting policies in Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Accounting Policies and Use of Estimates. The following is an update to our analysis related to self-insurance reserves.

We use a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for certain risks, including workers’ compensation, employee healthcare benefits, professional and general liability, property insurance, and director and officers’ liability insurance (see Note 11, Contingencies).

We are self-insured for professional liability risk with respect to 265 of the 494 communities in our Consolidated Portfolio. The other 229 communities are insured with conventional indemnity policies. The liability for self-insured incurred but not yet reported claims was $35.8 million and $36.1 million at March 31, 2014 and December 31, 2013, respectively. We believe that the range of reasonably possible losses as of March 31, 2014, based on sensitivity testing of the various underlying actuarial assumptions, is approximately $34.2 million to $51.5 million. The high end of the range reflects the potential for high-severity losses.

Communities not in the self-insurance pool are insured under commercial policies that provide for deductibles for each claim ranging from $50,000 to $250,000. As a result, the Company is, in effect, self-insured for claims that are less than the deductibles. The net liability for known claims and incurred not yet reported claims was $9.8 million and $8.9 million as of March 31, 2014 and December 31, 2013, respectively (the gross liability was $18.8 million and $16.5 million with corresponding estimated amounts receivable from the insurance companies of $9.0 million and $7.6 million, respectively).

We are self-insured for workers’ compensation risk (except in five states) up to $500,000 per claim through a high deductible, collateralized insurance program. The liability for self-insured known claims and incurred but not yet reported claims was $46.0 million and $44.5 million at March 31, 2014 and December 31, 2013, respectively. We believe that the range of reasonably possible losses as of March 31, 2014, based on sensitivity testing of the various underlying actuarial assumptions, is approximately $44.2 million to $49.9 million.

For employee health care benefits, we self-insure each participant up to $350,000 per year above which a catastrophic insurance policy covers any additional costs. The liability for self-insured incurred but not yet reported claims was $8.7 million and $8.5

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

million at March 31, 2014 and December 31, 2013, respectively. A 10.0% change in the estimated liability at March 31, 2014 would have increased or decreased Operated Portfolio expenses during the current period by approximately $870,000.

Liabilities associated with the risks that are retained by Emeritus are not discounted and we estimate them, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions. For professional liability and workers’ compensation claims, we engage third-party actuaries to assist us in estimating the related liabilities. In doing so, we record liabilities for estimated losses for both known claims and incurred but not reported claims. These estimates are based on historical paid and incurred losses and ultimate losses using several actuarial methods. The estimated accruals for these liabilities could be significantly affected if future occurrences and claims differ from these assumptions and historical trends. Changes in self-insurance reserves are recorded as an increase or decrease to expense in the period that the determination is made.

In March 2010, Congress enacted health care reform legislation, referred to as the Affordable Care Act (“ACA”), which we believe will increase our costs to provide healthcare benefits to our employees. The specific provisions of the ACA will be phased in over time through 2018, unless modifying legislation is passed before some of the provisions become effective. The ACA did not have a material financial impact on our Company in the three months of 2014, and we currently do not expect significant cost increases during the remainder of the year.

Impact of Inflation

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 the resident’s unit and assisted living services are influenced by the location of the community and local competition. Our ability to increase revenues in proportion to increased operating expenses may be limited. We typically do not rely to a significant extent on governmental reimbursement programs, which accounted for approximately 18.8% of our community and ancillary services revenues for the three months ended March 31, 2014. 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. Changing economic outlooks in the United States may impact our ability to raise prices. In recent years, inflation has not had a material impact on our financial position, revenues, income from continuing operations, or cash flows. We do not expect inflation affecting the U.S. dollar to materially impact our financial position, results of operations, or cash flows in the foreseeable future.

Non-GAAP Measures

A non-GAAP financial measure is generally defined as one that purports to measure historical financial position, results of operations, or cash flows but excludes or includes amounts that would not be excluded or included in most measures under GAAP.

Definition of Adjusted EBITDA:

We define Adjusted EBITDA as net income (loss) adjusted for the following items:


•	Depreciation and amortization;


•	Interest income;


•	Interest expense;


•	Net equity earnings or losses for unconsolidated joint ventures;


•	Provision for income taxes;


•	Certain noncash revenues and expenses;


•	Transaction costs; and


•	Transition costs (incremental costs to integrate new communities).

We define Adjusted EBITDAR as Adjusted EBITDA plus lease expense, net of amortization of above/below market rents and deferred straight-line rent.

Management’s Use of Adjusted EBITDA/EBITDAR:

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

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

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

Limitations of Adjusted EBITDA/EBITDAR:

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


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


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


•	Depreciation, 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 financial position and results of operations. We use these non-GAAP measures to provide a more complete understanding of the factors and trends affecting our business.

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

The table below shows the reconciliation of net loss to Adjusted EBITDA/EBITDAR for the three months ended March 31, 2014 and 2013 (in thousands):

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013



	Three Months Ended
	March 31,
	2014			2013
Net loss	$	(49,008	)	$	(39,665	)
Depreciation and amortization	46,228			45,218
Interest income	(109		)	(110		)
Interest expense	70,369			72,199
Net equity losses for unconsolidated joint ventures	131			12
Income tax provision	695			1,106
Loss from discontinued operations	1,539			—
Amortization of above/below market rents	1,230			1,246
Amortization of deferred gains	(224		)	(248		)
Gain on early extinguishment of debt	—			(493		)
Stock-based compensation	3,161			3,331
Change in fair value of derivative financial instruments	71			(5		)
Deferred revenue	258			2,088
Deferred straight-line rent	5,590			216
Impairment of long-lived assets	1,023			—
Transaction costs	10,366			647
Transition costs	79			—
Self-insurance reserve adjustments, prior years	2,023			7,482
Adjusted EBITDA	93,422			93,024
Lease expense	45,405			30,502
Adjusted EBITDAR	$	138,827		$	123,526

The table below shows the reconciliation of Adjusted EBITDAR to net cash provided by operating activities for the periods indicated (in thousands):



	Three Months Ended
	March 31,
	2014			2013
Adjusted EBITDAR	$	138,827		$	123,526
Interest income	109			110
Interest expense	(70,369		)	(72,199		)
Income tax provision	(695		)	(1,106		)
Amortization of loan fees	705			790
Allowance for doubtful receivables	2,759			2,172
Change in other operating assets and liabilities	(22,991		)	5,044
Transaction and financing costs	(10,366		)	(647		)
Self-insurance reserve adjustments, prior years	(2,023		)	(7,482		)
Lease expense	(45,405		)	(30,502		)
Non-cash interest expense	7,466			7,975
Other	(29		)	80
Net cash (used in) provided by operating activities	$	(2,012	)	$	27,761

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013

Definition of Cash From Facility Operations:

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


•	Changes in operating assets and liabilities, net;


•	Repayment of capital lease and financing obligations;


•	Recurring capital expenditures; and


•	Distributions from unconsolidated joint ventures, net.

We define Adjusted CFFO as CFFO adjusted for self-insurance reserve adjustments related to prior years, transaction costs and transition costs.

Recurring routine capital expenditures include expenditures capitalized in accordance with GAAP that are funded from CFFO. Amounts excluded from recurring routine capital expenditures consist primarily of community acquisitions, including expenditures incurred in the months immediately following acquisition (and specifically excluding the $30.0 million capital commitment required for the HCP Leased Communities), new construction and expansions, ROI-designated projects, computer hardware and software purchases, and purchases of vehicles.

Management’s Use of Cash From Facility Operations

We use CFFO to assess our overall liquidity and to determine levels of executive compensation. This measure provides an assessment of controllable expenses and affords us the ability to make decisions that facilitate meeting our current financial and liquidity goals as well as achieving optimal financial performance. It provides an indicator for us to determine if we need to make adjustments to our current spending decisions.

This metric measures our overall liquidity based on operational factors that we can influence in the short term, namely the cost structure or expenses of the organization. CFFO is one of the metrics used by us and our board of directors: (i) to review our ability to service our outstanding indebtedness (including our credit facilities and long-term leases); (ii) to assess our ability to make regular recurring routine capital expenditures to maintain and improve our communities on a period-to-period basis; (iii) for planning purposes, including preparation of our annual budget; (iv) in setting various covenants in our credit agreements; and (v) in determining levels of executive compensation.

Limitations of Cash From Facility Operations

CFFO has limitations as an analytical tool. It should not be viewed in isolation or as a substitute for GAAP measures of cash flows from operating activities. CFFO does not represent cash available for discretionary expenditures, since we may have mandatory debt service requirements or other non-discretionary expenditures not reflected in the measure.

We believe CFFO is useful to investors because it assists in their ability to meaningfully evaluate: (i) our ability to service our outstanding indebtedness, including our credit facilities and capital and financing leases; and (ii) our ability to make regular recurring routine capital expenditures to maintain and improve our communities.

CFFO is not an alternative to cash flows provided by or used in operating activities as calculated and presented in accordance with GAAP. You should not rely on CFFO as a substitute for any such GAAP financial measure. We strongly urge you to review the reconciliation of GAAP net cash provided by (used in) operating activities to CFFO, along with our condensed consolidated financial statements included herein. We also strongly urge you not to rely on any single financial measure to evaluate our business. In addition, because CFFO is not a measure of financial performance under GAAP and is susceptible to varying calculations, the CFFO measure as presented in this report may differ from and may not be comparable to similarly titled measures used by other companies.

The following table shows the reconciliation of net cash (used in) provided by operating activities to CFFO for the periods indicated (in thousands):

EMERITUS CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

Three Months Ended March 31, 2014 and 2013



	Three Months Ended
	March 31,
	2014			2013
Net cash (used in) provided by operating activities	$	(2,012	)	$	27,761
Changes in operating assets and liabilities, net	22,991			(5,044		)
Repayment of capital lease and financing obligations	(8,176		)	(6,001		)
Recurring capital expenditures	(4,995		)	(5,661		)
Distributions from unconsolidated joint ventures (a)	79			177
Cash From Facility Operations	7,887			11,232
Transaction costs	10,366			647
Transition costs	79			—
Self-insurance reserve adjustments, prior years	2,023			7,482
Adjusted Cash From Facility Operations	$	20,355		$	19,361

(a) Excludes distributions resulting from the HCP Transaction, the sale of communities and refinancing of debt.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risk from exposure to changes in interest rates due to our financing activities and changes in the availability of credit.

Our results of operations are affected by changes in interest rates as a result of our short-term and long-term borrowings. At March 31, 2014, we had approximately $304.8 million of variable rate borrowings based on LIBOR. Of this total variable rate debt, $78.2 million varies with LIBOR with no LIBOR floors or ceilings. For every 1.0% change in the LIBOR on this $78.2 million in variable rate debt, interest expense will either increase or decrease by $782,000. As of March 31, 2014, the $78.2 million of variable rate debt carried a weighted average variable rate of LIBOR plus 4.65% based on the monthly and 90-day LIBOR rates of 0.152% and 0.230%, respectively. In addition, we have variable rate debt of $226.6 million that has LIBOR floors. At March 31, 2014, this debt carried a weighted average floor of 1.08% and a weighted average spread of 4.02%, for a total weighted average rate of 5.10%. The LIBOR floors effectively make this debt fixed rate debt as long as the monthly LIBOR is less than the 1.08% weighted average floor. Increases or decreases to the monthly LIBOR do not change interest expense on this variable rate debt until the monthly LIBOR rises above the floor and, conversely, interest expense does not decrease when the monthly LIBOR falls below the floor.

This analysis does not consider changes in the actual level of borrowings or lease obligations that may occur subsequent to March 31, 2014. 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 we might be able to take with respect to our financial structure to mitigate the exposure to such a change.

In October 2011, pursuant to the terms of a credit agreement related to the acquisition of 24 communities, we purchased an interest rate cap for $1.6 million. This contract effectively caps the LIBOR on a notional amount of $132.0 million at 2.50% over the term of the loan, and expires in June 2016. (See Note 6, Derivative Financial Instruments.)

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. The Company maintains disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended). Management, under the supervision and with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness and design of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of March 31, 2014. Based on that evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and procedures were effective as of March 31, 2014.

(b) Changes in internal controls. Management has evaluated the effectiveness of our internal controls through March 31, 2014. Through our ongoing evaluation process to determine whether any changes occurred in internal control procedures in the first quarter of 2014, management has concluded that there were no such changes that materially affected, or are reasonably likely to materially affect, our controls over financial reporting.

PART II. OTHER INFORMATION

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

Item 1. Legal Proceedings

Merger Litigation

The allegations in the three lawsuits are similar. They purport to be brought as class actions on behalf of all shareholders of Emeritus. The complaints name as defendants Emeritus, the Emeritus Board of Directors, Brookdale and Merger Sub. The complaints allege that the Emeritus Board of Directors breached its fiduciary duties to Emeritus shareholders by, among other things, failing to maximize shareholder value in connection with the Merger or to engage in a fair sale process before approving the Merger. Specifically, the complaints allege that the Emeritus Board of Directors undervalued Emeritus in connection with the Merger and that the Emeritus Board of Directors agreed to certain deal protection mechanisms that precluded Emeritus from obtaining competing offers. The Sciabacucchi complaint also alleges that the Emeritus Board of Directors breached its fiduciary duties by failing to disclose all material information concerning the Merger to Emeritus’ shareholders. The three complaints also allege that Brookdale, Emeritus and Merger Sub aided and abetted the Emeritus Board of Directors’ alleged breaches of fiduciary duties. The complaints seek, among other things, injunctive relief, including rescission of the Merger, and damages, including counsel fees and expenses.

Other Legal Proceedings

The Company has been, is currently, and expects in the future to be involved in claims, lawsuits, and regulatory and other governmental audits, investigations and proceedings arising in the ordinary course of business. These claims, lawsuits and other matters, which are similar to those to which other companies in the senior living and healthcare industries are subject, include the following:

Professional and General Liability Claims - As a result of the nature of our business, we are subject to professional and general liability claims and lawsuits (with respect to which a substantial portion of our liability, if any, is self-insured).

Whistleblower Lawsuits - The Company may be subject to qui tam or “whistleblower” lawsuits under the False Claims Act and comparable federal and state laws for allegedly submitting fraudulent bills for services to the Medicare and Medicaid programs. Qui tam lawsuits typically remain under seal (and, as a result, are usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff and take the lead in the litigation.

Employment-related Lawsuits - The Company’s operations are subject to a variety of federal and state employment-related laws and regulations, including, but not limited to, the U.S. Fair Labor Standards Act, the Americans with Disabilities Act, regulations of the Equal Employment Opportunity Commission, the Office of Civil Rights and state attorneys general, federal and state wage and hour laws, and a variety of laws enacted by the federal and state governments that govern these and other employment-related matters. Accordingly, the Company is currently subject to employee-related claims and other lawsuits and proceedings in connection with the Company’s operations, including those related to alleged wrongful discharge, illegal discrimination and violations of equal employment and federal and state wage and hour laws.

Minimum Staffing Lawsuits - Various states in which the Company operates have established minimum staffing requirements or may establish minimum staffing requirements in the future. While the Company seeks to comply with all applicable staffing requirements, the regulations in this area are complex and the Company may experience

compliance issues from time to time.

Ordinary Course Matters - In addition to the matters described above, the Company is subject to various other claims, lawsuits and governmental audits, investigations and proceedings arising in the ordinary course of business.

The defense of the foregoing claims, lawsuits and governmental audits, investigations and proceedings, certain of which allege large amounts of damages and losses, may require the Company to incur significant expense and may necessitate significant time and attention from the Company’s management. Adverse outcomes in such matters, whether as a result of litigation or settlement, may (i) jeopardize the Company’s participation in certain state and federal healthcare programs, (ii) result in citations, civil and criminal penalties (including the loss of the Company’s licenses to operate one or more communities or healthcare activities), recoupment and/or substantial compensatory and punitive damages and attorneys’ fees that may, either individually or in the aggregate, have a material adverse effect on our business, financial position, results of operations and liquidity, (iii) cause the Company to close or sell one or more of its properties or otherwise modify the way in which the Company conducts its business, (iv) damage the Company’s reputation in various markets, which could adversely affect the Company’s ability to attract residents, patients, and employees, and (v) in the case of “whistleblower” lawsuits brought under the False Claims Act and comparable federal and state laws, result in awards of bounties to private qui tam plaintiffs who successfully bring these lawsuits and to the government programs.

We maintain a combination of self-insurance reserves and commercial insurance policies in amounts and with coverage and deductibles that we believe are adequate, based on the nature and risks of our business, historical experience and industry standards. We cannot predict the ultimate outcome of any pending litigation, claims, or regulatory and other governmental audits, investigations and proceedings. Certain of these matters are not covered by insurance, and, in any event, there is no assurance that our actual costs or damages related to any such matter will not exceed such reserves or applicable insurance policy limits.

On June 4, 2013, in Joan Boice et al. v. Emeritus Corporation et al., the Sacramento County Superior Court entered final judgment in favor of Joan Boice (deceased) and against the Company in the amount of $250,000 in compensatory damages and $23.0 million in punitive damages for alleged elder abuse. Judgment was also entered in favor of Ms. Boice’s three adult children for $250,000 and the court awarded the plaintiffs’ lawyer over $4.1 million in attorneys’ fees. On July 8, 2013, the Company filed a Notice of Appeal challenging, among other things, the excessive nature of the punitive damages award. Furthermore, the Company intends to argue that the trial court issued several erroneous rulings allowing the jury to consider extraneous, irrelevant, and collateral evidence unrelated to the care of Ms. Boice, meriting reversal or a remand for additional trial proceedings on all issues.

On July 29, 2013, a claim alleging the failure to provide certain services at our California assisted living communities was filed by Arville Winans, by and through his Guardian ad Litem, Renee Moulton, against the Company in the Alameda County Superior Court and subsequently removed to the United States District Court for the Northern District of California. In this case, the plaintiff is seeking to represent a class of residents at such California communities during the period beginning July 29, 2009. The plaintiff alleges violations of certain laws, including California’s Consumer Legal Remedies Act, Unfair Competition Law and Financial Elder Abuse statute. In connection with the claims for liability, the plaintiff is seeking an injunction, restitution, attorney's fees and costs, treble damages and punitive damages. The Company believes that the suit is without merit and has filed a motion to dismiss the action in its entirety.

Governmental Investigation

We are cooperating with the DOJ in connection with its investigation. We are currently unable to predict the outcome of this matter.

Item 1A. Risk Factors

There were no material changes to risk factors during the three months ended March 31, 2014 from those previously disclosed in Part I, Item 1A, Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2013, which could materially affect our business, financial condition, or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition, and/or operating results.

Item 6. Exhibits

Certain of the agreements included or incorporated by reference as exhibits to this report contain representations and warranties by each of the parties to the applicable agreement. These representations and warranties were made solely for the benefit of the other parties to the applicable agreement and (a) were not intended to be treated as categorical statements of fact, but rather as a way of allocating the risk to one of the parties if those statements prove to be inaccurate; (b) may have been qualified in such agreement by disclosures that were made to the other party in connection with the negotiation of the applicable agreement, which confidential disclosures are not necessarily reflected in the agreement; (c) may apply contract standards of “materiality” that are different from “materiality” under the applicable securities laws; and (d) were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement. Accordingly, those representations and warranties may not describe the actual state of affairs as of the date they were made or at any other time. Additional information about Emeritus may be found in our Annual Report on Form 10-K and our other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.



Number	Description		FootnoteNumber

2.1	Agreement and Plan of Merger, dated as of February 20, 2014, by and among Emeritus Corporation, Brookdale Senior Living, Inc. and Broadway Merger Sub Corporation		(1)
31.1	Certification of Periodic Reports
	31.1.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Granger Cobb dated May 8, 2014.	(2)
	31.1.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Robert C. Bateman dated May 8, 2014.	(2)
32.1	Certification of Periodic Reports
	32.1.1	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Granger Cobb dated May 8, 2014.	(2)
	32.1.2	Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 for Robert C. Bateman dated May 8, 2014.	(2)
101	XBRL Files
	101.INS	XBRL Instance Document.	(2)
	101.SCH	XBRL Taxonomy Extension Schema.	(2)
	101.CAL	XBRL Taxonomy Extension Calculation Linkbase.	(2)
	101.DEF	XBRL Taxonomy Extension Definition Linkbase.	(2)
	101.LAB	XBRL Taxonomy Extension Label Linkbase.	(2)
	101.PRE	XBRL Taxonomy Extension Presentation Linkbase.	(2)

Footnotes:


(1)	Incorporated herein by reference to Emeritus’ Current Report on Form 8-K filed February 21, 2014 (File No. 001-14012).

(2) Filed herewith.

SIGNATURE

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



Dated: May 8, 2014		EMERITUS CORPORATION
		(Registrant)

		/s/ Robert C. Bateman
		Robert C. Bateman, Executive Vice President—Finance and Chief Financial Officer