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Sunrise Senior Living 10-K 2008
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-K/A
(Amendment No. 2)
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2007
 
Commission File Number 1-16499
 
SUNRISE SENIOR LIVING, INC.  
(Exact name of registrant as specified in its charter)
 
     
Delaware
  54-1746596
     
(State or other jurisdiction
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
7902 Westpark
Drive McLean, VA
 
22102
     
(Address of principal
executive offices)
  (Zip Code)
 
Registrant’s telephone number, including area code: (703) 273-7500
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
  Name of Each Exchange on Which Registered
     
Common stock, $.01 par value per share
  New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer þ
  Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ
 
The aggregate market value of the Registrant’s Common Stock held by non-affiliates based upon the closing price of $39.99 per share on the New York Stock Exchange on June 29, 2007 was $1,784 million. Solely for the purposes of this calculation, all directors and executive officers of the registrant are considered to be affiliates.
 
The number of shares of Registrant’s Common Stock outstanding was 50,973,087 at July 11, 2008.
 
 
None


 

 
 
On July 31, 2008, Sunrise Senior Living, Inc. (the “Company”) filed its Annual Report on Form 10-K for the fiscal year ended December 31, 2007 (the “Original Form 10-K”). At the time of filing of the Original Form 10-K, the Company indicated that (a) it was not then in a position to include in the Original Form 10-K the separate financial statements of three ventures (Sunrise Aston Gardens Venture, LLC, PS Germany Investment (Jersey) LP and Sunrise IV Senior Living Holdings, LLC) that the SEC staff requested be included pursuant to Rule 3-09 of Regulation S-X and (b) it intended to file such financial statements by amendment as soon as they became available.
 
This Amendment No. 2 on Form 10-K/A is being filed to amend Item 8 of the Original Form 10-K and 10-K/A, Amendment No. 1 to provide the separate Rule 3-09 financial statements for Sunrise Aston Gardens Venture, LLC and Sunrise IV Senior Living Holdings, LLC as well as to amend Item 15(a)(1), which contains a listing of the financial statements included as part of the 2007 Form 10-K, to include a reference to the financial statements for these ventures. In addition, the Company is also amending Item 15(a)(3) and the Exhibit Index to include as exhibits new certifications by its Principal Executive Officer and Principal Financial Officer, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended and consents.
 
The Company also has revised Note 24 of the Notes to Consolidated Financial Statements to reflect the non-compliance with certain covenants related to our Bank Credit Facility.
 
Notes 2.1 and 11 of the financial statements of PS Germany Investment (Jersey) Limited Partnership have been revised to include a discussion of the Company’s non-compliance with certain covenants related to our Bank Credit Facility and a discussion of subsequent events occurring between September 10, 2008 and December 23, 2008.
 
There are no other changes to the Form 10-K/A, Amendment No. 1 other than those outlined above. This Amendment does not reflect events occurring after the filing of the Original Form 10-K, nor does it modify or update disclosures therein in any way other than as outlined above.
 
Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the complete text of each Item, as amended, is presented below.


2


 

         
    Page
 
Item 8.  Financial Statements and Supplementary Data
       
       
Sunrise Senior Living, Inc.
       
    5  
    6  
    7  
    8  
    9  
    10  
PS UK Investment (Jersey) LP
       
    65  
    66  
    67  
    68  
    69  
    70  
AL US Development Venture, LLC
       
    91  
    92  
    93  
    94  
    95  
    96  
Sunrise First Assisted Living Holdings, LLC
       
    102  
    103  
    104  
    105  
    106  
    107  
Sunrise Second Assisted Living Holdings, LLC
       
    112  
    113  
    114  
    115  
    116  
    117  
Metropolitan Senior Housing, LLC
       
    122  
    123  
    124  
    125  
    126  
    127  
PS Germany Investment (Jersey) LP
       
    134  
    135  
    136  
    137  
    138  
    139  


3


 


 

 
 
Stockholders and Board of Directors
Sunrise Senior Living, Inc.
 
We have audited the accompanying consolidated balance sheets of Sunrise Senior Living, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
Since the date of completion of our audit of the accompanying consolidated financial statements and initial issuance of our report thereon dated July 30, 2008, except for Paragraph 1 of Note 3, as to which the date is October 15, 2008, the Company, as discussed in Note 24, amended its Bank Credit Facility as a result of non-compliance with specific covenants and agreed to commence a process to revise and restructure the Bank Credit Facility on terms acceptable to the lenders. The resolution of this uncertainty may adversely affect the Company’s liquidity and operations. Note 24 describes management’s plans to address these issues.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunrise Senior Living, Inc. as of December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
 
As discussed in Note 3 to the accompanying consolidated financial statements, the Company has restated its financial statements for the years ended December 31, 2006 and 2005 and has restated its statement of cash flows for the year ended December 31, 2007.
 
As discussed in Note 2 to the accompanying consolidated financial statements, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes and EITF Issue No. 06-8, Applicability of the Assessment of a Buyer’s Continuing Investments under FASB Statement No. 66, Accounting for Sales of Real Estate for Condominiums, effective January 1, 2007.
 
Also as discussed in Note 2 to the accompanying consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), Share-Based Payment, effective January 1, 2006.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sunrise Senior Living, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated July 30, 2008 expressed an adverse opinion thereon.
 
/s/ Ernst & Young LLP
 
McLean, Virginia
July 30, 2008, except for Paragraph 1
of Note 3, as to which the date is
October 15, 2008 and for Paragraphs 1
through 10 of Note 24, as to which the
date is December 29, 2008.


5


 

 
 
                 
    December 31,  
(In thousands, except per share and share amounts)   2007     2006  
          (Restated)  
 
ASSETS
               
Current Assets:
               
Cash and cash equivalents
  $ 138,212     $ 81,990  
Accounts receivable, net
    76,909       75,055  
Notes receivable
          4,174  
Income taxes receivable
    63,624       30,873  
Due from unconsolidated communities, net
    61,854       80,729  
Deferred income taxes, net
    33,567       29,998  
Restricted cash
    61,999       34,293  
Prepaid insurance
    23,720       5,485  
Prepaid expenses and other current assets
    70,079       19,401  
                 
Total current assets
    529,964       361,998  
Property and equipment, net
    656,211       609,385  
Property and equipment subject to a sales contract, net
          193,158  
Property and equipment subject to financing, net
    58,871       62,520  
Notes receivable
    9,429       17,631  
Due from unconsolidated communities
    19,555       24,959  
Intangible assets, net
    83,769       103,771  
Goodwill
    169,736       218,015  
Investments in unconsolidated communities
    97,173       104,272  
Restricted cash
    165,386       143,760  
Other assets, net
    8,503       8,832  
                 
Total assets
  $ 1,798,597     $ 1,848,301  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
Current Liabilities:
               
Current maturities of long-term debt
  $ 122,541     $ 91,923  
Outstanding draws on bank credit facility
    100,000       50,000  
Accounts payable and accrued expenses
    275,362       216,087  
Due to unconsolidated communities
    37,344       5,792  
Deferred revenue
    9,285       8,703  
Entrance fees
    34,512       38,098  
Self-insurance liabilities
    67,267       41,379  
                 
Total current liabilities
    646,311       451,982  
Long-term debt, less current maturities
    31,347       48,682  
Deposits related to properties subject to a sales contract
          240,367  
Liabilities related to properties accounted for under the financing method
    54,317       66,283  
Investment accounted for under the profit-sharing method
    51,377       29,148  
Guarantee liabilities
    65,814       75,805  
Self-insurance liabilities
    74,971       72,993  
Deferred gains on the sale of real estate and deferred revenues
    74,367       51,958  
Deferred income tax liabilities
    82,605       78,632  
Other long-term liabilities, net
    133,717       85,228  
                 
Total liabilities
    1,214,826       1,201,078  
                 
Minority interests
    10,208       16,515  
Stockholders’ Equity:
               
Preferred stock, $0.01 par value, 10,000,000 shares authorized, no shares issued and outstanding
           
Common stock, $0.01 par value, 120,000,000 shares authorized, 50,556,925 and 50,572,092 shares issued and outstanding, net of 103,696 and 27,197 treasury shares, at December 31, 2007 and 2006, respectively
    506       506  
Additional paid-in capital
    452,640       445,275  
Retained earnings
    112,123       182,398  
Accumulated other comprehensive income
    8,294       2,529  
                 
Total stockholders’ equity
    573,563       630,708  
                 
Commitments and contingencies
               
Total liabilities and stockholders’ equity
  $ 1,798,597     $ 1,848,301  
                 
 
See accompanying notes.


6


 

SUNRISE SENIOR LIVING, INC.
 
 
                         
    Year Ended December 31,  
(In thousands, except per share amounts)   2007     2006     2005  
          (Restated)     (Restated)  
 
Operating revenue:
                       
Management fees
  $ 127,830     $ 117,228     $ 104,823  
Buyout fees
    1,626       134,730       83,036  
Professional fees from development, marketing and other
    38,855       28,553       24,920  
Resident fees for consolidated communities
    402,396       381,709       341,610  
Hospice and other ancillary services
    125,796       76,882       44,641  
Reimbursed contract services
    956,047       911,979       911,992  
                         
Total operating revenues
    1,652,550       1,651,081       1,511,022  
Operating expenses:
                       
Development and venture expense
    79,203       69,145       41,064  
Community expense for consolidated communities
    290,203       276,833       251,058  
Hospice and other ancillary services expense
    134,634       74,767       45,051  
Community lease expense
    68,994       61,991       57,946  
General and administrative
    187,325       131,473       106,601  
Accounting Restatement and Special Independent Committee Inquiry
    51,707       2,600        
Loss on financial guarantees and other contracts
    22,005       89,676        
Provision for doubtful accounts
    9,564       14,632       1,675  
Impairment of owned communities
    7,641       15,730       2,472  
Impairment of goodwill and intangible assets
    56,729              
Depreciation and amortization
    55,280       48,648       42,981  
Write-off of abandoned development projects
    28,430       1,329       902  
Write-off of unamortized contract costs
          25,359       14,609  
Reimbursed contract services
    956,047       911,979       911,992  
                         
Total operating expenses
    1,947,762       1,724,162       1,476,351  
                         
(Loss) income from operations
    (295,212 )     (73,081 )     34,671  
Other non-operating income (expense):
                       
Interest income
    9,894       9,577       6,231  
Interest expense
    (6,647 )     (6,204 )     (11,882 )
(Loss) gain on investments
          (5,610 )     2,036  
Other (expense) income
    (6,089 )     6,706       3,105  
                         
Total other non-operating (expense) income
    (2,842 )     4,469       (510 )
Gain on the sale and development of real estate and equity interests
    105,081       51,347       81,723  
Sunrise’s share of earnings and return on investment in unconsolidated communities
    108,947       43,702       13,472  
Gain (loss) from investments accounted for under the profit-sharing method
    22       (857 )     (857 )
Minority interests
    4,470       6,916       6,721  
                         
(Loss) income before provision for income taxes
    (79,534 )     32,496       135,220  
Benefit from (provision for) income taxes
    9,259       (17,212 )     (52,156 )
                         
Net (loss) income
  $ (70,275 )   $ 15,284     $ 83,064  
                         
Earnings per share data:
                       
Basic net (loss) income per common share
  $ (1.41 )   $ 0.31     $ 2.00  
Diluted net (loss) income per common share
    (1.41 )     0.30       1.74  
 
See accompanying notes.


7


 

SUNRISE SENIOR LIVING, INC.
 
 
                                                         
                                  Accumulated
       
    Shares of
    Common
    Additional
                Other
       
    Common
    Stock
    Paid-in
    Retained
    Deferred
    Comprehensive
       
(In thousands)   Stock     Amount     Capital     Earnings     Compensation     Income (Loss)     Total  
 
Balance at January 1, 2005 (As previously stated)
    41,138     $ 412     $ 279,116     $ 91,545     $ (4,535 )   $ 3,165     $ 369,703  
Effect of restatement
                            (7,495 )                     (7,495 )
                                                         
Balance at January 1, 2005 (Restated)
    41,138       412       279,116       84,050       (4,535 )     3,165       362,208  
Net income (Restated)
                      83,064                   83,064  
Foreign currency translation loss, net of tax
                                  (3,231 )     (3,231 )
Sunrise’s share of investee’s other comprehensive loss
                                  (503 )     (503 )
                                                         
Total comprehensive income (Restated)
                                        79,330  
                                                         
Issuance of common stock to employees
    2,248       22       31,307                         31,329  
Repurchase of common stock
    (348 )     (3 )     (8,709 )                       (8,712 )
Conversion of convertible debt
    3             55                         55  
Issuance of restricted stock
    412       4       10,995             (10,997 )           2  
Amortization of restricted stock
                            3,209             3,209  
Tax effect of stock-based compensation
                13,443                         13,443  
                                                         
Balance at December 31, 2005 (Restated)
    43,453       435       326,207       167,114       (12,323 )     (569 )     480,864  
Net income (Restated)
                      15,284                   15,284  
Foreign currency translation income, net of tax
                                  2,205       2,205  
Sunrise’s share of investee’s other comprehensive income
                                  893       893  
                                                         
Total comprehensive income (Restated)
                                        18,382  
                                                         
Issuance of common stock to employees
    374       3       5,161                         5,164  
Conversion of convertible debt
    6,700       67       117,917                         117,984  
Issuance of restricted stock
    45       1       532                         533  
Forfeiture of restricted stock
                (5 )                       (5 )
Adoption of SFAS 123R
                (12,323 )           12,323              
Stock-based compensation expense
                5,846                         5,846  
Tax effect of stock-based compensation
                1,940                         1,940  
                                                         
Balance at December 31, 2006 (Restated)
    50,572       506       445,275       182,398             2,529       630,708  
Net loss
                      (70,275 )                 (70,275 )
Foreign currency translation income, net of tax
                                  5,865       5,865  
Sunrise’s share of investee’s other comprehensive income
                                  (100 )     (100 )
                                                         
Total comprehensive loss
                                        (64,510 )
                                                         
Issuance of restricted stock
    88       1                               1  
Forfeiture or surrender of restricted stock
    (103 )     (1 )     (1,818 )                       (1,819 )
Stock-based compensation expense
                7,020                         7,020  
Tax effect of stock-based compensation
                2,163                         2,163  
                                                         
Balance at December 31, 2007
    50,557     $ 506     $ 452,640     $ 112,123     $     $ 8,294     $ 573,563  
                                                         
 
See accompanying notes.


8


 

SUNRISE SENIOR LIVING, INC.
 
 
                         
    Year Ended December 31,  
    2007
    2006
    2005
 
(In thousands)   (Restated)     (Restated)     (Restated)  
 
Operating activities
                       
Net (loss) income
  $ (70,275 )   $ 15,284     $ 83,064  
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
                       
Gain on sale and development of real estate and equity interests
    (105,081 )     (51,347 )     (81,723 )
(Gain) loss from investments accounted for under the profit-sharing method
    (22 )     857       857  
Gain from application of financing method
          (1,155 )     (528 )
Gain on sale of investment in Sunrise REIT debentures
                (2,036 )
Loss on sale of investments
          5,610        
Impairment of goodwill and other intangible assets
    56,729              
Write-off of abandoned development projects
    28,430       1,329       902  
Provision for doubtful accounts
    9,564       14,632       1,675  
Provision for deferred income taxes
    733       (3,853 )     29,357  
Impairment of long-lived assets
    7,641       15,730       2,472  
Loss on financial guarantees and other contracts
    22,005       89,676        
Sunrise’s share of earnings and return on investment in unconsolidated communities
    (108,947 )     (11,997 )     (13,073 )
Distributions of earnings from unconsolidated communities
    168,322       66,381       26,545  
Minority interest in income/loss of controlled entities
    (4,470 )     (6,916 )     (6,721 )
Depreciation and amortization
    55,280       48,648       42,981  
Write-off of unamortized contract costs
          25,359       14,609  
Amortization of financing costs
    1,051       1,404       1,483  
Stock-based compensation
    7,020       6,463       5,465  
Changes in operating assets and liabilities:
                       
(Increase) decrease in:
                       
Accounts receivable
    (12,388 )     (23,242 )     3,850  
Due from unconsolidated communities
    28,111       (83,451 )     (6,279 )
Prepaid expenses and other current assets
    (60,282 )     (4,041 )     (3,425 )
Captive insurance restricted cash
    (32,930 )     (48,840 )     (28,130 )
Other assets
    (35,666 )     6,694       (6,189 )
Increase (decrease) in:
                       
Accounts payable, accrued expenses and other liabilities
    140,589       22,204       68,820  
Entrance fees
    (3,586 )     913       1,095  
Self-insurance liabilities
    12,866       30,186       21,885  
Guarantee liabilities
    (5,829 )            
Deferred revenue and gains on the sale of real estate
    29,621       983       33,034  
                         
Net cash provided by operating activities
    128,486       117,511       189,990  
                         
Investing activities
                       
Capital expenditures
    (245,523 )     (188,655 )     (132,857 )
Acquisitions of business assets
    (49,917 )     (103,491 )     (75,532 )
Dispositions of property
    60,387       83,290       56,246  
Cash obtained in acquisition of Greystone
                10,922  
Change in restricted cash
    (21,792 )     (11,428 )     (15,701 )
Purchases of short-term investments
    (448,900 )     (172,575 )     (62,825 )
Proceeds from short-term investments
    448,900       172,575       77,725  
Increase in investments and notes receivable
    (183,314 )     (343,286 )     (158,697 )
Proceeds from investments and notes receivable
    220,312       376,061       187,042  
Investments in unconsolidated communities
    (29,297 )     (77,371 )     (64,080 )
Distributions of capital from unconsolidated communities
    601       5,954       9,273  
                         
Net cash used in investing activities
    (248,543 )     (258,926 )     (168,484 )
                         
Financing activities
                       
Net proceeds from exercised options
          4       29,065  
Additional borrowings of long-term debt
    243,564       154,140       149,539  
Repayment of long-term debt
    (66,105 )     (90,781 )     (137,296 )
Contribution from minority interests
          15,669       5,000  
Distributions to minority interests
    (1,180 )     (630 )     (1,021 )
Financing costs paid
          (75 )     (2,622 )
Repurchases of common stock
                (8,712 )
                         
Net cash provided by financing activities
    176,279       78,327       33,953  
                         
Net increase (decrease) in cash and cash equivalents
    56,222       (63,088 )     55,459  
Cash and cash equivalents at beginning of year
    81,990       145,078       89,619  
                         
Cash and cash equivalents at end of year
  $ 138,212     $ 81,990     $ 145,078  
                         
 
See accompanying notes.


9


 

Sunrise Senior Living, Inc.
 
 
1.   Organization and Presentation
 
 
We are a provider of senior living services in the United States, Canada, the United Kingdom and Germany. We were incorporated in Delaware on December 14, 1994.
 
At December 31, 2007, we operated 439 communities, including 402 communities in the United States, 12 communities in Canada, 17 communities in the United Kingdom and eight communities in Germany, with a total resident capacity of approximately 54,000. Our communities offer a full range of personalized senior living services, from independent living, to assisted living, to care for individuals with Alzheimer’s and other forms of memory loss, to nursing, rehabilitative care and hospice services. We develop senior living communities for ourself, for unconsolidated ventures in which we retain an ownership interest and for third parties.
 
 
The consolidated financial statements which are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) include our wholly owned and controlled subsidiaries. Variable interest entities (“VIEs”) in which we have an interest have been consolidated when we have been identified as the primary beneficiary. Commencing with our adoption of EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights (“EITF 04-5”), entities in which we hold the managing member or general partner interest are consolidated unless the other members or partners have either (1) the substantive ability to dissolve the entity or otherwise remove us as managing member or general partner without cause or (2) substantive participating rights, which provide the other partner or member with the ability to effectively participate in the significant decisions that would be expected to be made in the ordinary course of business. EITF 04-5 was effective June 29, 2005 for new or modified limited partnership arrangements and effective January 1, 2006 for existing limited partnership arrangements. There are no previously unconsolidated entities that required consolidation as a result of adoption of EITF 04-5. Investments in ventures in which we have the ability to exercise significant influence but do not have control over are accounted for using the equity method. All intercompany transactions and balances have been eliminated in consolidation.
 
2.   Significant Accounting Policies
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
 
 
We consider cash and cash equivalents to include currency on hand, demand deposits, and all highly liquid investments with a maturity of three months or less at the date of purchase.
 
 
We utilize large deductible blanket insurance programs in order to contain costs for certain lines of insurance risks including workers’ compensation and employers’ liability risks, automobile liability risk, employment practices liability risk and general and professional liability risks (“Self-Insured Risks”). We have self-insured a portion of the Self-Insured Risks through our wholly owned captive insurance subsidiary, Sunrise Senior Living Insurance, Inc. (the “Sunrise Captive”). The Sunrise Captive issues policies of insurance to and receives premiums from us that are reimbursed through expense allocations to each operated community and us. The Sunrise Captive pays the costs for each claim above a deductible up to a per claim limit. Cash held by Sunrise Captive of $128.2 million and $95.3 million at December 31, 2007 and 2006, respectively, is available to pay claims. The


10


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
earnings from the investment of the cash of Sunrise Captive are used to reduce future costs of and pay the liabilities of Sunrise Captive. Interest income in Sunrise Captive was $3.5 million, $2.1 million and $0.6 million for 2007, 2006 and 2005, respectively. Restricted cash also includes escrow accounts related to other insurance programs, land deposits, a bonus program and other items.
 
 
We provide an allowance for doubtful accounts on our outstanding receivables based on an analysis of collectibility, including our collection history and generally do not require collateral to support outstanding balances.
 
 
We on occasion may provide financing to unconsolidated ventures at negotiated interest rates. These loans are included in “Notes receivable” in the consolidated balance sheets. The collectibility of these notes is monitored based on the current performance of the ventures, the budgets and projections for future performance. If circumstances were to suggest that any amounts with respect to these notes would be uncollectible, we would establish a reserve to record the notes at their net realizable value. Generally we do not require collateral to support outstanding balances.
 
 
Due from unconsolidated communities represents amounts due from unconsolidated ventures for development and management costs, including development fees, operating costs such as payroll and insurance costs, and management fees. Development costs are reimbursed when third-party financing is obtained by the venture. Operating costs are generally reimbursed within thirty days.
 
 
Property and equipment is recorded at cost. Depreciation is computed using the straight-line method over the lesser of the estimated useful lives of the related assets or the remaining lease term. Repairs and maintenance are charged to expense as incurred.
 
In conjunction with the acquisition of land and the development and construction of communities, preacquisition costs are expensed as incurred until we determine that the costs are directly identifiable with a specific property. The costs would then be capitalized if the property was already acquired or the acquisition of the property is probable. Upon acquisition of the land, we commence capitalization of all direct and indirect project costs clearly associated with the development and construction of the community. We expense indirect costs as incurred that are not clearly related to projects. We charge direct costs to the projects to which they relate. If a project is abandoned, we expense any costs previously capitalized. We capitalize the cost of the corporate development department based on the time employees devote to each project. We capitalize interest as described in “Capitalization of Interest Related to Development Projects” and other carrying costs to the project and the capitalization period continues until the asset is ready for its intended use or is abandoned.
 
We capitalize the cost of tangible assets used throughout the selling process and other direct costs, provided that their recovery is reasonably expected from future sales.
 
We review the carrying amounts of long-lived assets for impairment when indicators of impairment are identified. If the carrying amount of the long-lived asset (group) exceeds the undiscounted expected cash flows that are directly associated with the use and eventual disposition of the asset (group) we record an impairment charge to the extent the carrying amount of the asset exceeds the fair value of the assets. We determine the fair value of long-lived assets based upon valuation techniques that include prices for similar assets (group).


11


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
We account for sales of real estate in accordance with FASB Statement No. 66, Accounting for Sales of Real Estate (“SFAS 66”). For sales transactions meeting the requirements of SFAS 66 for full accrual profit recognition, the related assets and liabilities are removed from the balance sheet and the gain or loss is recorded in the period the transaction closes. For sales transactions that do not meet the criteria for full accrual profit recognition, we account for the transactions in accordance with the methods specified in SFAS 66. For sales transactions that do not contain continuing involvement following the sale or if the continuing involvement with the property is contractually limited by the terms of the sales contract, profit is recognized at the time of sale. This profit is then reduced by the maximum exposure to loss related to the contractually limited continuing involvement. Sales to ventures in which we have an equity interest are accounted for in accordance with the partial sale accounting provisions as set forth in SFAS 66.
 
For sales transactions that do not meet the full accrual sale criteria as set forth in SFAS 66, we evaluate the nature of the continuing involvement and account for the transaction under an alternate method of accounting rather than full accrual sale, based on the nature and extent of the continuing involvement. Some transactions may have numerous forms of continuing involvement. In those cases, we determine which method is most appropriate based on the substance of the transaction.
 
Venture agreements may contain provisions which provide us with an option or obligation to repurchase the property from the venture at a fixed price that is higher than the sales price. In these instances, the financing method of accounting is followed. Under the financing method of accounting, we record the proceeds received from the buyer as a financing obligation and continue to keep the property and related accounts recorded on our books. The results of operations of the property, net of expenses other than depreciation (net operating income), is reflected as “interest expense” on the financing obligation. Because the transaction includes an option or obligation to repurchase the asset at a higher price, interest is recorded to accrete the liability to the repurchase price. Depreciation expense continues to be recorded as a period expense. All cash paid or received by us is recorded as an adjustment to the financing obligation. If the repurchase option or obligation expires and all other criteria for profit recognition under the full accrual method have been met, a sale is recorded and gain is recognized. The assets are recorded in “Property and equipment subject to financing, net” in the consolidated balance sheets, and the liabilities are recorded in “Liabilities related to properties accounted for under the financing method” in the consolidated balance sheets.
 
In transactions accounted for as partial sales, we determine if the buyer of the majority equity interest in the venture was provided a preference as to cash flows in either an operating or a capital waterfall. If a cash flow preference has been provided, profit, including our development fee, is only recognizable to the extent that proceeds from the sale of the majority equity interest exceed costs related to the entire property.
 
We also may provide a guarantee to support the operations of the properties. If the guarantees are for an extended period of time, we apply the profit-sharing method and the property remains on the books, net of any cash proceeds received from the buyer. If support is required for a limited period of time, sale accounting is achieved and profit on the sale may begin to be recognized on the basis of performance of the services required when there is reasonable assurance that future operating revenues will cover operating expenses and debt service.
 
Under the profit-sharing method, the property portion of our net investment is amortized over the life of the property. Results of operations of the communities before depreciation, interest and fees paid to us is recorded as “Loss from investments accounted for under the profit-sharing method” in the consolidated statements of income. The net income from operations as adjusted is added to the investment account and losses are reflected as a reduction of the net investment. Distributions of operating cash flows to other venture partners are reflected as an additional expense. All cash paid or received by us is recorded as an adjustment to the net investment. The net investment is reflected in “Investments accounted for under the profit-sharing method” in the consolidated balance sheets.


12


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
We provided a guaranteed return on investment to certain buyers of properties. When the guarantee was for an extended period of time, SFAS 66 precludes sale accounting and we applied the profit-sharing method. When the guarantee was for a limited period of time, the deposit method was applied until operations of the property covered all operating expenses, debt service, and contractual payments, at which time profit was recognized under the performance of services method.
 
Under the deposit method, we did not recognize any profit, and continued to report in our financial statements the property and related debt even if the debt had been assumed by the buyer, and disclosed that those items are subject to a sales contract. We continued to record depreciation expense. All cash paid or received by us was recorded as an adjustment to the deposit. When the transaction qualified for profit recognition under the full accrual method, the application of the deposit method was discontinued and the gain was recognized. The assets were recorded in “Property and equipment, subject to a sales contract, net” and the liabilities were recorded in “Deposits related to properties subject to a sales contract” in the consolidated balance sheets. At December 31, 2007, we no longer have any sales transactions accounted for under the deposit method.
 
 
Interest is capitalized on real estate under development, including investments in ventures in accordance with SFAS No. 34, Capitalization of Interest Cost, (“SFAS 34”) and in accordance with FASB Statement No. 58, Capitalization of Interest Cost in Financial Statements That Include Investments Accounted for by the Equity Method (“SFAS 58”). Under SFAS 34 the capitalization period commences when development begins and continues until the asset is ready for its intended use or the enterprise suspends substantially all activities related to the acquisition of the asset. Under SFAS 58, we capitalize interest on our investment in ventures for which the equity therein is utilized to construct buildings and cease capitalizing interest on our equity investment when the first property in the portfolio commences operations. The amount of interest capitalized is based on the stated interest rates, including amortization of deferred financing costs. The calculation includes interest costs that theoretically could have been avoided, based on specific borrowings to the extent there are specific borrowings. When project specific borrowings do not exist or are less than the amount of qualifying assets, the calculation for such excess uses a weighted average of all other debt outstanding.
 
 
We capitalize costs incurred to acquire management, development and other contracts. In determining the allocation of the purchase price to net tangible and intangible assets acquired, we make estimates of the fair value of the tangible and intangible assets using information obtained as a result of pre-acquisition due diligence, marketing, leasing activities and independent appraisals.
 
Intangible assets are valued using expected discounted cash flows and are amortized using the straight-line method over the remaining contract term, generally ranging from one to 30 years. The carrying amounts of intangible assets are reviewed for impairment when indicators of impairment are identified. If the carrying amount of the asset (group) exceeds the undiscounted expected cash flows that are directly associated with the use and eventual disposition of the asset (group), an impairment charge is recognized to the extent the carrying amount of the asset exceeds the fair value.
 
Goodwill represents the costs of business acquisitions in excess of the fair value of identifiable net assets acquired. We evaluate the fair value of goodwill to assess potential impairment on an annual basis, or during the year if an event or other circumstance indicates that we may not be able to recover the carrying amount of the asset. We evaluate the fair value of goodwill at the reporting unit level and make the determination based upon future cash flow projections. We record an impairment loss for goodwill when the carrying value of the goodwill is less than the estimated fair value.


13


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
We hold a minority equity interest in ventures established to develop or acquire and own senior living communities. Those ventures are generally limited liability companies or limited partnerships. Our equity interest in these ventures generally ranges from 10% to 50%.
 
In accordance with FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities (“FIN 46R”), we review all of our ventures to determine if they are variable interest entities (“VIEs”). If a venture is a VIE, it is consolidated by the primary beneficiary, which is the variable interest holder that absorbs the majority of the venture’s expected losses, receives a majority of the venture’s expected residual returns, or both. At December 31, 2007, we consolidated seven VIEs where we are the primary beneficiary.
 
In accordance with EITF 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, the general partner or managing member of a venture consolidates the venture unless the limited partners or other members have either (1) the substantive ability to dissolve the venture or otherwise remove the general partner or managing member without cause or (2) substantive participating rights in significant decisions of the venture, including authorizing operating and capital decisions of the venture, including budgets, in the ordinary course of business. We have reviewed all ventures that are not VIEs where we are the general partner or managing member and have determined that in all cases the limited partners or other members have substantive participating rights such as those set forth above and, therefore, no ventures are consolidated under EITF 04-5.
 
For ventures not consolidated, we apply the equity method of accounting in accordance with APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, and Statement of Position No. 78-9, Accounting for Investments in Real Estate Ventures, (“SOP 78-9”). Equity method investments are initially recorded at cost and subsequently are adjusted for our share of the venture’s earnings or losses and cash distributions. In accordance with SOP 78-9, the allocation of profit and losses should be analyzed to determine how an increase or decrease in net assets of the venture (determined in conformity with GAAP) will affect cash payments to the investor over the life of the venture and on its liquidation. Because certain venture agreements contain preferences with regard to cash flows from operations, capital events and/or liquidation, we reflect our share of profits and losses by determining the difference between our “claim on the investee’s book value” at the end and the beginning of the period. This claim is calculated as the amount that we would receive (or be obligated to pay) if the investee were to liquidate all of its assets at recorded amounts determined in accordance with GAAP and distribute the resulting cash to creditors and investors in accordance with their respective priorities. This method is commonly referred to as the hypothetical liquidation at book value method.
 
Our reported share of earnings is adjusted for the impact, if any, of basis differences between our carrying value of the equity investment and our share of the venture’s underlying assets. We generally do not have future requirements to contribute additional capital over and above the original capital commitments, and in accordance with APB 18, we discontinue applying the equity method of accounting when our investment is reduced to zero barring an expectation of an imminent return to profitability. If the venture subsequently reports net income, the equity method of accounting is resumed only after our share of that net income equals the share of net losses not recognized during the period the equity method was suspended.
 
When the majority equity partner in one of our ventures sells its equity interest to a third party, the venture frequently refinances its senior debt and distributes the net proceeds to the equity partners. All distributions received by us, which are not refundable either by agreement, or by law, are first recorded as a reduction of our investment. Next, we record a liability for any contractual or implied future financial support to the venture including obligations in our role as a general partner. Any remaining distributions are recorded as “Sunrise’s share of earnings and return on investment in unconsolidated communities” in the consolidated statements of income.
 
We evaluate realization of our investment in ventures accounted for using the equity method if circumstances indicate that our investment is other than temporarily impaired.


14


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Costs incurred in connection with obtaining permanent financing for our consolidated communities are deferred and amortized over the term of the financing using the effective interest method. Deferred financing costs are included in “Other assets” in the consolidated balance sheets.
 
 
We offer a variety of insurance programs to the communities we operate. These programs include property insurance, general and professional liability insurance, excess/umbrella liability insurance, crime insurance, automobile liability and physical damage insurance, workers’ compensation and employers’ liability insurance and employment practices liability insurance (the “Insurance Program”). Substantially all of the communities we operate participate in the Insurance Program are charged their proportionate share of the cost of the Insurance Program.
 
We utilize large deductible blanket insurance programs in order to contain costs for certain of the lines of insurance risks in the Insurance Program including workers’ compensation and employers’ liability risks, automobile liability risk, employment practices liability risk and general and professional liability risks (“Self-Insured Risks”). The design and purpose of a large deductible insurance program is to reduce overall premium and claim costs by internally financing lower cost claims that are more predictable from year to year, while buying insurance only for higher-cost, less predictable claims.
 
We have self-insured a portion of the Self-Insured Risks through the Sunrise Captive. The Sunrise Captive issues policies of insurance to and receives premiums from us that are reimbursed through expense allocation to each operated community. The Sunrise Captive pays the costs for each claim above a deductible up to a per claim limit. Third-party insurers are responsible for claim costs above this limit. These third-party insurers carry an A.M. Best rating of A-/VII or better.
 
We record outstanding losses and expenses for all Self-Insured Risks and for claims under insurance policies based on management’s best estimate of the ultimate liability after considering all available information, including expected future cash flows and actuarial analyses. We believe that the allowance for outstanding losses and expenses is appropriate to cover the ultimate cost of losses incurred at December 31, 2007, but the allowance may ultimately be settled for a greater or lesser amount. Any subsequent changes in estimates are recorded in the period in which they are determined and will be shared with the communities participating in the insurance programs based on the proportionate share of any changes.
 
 
We offer employees an option to participate in our self-insured health and dental plan. The cost of our employee health and dental benefits, net of employee contributions, is shared between us and the communities based on the respective number of participants working either at our corporate headquarters or at the communities. Funds collected are used to pay the actual program costs including estimated annual claims, third-party administrative fees, network provider fees, communication costs, and other related administrative costs incurred by us. Although claims under this plan are self-insured, we have aggregate protection which caps the potential liability for both individual and total claims during a plan year. Claims are paid as they are submitted to the plan administrator. We also record a liability for outstanding claims and claims that have been incurred but not yet reported. This liability is based on the historical claim reporting lag and payment trends of health insurance claims. We believe that the liability for outstanding losses and expenses is adequate to cover the ultimate cost of losses incurred at December 31, 2007, but actual claims may differ. Any subsequent changes in estimates are recorded in the period in which they are determined and will be shared with the communities participating in the program based on their proportionate share of any changes.


15


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
We lease communities under operating leases and own communities that provide life care services under various types of entrance fee agreements with residents (“Entrance Fee Communities” or “Continuing Care Retirement Communities”). Residents of Entrance Fee Communities are required to sign a continuing care agreement with us. The care agreement stipulates, among other things, the amount of all entrance and monthly fees, the type of residential unit being provided, and our obligation to provide both health care and non-health care services. In addition, the care agreement provides us with the right to increase future monthly fees. The care agreement is terminated upon the receipt of a written termination notice from the resident or the death of the resident. Refundable entrance fees are returned to the resident or the resident’s estate depending on the form of the agreement either upon reoccupancy or termination of the care agreement.
 
When the present value of estimated costs to be incurred under care agreements exceeds the present value of estimated revenues, the present value of such excess costs is accrued. The calculation assumes a future increase in the monthly revenue commensurate with the monthly costs. The calculation currently results in an expected positive net present value cash flow and, as such, no liability was recorded as of December 31, 2007. A liability of $1.3 million was recorded at December 31, 2006.
 
Refundable entrance fees are primarily non-interest bearing and, depending on the type of plan, can range from between 30% to 100% of the total entrance fee less any additional occupant entrance fees. As these obligations are considered security deposits, interest is not imputed on these obligations. Deferred entrance fees were $34.5 million and $38.1 million at December 31, 2007 and 2006, respectively.
 
Non-refundable portions of entrance fees are deferred and recognized as revenue using the straight-line method over the actuarially determined expected term of each resident’s contract.
 
 
Guarantees entered into in connection with the sale of real estate often prevent us from either accounting for the transaction as a sale of an asset or recognizing in earnings the profit from the sale transaction. Guarantees not entered into in connection with the sale of real estate are considered financial instruments. For guarantees considered financial instruments we recognize at the inception of a guarantee or the date of modification, a liability for the fair value of the obligation undertaken in issuing a guarantee. On a quarterly basis, we evaluate the estimated liability based on the operating results and the terms of the guarantee. If it is probable that we will be required to fund additional amounts than previously estimated a loss is recorded. Fundings that are recoverable as a loan from a venture are considered in the determination of the contingent loss recorded. Loan amounts are evaluated for impairment at inception and then quarterly.
 
 
In accordance with FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations — an interpretation of FASB Statement No. 143, Asset Retirement Obligations (“FIN 47”) we record a liability for a conditional asset retirement obligation if the fair value of the obligation can be reasonably estimated.
 
Certain of our operating real estate assets contain asbestos. The asbestos is appropriately contained, in accordance with current environmental regulations, and we have no current plans to remove the asbestos. When, and if, these properties are demolished, certain environmental regulations are in place which specify the manner in which the asbestos must be handled and disposed of. Because the obligation to remove the asbestos has an indeterminable settlement date, we are not able to reasonably estimate the fair value of this asset retirement obligation. Asbestos has also been found at some of our development sites where old buildings are scheduled to be demolished and replaced with new Sunrise facilities. As of December 31, 2007 and 2006 our estimates for asbestos removal costs for these sites were insignificant.


16


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
In addition, certain of our long-term ground leases include clauses that may require us to dispose of the leasehold improvements constructed on the premises at the end of the lease term. These costs, however, are not estimable due to the range of potential settlement dates and variability among properties. Further, the present value of the expected costs is insignificant as the remaining term of each of the leases is fifty years or more.
 
 
Deferred income taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. We record the current year amounts payable or refundable, as well as the consequences of events that give rise to deferred tax assets and liabilities based on differences in how these events are treated for tax purposes. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans and other expectations about future outcomes. We provide a valuation allowance against the net deferred tax assets when it is more likely than not that sufficient taxable income will not be generated to utilize the net deferred tax assets.
 
 
“Management fees” is comprised of fees from management contracts for operating communities owned by unconsolidated ventures and third parties, which consist of base management fees and incentive management fees. The management fees are generally between five and eight percent of a managed community’s total operating revenue. Fees are recognized in the month they are earned in accordance with the terms of the management contract.
 
“Buyout fees” is comprised of fees primarily related to the buyout of management contracts.
 
“Professional fees from development, marketing and other” is comprised of fees received for services provided prior to the opening of an unconsolidated community. Our development fees related to building design and construction oversight are recognized using the percentage-of-completion method and the portion related to marketing services is recognized on a straight-line basis over the estimated period the services are provided. The cost-to-cost method is used to measure the extent of progress toward completion for purposes of calculating the percentage of completion portion of the revenues. Greystone Communities, Inc.’s (“Greystone”) development contracts are multiple element arrangements. Since there is not sufficient objective and reliable evidence of the fair value of undelivered elements at each billing milestone, we defer revenue recognition until the completion of the development contract. Deferred development revenue for these Greystone contracts were $54.6 million and $28.1 million at December 31, 2007 and 2006, respectively, and is included in “Deferred gains on the sale of real estate and deferred revenues” in the balance sheet.
 
We form ventures, along with third-party partners, to invest in the pre-finance stage of certain Greystone development projects. When the initial development services are successful and permanent financing for the project is obtained, the ventures are repaid the initial invested capital plus fees generally between 50% and 75% of their investment. We consolidated these ventures that are formed to invest in the project as we control them. No revenue is recognized until the permanent financing is in place.
 
“Resident fees from consolidated communities” are recognized monthly as services are provided. Agreements with residents are generally for a term of one year and are cancelable by residents with thirty days notice.
 
“Hospice and other ancillary services” is comprised of fees for providing palliative end of life care and support services for terminally ill patients and their families, fees for providing care services to residents of certain communities owned by ventures and fees for providing private duty home health assisted living services. Hospice revenues are highly dependent on payments from Medicare, paid primarily on a per diem basis, from the Medicare programs. Because we generally receive fixed payments for our hospice care services based on the level of care provided to our hospice patients, we are at risk for the cost of services provided to our hospice patients. Reductions or changes in Medicare funding could significantly affect our results of our hospice operations. Reductions in


17


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
amounts paid by government programs for the services or changes in methods or regulations governing payments could cause our net hospice revenue and profits to materially decline.
 
“Reimbursed contract services” is comprised of reimbursements for expenses incurred by us, as the primary obligor, on behalf of communities operated by us under long-term management agreements. Revenue is recognized when we incur the related costs. If we are not the primary obligor, certain costs, such as interest expense, real estate taxes, depreciation, ground lease expense, bad debt expense and cost incurred under local area contracts, are not included. The related costs are included in “Reimbursed contract services” expense.
 
We considered the indicators in EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, in making our determination that revenues should be reported gross versus net. Specifically, we are the primary obligor for certain expenses incurred at the communities, including payroll costs, insurance and items such as food and medical supplies purchased under national contracts entered into by us. We, as manager, are responsible for setting prices paid for the items underlying the reimbursed expenses, including setting pay-scales for our employees. We select the supplier of goods and services to the communities for the national contracts that we enter into on behalf of the communities. We are responsible for the scope, quality and extent of the items for which we are reimbursed. Based on these indicators, we have determined that it is appropriate to record revenues gross versus net.
 
 
On January 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payments (“SFAS 123(R)”) to record compensation expense for our employee stock options, restricted stock awards, and employee stock purchase plan. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS 123”) and supersedes Accounting Principles Board Opinion No. 25 (“APB 25”), Accounting for Stock Issued to Employees, and its related implementation guidance. Prior to the adoption of SFAS 123(R), we followed the intrinsic value method in accordance with APB 25, in accounting for its stock options and other equity instruments.
 
SFAS 123(R) requires that all share-based payments to employees be recognized in the consolidated statements of income based on their grant date fair values with the expense being recognized over the requisite service period. We use the Black-Scholes model to determine the fair value of our awards at the time of grant.
 
 
Our reporting currency is the U.S. dollar. Certain of our subsidiaries’ functional currencies are the local currency of the respective country. In accordance with SFAS No. 52, Foreign Currency Translation, balance sheets prepared in their functional currencies are translated to the reporting currency at exchange rates in effect at the end of the accounting period except for stockholders’ equity accounts and intercompany accounts with consolidated subsidiaries that are considered to be of a long-term nature, which are translated at rates in effect when these balances were originally recorded. Revenue and expense accounts are translated at a weighted average of exchange rates during the period. The cumulative effect of the translation is included in “Accumulated other comprehensive (loss) income” in the consolidated balance sheets.
 
 
We expense advertising as incurred. Total advertising expense for the years ended December 31, 2007, 2006 and 2005 was $4.2 million, $3.3 million, and $3.6 million, respectively.
 
 
We are subject to various legal proceedings and claims, the outcomes of which are subject to significant uncertainty. We record an accrual for loss contingencies when a loss is probable and the amount of the loss can be


18


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
reasonably estimated. We review these accruals quarterly and make revisions based on changes in facts and circumstances.
 
 
Certain amounts have been reclassified to conform to the current year presentation.
 
 
We adopted Financial Accounting Standards Board (“FASB”) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), effective January 1, 2007. FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and it seeks to reduce diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position that an entity takes or expects to take in a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Under FIN 48, an entity may only recognize or continue to recognize tax positions that meet a “more likely than not” threshold. There was no adjustment to our recorded tax liability as a result of adopting FIN 48.
 
In November 2006, the Emerging Issues Task Force of FASB (“EITF”) reached a consensus on EITF Issue No. 06-8, Applicability of the Assessment of a Buyer’s Continuing Investment under FASB Statement No. 66, Accounting for Sales of Real Estate, for Sales of Condominiums (“EITF 06-8”). EITF 06-8 requires condominium sales to meet the continuing investment criterion in SFAS No. 66 in order for profit to be recognized under the percentage of completion method. EITF 06-8 was effective for us at January 1, 2007. We are currently developing one condominium project for an unconsolidated venture. The venture has applied EITF 06-8 for sales.
 
 
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). This standard defines fair value, establishes a methodology for measuring fair value and expands the required disclosure for fair value measurements. SFAS 157 is effective for us as of January 1, 2009. Provisions of SFAS 157 are required to be applied prospectively as of the beginning of the first fiscal year in which SFAS 157 is applied. We are evaluating the impact that SFAS 157 will have on our financial statements.
 
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The irrevocable election of the fair value option is made on an instrument by instrument basis, and applied to the entire instrument, and not just a portion of it. The changes in fair value of each item elected to be measured at fair value are recognized in earnings each reporting period. SFAS 159 does not affect any existing pronouncements that require assets and liabilities to be carried at fair value, nor does it eliminate any existing disclosure requirements. This standard is effective for us as of January 1, 2008. We have not chosen to measure any financial instruments at fair value.
 
In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS 141R”). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in business combinations to be recorded at “full fair value.” The standard is effective for us as of January 1, 2009, and earlier adoption is prohibited. All of our future acquisitions will be impacted by this standard.
 
On December 4, 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements — an Amendment of ARB No. 51 (“SFAS No. 160”). SFAS No. 160 establishes new accounting and reporting standards for a non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements separate from the parent’s equity. The amount of net income attributable to the


19


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
non-controlling interest will be included in consolidated net income on the face of the income statement. SFAS No. 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation, are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. SFAS No. 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. SFAS No. 160 is effective as of January 1, 2009. We are currently evaluating the impact that SFAS No. 160 will have on our financial statements.
 
3.   Restatement Related to Statement of Cash Flows Classifications and Accounting for Lease Payments and Non-Refundable Entrance Fees for Two Continuing Care Retirement Communities
 
 
The 2007 Consolidated Statement of Cash Flows has been restated primarily to reflect proper classification of transactions with unconsolidated communities, assumption of debt related to sales transactions and the classification of gain resulting from sales transactions. The effect of the restatement on the 2007 Consolidated Statement of Cash Flows was to decrease net cash provided by operating activities from $235.0 million to $128.5 million, to increase net cash used in investing activities from $235.5 million to $248.5 million and to increase net cash provided by financing activities from $56.7 million to $176.3 million. In 2007, $119.1 million of debt was assumed by third parties as part of sales transactions. Cash flows for the year ended December 31, 2007 as previously reported and as restated are reflected in the following table (for restated line items only):
 
2007 Consolidated Statement of Cash Flows
 
                 
(In thousands)   As Reported     As Restated  
 
Gain on sale and development of real estate and equity interests
  $ (61,635 )   $ (105,081 )
(Increase) decrease in:
               
Accounts receivable
    (16,536 )     (12,388 )
Due from unconsolidated senior living communities
    102,996       28,111  
Prepaid expenses and other current assets
    (55,443 )     (60,282 )
Other assets
    (1,177 )     (35,666 )
Increase (decrease) in:
               
Accounts payable and accrued expenses
    78,576       140,589  
Self-insurance liabilities
    27,866       12,866  
Guarantee liabilities
    (5,806 )     (5,829 )
Net cash provided by operating activities
    235,007       128,486  
Capital expenditures
    (240,309 )     (245,523 )
Dispositions of property
    171,338       60,387  
Change in restricted cash
    (20,579 )     (21,792 )
Increase in investments and notes receivable
    (181,451 )     (183,314 )
Proceeds from investments and notes receivable
    136,744       220,312  
Investments in unconsolidated communities
    (51,940 )     (29,297 )
Net cash used in investing activities
    (235,513 )     (248,543 )
Additional borrowings of long-term debt
    229,688       243,564  
Repayment of long-term debt
    (170,860 )     (66,105 )
Contribution from minority interests
    3,210        
Distributions to minority interest
    (5,310 )     (1,180 )
Net cash provided by financing activities
    56,728       176,279  


20


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Accounting for Lease Payments and Non-Refundable Entrance Fees
 
We lease six CCRCs under operating leases and provide life care services under various types of entrance fee agreements with residents. Upon admission to a community, the resident signs a continuing care agreement with us. The care agreement stipulates, among other things, the amount of all entrance and monthly fees, the type of residential unit being provided, and our obligation to provide both health care and non-health care services. In addition, the care agreement provides us with the right to increase future monthly fees. The care agreement is terminated upon the receipt of a written termination notice from the resident or the death of the resident. The refundable portion of the entrance fee is returned to the resident or the resident’s estate depending on the form of the agreement either upon reoccupancy or termination of the care agreement. The obligation to repay is acknowledged through the provisions of a Lifecare Bond. The non-refundable portion of the entrance fee is deferred and recognized as revenue using the straight-line method over the actuarially determined expected term of each resident’s contract. For one of these communities, the entrance fees are fully refundable and two communities do not have entrance fees. For the remaining three communities, residents choose between various entrance fee packages where the non-refundable component ranges from 10% to 100% of the total entrance fee (the larger the non-refundable portion, the lower the total payment).
 
For two CCRCs that were previously owned by MSLS, the sale of the CCRCs by MSLS to a third party resulted in a bifurcation of real estate ownership and operations, and separated the entrance fee repayment obligation from us, as the third party lessor became the primary obligor of the Lifecare Bonds. We collect the entrance fees from the resident under a continuing care agreement. In accordance with our lease, we sell and issue the Lifecare Bonds to residents on behalf of the lessor and remit all entrance fees to the lessor. In accordance with the terms of these two leases, we receive a rent credit against the amount of minimum rent due each accounting period equal to the amount of non-refundable fees collected by us from residents and remitted to the lessor.
 
Historically, we reported rent expense net of the amount of rent credit we received from the landlord for the non-refundable fees. We also did not consider the entrance fees to be compensation for the services we were providing to the resident and therefore did not record them as deferred revenue on our balance sheet.
 
Upon further review, we have now determined that we are the primary obligor to the resident for life care services and for providing a unit for the resident to occupy when we enter into the continuing care agreement with the resident. We enter into leases to be able to fulfill our obligation to provide a unit for the resident. For the non-refundable component of the entrance fee we have determined we should defer the fee and amortize it into income as we provide services to the resident over the expected term of the continuing care agreement. As there is a legal assignment of the obligation to repay the Lifecare bond to the lessor, we are not required to record the liability on our books and, therefore, no accounting adjustment was required for this item.
 
In regard to the calculation of rent expense, all payments to the lessor both for minimum rent (which in accordance with the lease is a fixed amount, with a scheduled 3% annual increase, less a rent credit equal to the amount of non-refundable entrance fees) and the non-refundable entrance fees are considered rent expense.
 
The effect of the restatement was to decrease retained earnings at January 1, 2005 by approximately $7.5 million, to reduce pre-tax income in 2005 and 2006 by approximately $6.6 million and $8.3 million, respectively, and to reduce 2005 and 2006 net income by approximately $4.0 million and $5.1 million, respectively. The restatement resulted in an increase to resident fees for consolidated communities of approximately $1.6 million in 2005 and $2.7 million in 2006, and an increase to community lease expense of approximately $8.2 million in 2005 and $11.0 million in 2006. We have restated the prior-period financial statements to correct these errors in accordance with SFAS No. 154, Accounting Changes and Error Corrections.


21


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
4.   Allowance for Doubtful Accounts
 
Allowance for doubtful accounts consists of the following (in thousands):
 
                         
    Accounts
             
    Receivable     Other Assets     Total  
 
Balance January 1, 2005 (restated)
  $ 1,888     $     $ 1,888  
Provision for doubtful accounts
    1,675             1,675  
Write-offs
    (1,065 )           (1,065 )
                         
Balance December 31, 2005 (restated)
    2,498             2,498  
Provision for doubtful accounts
    6,632       8,000       14,632  
Write-offs
    (1,626 )           (1,626 )
                         
Balance December 31, 2006 (restated)
    7,504       8,000       15,504  
Provision for doubtful accounts
    7,644       1,920       9,564  
Write-offs
    (4,708 )           (4,708 )
                         
Balance December 31, 2007
  $ 10,440     $ 9,920     $ 20,360  
                         
 
5.   Property and Equipment
 
Property and equipment consists of the following (in thousands):
 
                         
    December 31,  
    Asset Lives     2007     2006  
 
Land and land improvements
    15 years     $ 77,709     $ 76,456  
Building and building improvements
    40 years       337,310       330,431  
Furniture and equipment
    3-10 years       148,829       122,479  
                         
              563,848       529,366  
Less: Accumulated depreciation
            (157,744 )     (125,315 )
                         
              406,104       404,051  
Construction in progress
            250,107       205,334  
                         
Property and equipment, net
          $ 656,211     $ 609,385  
                         
 
Depreciation expense for communities was $33.9 million, $27.1 million, and $20.4 million in 2007, 2006, and 2005, respectively, excluding depreciation expense related to properties subject to the deposit method, financing method and profit-sharing method of accounting. See Note 7.
 
During 2007, we recorded an impairment charge of $7.6 million related to two communities acquired in 1999 and 2006. During 2006, we recorded an impairment charge of $15.7 million related to seven small senior living communities which were acquired between 1996 and 1999.
 
In 2007, we decided to discontinue development of four senior living condominium projects due to adverse economic conditions and as a result, we recorded pre-tax charges totaling approximately $21.0 million in 2007 to write-off capitalized development costs for these projects. In the first quarter of 2008, we suspended the development of the remaining three condominium projects and as a result, we expect to record pre-tax charges totaling approximately $22.0 million in the first quarter of 2008.


22


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
6.   Acquisitions
 
 
In August 2007, we purchased a 90% interest in Sunrise Connecticut Avenue Assisted Living, LLC, a venture in which we previously owned a 10% interest, for approximately $28.9 million and approximately $1.0 million in transaction costs. Approximately $19.9 million of existing debt was paid off at closing and we entered into new debt of $40.0 million. As a result of the acquisition, Sunrise Connecticut Avenue Assisted Living, LLC is our wholly owned subsidiary and the financial results are consolidated as of the acquisition date in August 2007.
 
The purchase price was allocated to the assets acquired, including intangible assets and liabilities assumed, based on their estimated fair values. The purchase price values that were assigned as follows (in millions):
 
         
Net working capital
  $ 0.6  
Property and equipment
    40.3  
Other assets
    0.1  
Land
    8.8  
Less: Debt of venture assumed
    (19.9 )
         
Total purchase price (including transaction costs)
  $ 29.9  
         
 
Sunrise Connecticut Avenue Assisted Living, LLC does not meet the definition of a significant subsidiary and therefore historical and pro forma information is not disclosed.
 
 
In August 2006, we acquired the long term management contracts of two San Francisco Bay Area CCRCs and the ownership of one community. The two managed communities are condominiums owned by the residents. The three communities have a combined capacity of more than 200 residents.
 
The purchase price was allocated to the assets acquired, including intangible assets and liabilities assumed, based on their estimated fair values. The purchase price values were assigned as follows (in millions):
 
         
Net working capital
  $ 0.9  
Land, property and equipment
    17.0  
Entrance fee liability and future service obligations
    (11.5 )
Management contracts and other assets
    21.0  
         
Total purchase price (including transaction costs)
  $ 27.4  
         
 
The weighted-average amortization period for the management contracts is 30 years. Raiser does not meet the definition of a significant subsidiary and therefore historical and pro forma information is not disclosed.
 
 
In September 2006, we acquired Trinity Hospice, Inc. (“Trinity”), a large provider of hospice services in the United States. Trinity currently operates 20 hospice programs across the United States.


23


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
The purchase price was allocated to the assets acquired, including intangible assets consisting primarily of trade-name, referral network and non-compete agreements, and liabilities assumed, based on their estimated fair values. The purchase price values were assigned as follows (in millions):
 
         
Net working capital
  $ 3.7  
Property and equipment
    1.5  
Intangible assets
    9.7  
Goodwill
    59.3  
Other assets
    0.4  
         
Total purchase price (including transaction costs)
  $ 74.6  
         
 
The weighted-average amortization period for the intangible assets is five years. Trinity does not meet the definition of a significant subsidiary and therefore historical and pro forma information is not disclosed.
 
As of December 31, 2006, Trinity’s average daily census was approximately 1,500. As of December 31, 2007, Trinity’s average daily census was approximately 1,300. This decline in census from 2006 to 2007 was partially the result of the closing of certain operating locations in non-core Sunrise markets and Trinity’s focus on remediation efforts. As a result of a review of the goodwill and intangible assets related to Trinity, we recorded an impairment loss of approximately $56.7 million in 2007.
 
 
In May 2005, we acquired Greystone for a total purchase price of approximately $49.0 million with a potential acquisition cost of $54.0 million subject to various adjustments set forth in the acquisition agreement. Performance milestones were reached in 2006 and 2007, with $2.5 million expected to be paid in 2008.
 
In July 2005 we contributed approximately $25.8 million in cash in exchange for a 20% interest in an unconsolidated venture formed to purchase assets from The Fountains, an Arizona based owner and operator of senior living communities.
 
7.   Sales of Real Estate
 
Total gains (losses) on sale recognized are as follows (in millions):
 
                         
    December 31,  
    2007     2006     2005  
 
Properties accounted for under basis of performance of services
  $ 3.6     $ 1.8     $ 0.6  
Properties accounted for previously under financing method
    32.8              
Properties accounted for previously under deposit method
    52.4       35.3       81.3  
Land sales
    5.7       5.4       (0.2 )
Sales of equity interests and other sales
    10.6       8.8        
                         
Total gains on the sale and development of real estate and equity interests
  $ 105.1     $ 51.3     $ 81.7  
                         
 
Basis of Performance of Services
 
During the years ended December 31, 2007, 2006 and 2005, we sold majority membership interests in entities owning partially developed land or sold partially developed land to ventures with three, nine and seven underlying communities, respectively, for $86.2 million, $182.5 million and $98.0 million, net of transaction costs, respectively. In connection with the transactions, we provided guarantees to support the operations of the underlying communities for a limited period of time. In addition, we operate the communities under long-term management


24


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
agreements upon opening. Due to our continuing involvement, all gains on the sale and fees received after the sale are initially deferred. Any fundings under the cost overrun guarantees and the operating deficit guarantees are recorded as a reduction of the deferred gain. Gains and development fees are recognized on the basis of performance of the services required. Deferred gains of $1.7 million, $7.7 million and $8.3 million were recorded in 2007, 2006 and 2005, respectively. Gains of $3.6 million, $1.8 million and $0.6 million were recognized in 2007, 2006 and 2005, respectively.
 
Financing Method
 
In 2004, we sold majority membership interests in two entities which owned partially developed land to two separate ventures. In conjunction with these two sales, we had an option to repurchase the communities from the venture at an amount that was higher than the sales price. At the date of sale, it was likely that we would repurchase the properties, and as a result the financing method of accounting has been applied.
 
In March 2007, the two separate ventures were recapitalized and merged into one new venture. Per the terms of the transaction, we no longer had an option to repurchase the communities. Thus, there were no longer any forms of continuing involvement that would preclude sale accounting and a gain on sale of $32.8 million was recognized in 2007. No gains were recognized in 2006 or 2005.
 
Relevant details are as follows (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Property and equipment subject to financing, net
  $     $ 62,520     $ 64,174  
Liabilities relating to properties subject to the financing method
          (66,283 )     (64,208 )
Depreciation expense
    505       1,959       363  
Development fees received, net of costs
                1,335  
Management fees received
    230       981       93  
 
In December 2007, we sold a majority membership interest in an entity which owned an operating community. In conjunction with the sale, the buyer had the option to put its interests and shares back to us if certain conditions were not met by June 2008. If the conditions were met prior to June 2008, the buyer’s put option would be extinguished. As of December 31, 2007, the conditions were not met. Due to the existence of the put option that allows the buyer to compel us to repurchase the property, we applied the financing method of accounting. The total property and equipment subject to financing, net, was $58.9 million and the liability relating to properties subject to the financing method was $54.3 million at December 31, 2007.
 
In February 2008, the required conditions were met, the buyer’s put option was extinguished and sale accounting was achieved. In connection with the sale, we also provided a guarantee to support the operations of the property for a limited period of time. Due to this continuing involvement, the gain on sale will be initially deferred and then recognized using the basis of performance of services method.
 
Deposit method
 
We accounted for the sale of an operating community in 2004 under the deposit method of accounting as we guaranteed to make monthly payments to the buyer equal to the amount by which a net operating income target exceeded actual net operating income for the community. The guarantee expired on the earlier of (a) the end of any consecutive twelve month period during which the property achieved its net operating income target, or (b) October 31, 2006. We recorded a gain of $4.0 million upon expiration of the guarantee on October 31, 2006. No gains were recognized in 2005 and 2004.


25


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Relevant details are as follows (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Property subject to sales contract, net
  $     $     $ 10,142  
Deposits related to properties subject to a sales contract
                (13,843 )
Depreciation expense
          296       331  
Development fees received, net of costs
                 
Management fees received
          198       192  
 
During 2003, we sold a portfolio of 13 operating communities and five communities under development for approximately $158.9 million in cash, after transaction costs, which was approximately $21.5 million in excess of our capitalized costs. In connection with the transaction, we agreed to provide support to the buyer if the cash flows from the communities were below a stated target. The guarantee expired at the end of the 18th full calendar month from the date on which all permits and licenses necessary for the admittance of residents had been obtained for the last development property. The last permits were obtained in January 2006 and the guarantee expired in July 2007. We recorded a gain of $52.5 million upon the expiration of the guarantee.
 
Relevant details are as follows (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Properties subject to sales contract, net
  $     $ 193,158     $ 197,781  
Deposits related to properties subject to a sales contract
          (240,367 )     (236,692 )
Depreciation expense
    4,876       8,257       7,168  
Development fees received, net of costs
          20       1,412  
Management fees received
    2,331       3,738       3,023  
 
During 2003, we sold three portfolios with a combined 28 operating communities. In connection with the sale, we were obligated to fund any net operating income shortfall as compared to a stated benchmark for a period of 12 to 24 months following the date of sale. In 2004, we sold a portfolio of five operating communities. In connection with the sale, we guaranteed a stated level of net operating income for an 18-month period following the date of sale. These guarantees, in accordance with SFAS 66, require the application of the deposit method of accounting. We recorded pre-tax gains of approximately $0, $28.3 million and $80.9 million in 2007, 2006 and 2005, respectively, as these guarantees expired.
 
Relevant details are as follows (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Properties subject to sales contract, net
  $  —     $     $ 47,308  
Deposits related to properties subject to a sales contract
                (74,247 )
Depreciation expense
          848       6,644  
Development fees received, net of costs
                 
Management fees received
          617       4,548  
 
In addition, during 2007, 2006 and 2005, Sunrise recognized losses or gains on sales of $(0.1) million, $3.0 million and $0.4 million, respectively, related to communities that were sold in 2002, but the gain had been deferred.


26


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Land Sales
 
During 2007, 2006 and 2005, we sold three, two and one pieces of undeveloped land, respectively. There were no forms of continuing involvement that precluded sale accounting or gain recognition. We recognized gains or losses of $5.7 million, $5.4 million and $(0.2) million, respectively, related to these land sales.
 
Sales of Equity Interests
 
During 2007 and 2006, we sold our equity interest in four and two ventures, respectively, whose underlying asset is real estate. In accordance with EITF No. 98-8, Accounting for Transfers of Investments That Are in Substance Real Estate (“EITF 98-8”), the sale of an investment in the form of a financial asset that is in substance real estate should be accounted for in accordance with SFAS 66. For all of the transactions, we did not provide any forms of continuing involvement that would preclude sale accounting or gain recognition. We recognized gains on sale of $10.6 million and $8.8 million in 2007 and 2006, respectively, related to these sales.
 
Gain (Loss) from Investments Accounted for Under the Profit-Sharing Method, net
 
We currently apply the profit-sharing method to the following transactions as we provided guarantees to support the operations of the properties for an extended period of time:
 
(1) during 2006, the sale of two entities related to a partially developed condominium project;
 
(2) during 2004, the sale of a majority membership interest in one venture with two underlying properties; and
 
(3) during 2004, the sale of three partially developed communities
 
Relevant details are as follows (in thousands):
 
                         
    Year Ended December 31,  
    2007     2006     2005  
 
Revenue
  $ 23,791     $ 19,902     $ 11,077  
Expenses
    (17,450 )     (16,528 )     (10,310 )
                         
Income from operations before depreciation
    6,341       3,374       767  
Depreciation expense
                1,964  
Distributions to other investors
    (6,319 )     (4,231 )     (3,588 )
                         
Income (loss) from investments accounted for under the profit-sharing method
  $ 22     $ (857 )   $ (857 )
                         
Investments accounted for under the profit-sharing method, net
  $ (51,377 )   $ (29,148 )   $ (5,106 )
Amortization expense on investments accounted for under the profit-sharing method
  $ 1,800     $ 1,800     $  
 
Condominium Sales
 
We began to develop senior living condominium projects in 2004. In 2006, we sold a majority interest in one condominium and assisted living venture to third parties. In conjunction with the development agreement for this project, we agreed to be responsible for actual project costs in excess of budgeted project costs of more than $10.0 million (subject to certain limited exceptions). Project overruns to be paid by us are projected to be approximately $48.0 million. Of this amount, $10.0 million is recoverable as a loan from the venture and $14.7 million relates to proceeds from the sale of real estate, development fees and pre-opening fees. During 2006, we recorded a loss of approximately $17.2 million due to this commitment. During 2007, we recorded an additional loss of approximately $6.0 million due to increases in the budgeted projected costs. Through June 30, 2008, we have paid approximately $47.0 million in cost overruns.


27


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
8.   Variable Interest Entities
 
At December 31, 2007, we held a management agreement with one entity and an equity interest in eight ventures that are considered VIEs, for a total of nine VIEs. We are the primary beneficiary of and, therefore, consolidate seven of these VIEs. We are not considered the primary beneficiary of the remaining two VIEs and, therefore, account for these investments under the equity or cost method of accounting.
 
 
  •  The entity that we have a management agreement with is a continuing care retirement community located in the U.S. comprised of 254 continuing care retirement community apartments, 32 assisted living units, 27 Alzheimer care apartments and 60 skilled nursing beds. We have included $20.1 million and $21.4 million, respectively, of net property and equipment related to this entity in our 2007 and 2006 consolidated balance sheets and $24.6 million and $25.2 million, respectively, of debt. We guaranteed in 2007 and 2006 $23.2 million and $23.8 million, respectively, of this debt. We included $1.5 million, $1.5 million and $1.1 million, respectively, of depreciation and amortization expense related to this entity in our 2007, 2006 and 2005 consolidated statements of income.
 
  •  Six of the seven consolidated VIEs are investment partnerships formed with third-party partners to invest capital in the pre-finance stage of certain Greystone projects. When the initial development services are successful and permanent financing for the project is obtained, the partners are repaid their initial invested capital plus fees generally between 50% and 75% of their investment. Greystone, which was acquired by us in May 2005, is a developer and manager of CCRCs. We have included $9.0 million and $13.8 million of cash related to these ventures in our 2007 and 2006 consolidated balance sheets, respectively. At December 31, 2006, six Greystone VIEs were consolidated. During 2007, two of these six ventures were no longer considered VIEs and were deconsolidated. Two new Greystone investment partnerships were formed to invest seed capital in 2007 and at December 31, 2007, six Greystone VIEs were consolidated.
 
 
  •  Sunrise At Home Senior Living Services, Inc. (“Sunrise At Home”) was a venture between Sunrise and two third parties. The venture offered home health services by highly trained staff members in customers’ homes and had annual revenue of approximately $19.0 million in 2006. In June 2007, Sunrise At Home was merged with Alliance Care and we received a preferred equity interest in Alliance Care. Alliance Care provides services to seniors, including physician house calls and mobile diagnostics, home care and private duty services through 24 local offices located in seven states. Additionally, Alliance Care operates over 125 Healthy Lifestyle Centers providing therapeutic rehabilitation and wellness programs in senior living facilities. As a result of the merger, we are no longer the primary beneficiary and deconsolidated Sunrise At Home as of the merger date. At December 31, 2007, Alliance Care has total assets of $41.2 million, total liabilities of $38.1 million, and annual revenue of $84.3 million.
 
  •  In July 2007, we formed a venture with a partner to purchase six communities from our first UK venture. The new venture also entered into a firm commitment to purchase 11 additional communities from the venture which are currently under development in the UK. At December 31, 2007, this venture has total assets of $562.7 million, total liabilities of $472.0 million, and annual revenue of $17.0 million.
 
Our book equity investment in these non-consolidated VIEs was $5.5 million at December 31, 2007, and that amount is our maximum exposure to loss.
 
At December 31, 2006, six ventures with Sunrise REIT were VIEs. In April 2007, Ventas acquired Sunrise REIT. After the acquisition, these ventures were no longer considered VIEs.


28


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
9.   Buyout of Management Contracts
 
During 2006, Five Star bought out 18 management contracts for which we were the manager. We recognized $131.1 million in buyout fees and an additional $3.6 million for management fees which would have been earned during the transition period. We also wrote-off the related remaining $25.4 million unamortized management contract intangible asset.
 
During 2005, Five Star bought out 12 management contracts for which we were the manager. We recognized $83.0 million in buyout fees. We also wrote-off the related remaining $14.6 million unamortized management contract intangible asset. Five Star’s right to buyout these contracts was unconditional regardless of performance.
 
10.   Notes Receivable
 
Notes receivable (including accrued interest) consist of the following (in thousands):
 
                         
          December 31,  
    Interest Rate(1)     2007     2006  
 
Note V with international venture
    4.37 %   $ 592     $ 1,030  
Promissory Note XIV
    Euribor + 4.25 %     8,837       4,834  
Promissory Note XIII
    7.50 %           11,767  
Note VI, revolving credit agreement
    10.00 %           4,174  
                         
              9,429       21,805  
Current maturities
                  (4,174 )
                         
            $ 9,429     $ 17,631  
                         
 
 
(1) Interest rate at December 31, 2007
 
All the notes are with affiliated ventures with the exception of Promissory Note XIII.
 
In 2002, we jointly formed a venture (“International LLC III”) in which we have a 20% ownership interest. In May 2002, we agreed to loan funds to International LLC III (“Note V”) to partially finance the initial development and construction of communities in the United Kingdom and Germany. Outstanding principal and interest are due as senior living communities are sold by the venture. A portion of the note was repaid in 2007.
 
In December 2005, we agreed to loan International LLC III up to 10 million Euros ($14.719 million at December 31, 2007) (“Promissory Note XIV”) on a revolving basis to fund operating deficits of the lease-up communities in Germany. The loan is unsecured and subordinated to the senior lenders of the German communities. Outstanding principal and interest payments are due on the earlier of December 31, 2010 or the termination of senior financing, with one two-year renewal at the option of International LLC III. As of December 31, 2007, the full 10 million Euros has been funded. We currently do not expect to receive repayment of 3.996 million Euros ($5.882 million). The carrying value above has been reduced by this estimated uncollectible amount of $5.882 million.
 
In May 2004, we accepted a promissory note of $10.0 million (“Promissory Note XIII”). We had an option to purchase an alternate property (land) from the borrower, and if we chose to purchase this land, the purchase price of the alternate property would be credited against the principal balance of this note, under the terms of the note agreement. Outstanding principal and interest were due on June 1, 2006. During 2006, the maturity date on the promissory note was extended until May 15, 2008. The land was purchased during 2007 and the note was repaid. This note was collateralized by the underlying land.
 
In 2002, we jointly formed a venture (“LLC VI”) in which we have a 20% ownership interest. The purpose of LLC VI is to develop, construct and own senior living communities. We agreed to loan LLC VI up to $20.0 million


29


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
(“Note VI”) through a revolving credit agreement to partially finance the initial development and construction of 15 communities. Note VI is secured by the communities and is subordinated to other lenders of LLC VI. LLC VI borrowed an additional $10.4 million against the credit agreement and we received payments of $9.2 million for principal. The note was repaid as part of a recapitalization in 2007.
 
We recorded interest income on these notes of $0.3 million, $1.5 million and $3.1 million in 2007, 2006 and 2005, respectively.
 
11.   Intangible Assets and Goodwill
 
Intangible assets consist of the following (in thousands):
 
                         
    Estimated
    December 31,  
    Useful Life     2007     2006  
 
Management contracts less accumulated amortization of $23,084 and $13,242
    1-30 years     $ 76,909     $ 88,581  
Leaseholds less accumulated amortization of $3,577 and $3,162
    10-29 years       4,307       4,721  
Other intangibles less accumulated amortization of $628 and $1,173
    1-40 years       2,553       10,469  
                         
            $ 83,769     $ 103,771  
                         
 
Amortization was $14.2 million, $8.8 million and $6.1 million in 2007, 2006 and 2005, respectively. In addition, in 2006 and 2005, we wrote-off $25.4 million and $14.6 million, respectively, representing the unamortized intangible asset for management contracts that were bought out (see Note 9) and other intangible assets. Amortization is expected to be approximately $11.0 million, $10.3 million, $6.7 million, $3.1 million and $2.9 million in 2008, 2009, 2010, 2011 and 2012, respectively.
 
Goodwill was $169.7 million and $218.0 million at December 31, 2007 and 2006, respectively. In 2006, we initially recorded goodwill of $59.3 million related to the acquisition of Trinity (see Note 6). We recorded goodwill of $31.5 million in 2005 and increased goodwill by $2.5 million and $5.0 million in 2007 and 2006, respectively, to reflect the earn-out related to the acquisition of Greystone. In 2007, we recorded an impairment charge of $56.7 million related to our Trinity goodwill and related intangible assets.


30


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
12.   Investments in Unconsolidated Communities
 
The following are our investments in unconsolidated communities as of December 31, 2007:
 
         
    Sunrise
 
Venture
  Ownership  
 
Karrington of Findlay Ltd. 
    50.00 %
MorSun Tenant LP
    50.00 %
Sunrise/Inova McLean Assisted Living, LLC
    40.00 %
AU-HCU Holdings, LLC(1)
    30.00 %
RCU Holdings, LLC(1)
    30.00 %
SunVest, LLC(1)
    30.00 %
AL One Investments, LLC
    25.36 %
Metropolitan Senior Housing, LLC
    25.00 %
Sunrise at Gardner Park, LP
    25.00 %
Sunrise Floral Vale Senior Living, LP
    25.00 %
Cheswick & Cranberry, LLC
    25.00 %
BG Loan Acquisition LP
    25.00 %
Sunrise Aston Gardens Venture, LLC
    25.00 %
Master MorSun, LP
    20.00 %
Master MetSun, LP
    20.00 %
Master MetSun Two, LP
    20.00 %
Master MetSun Three, LP
    20.00 %
Sunrise First Assisted Living Holdings, LLC
    20.00 %
Sunrise Second Assisted Living Holdings, LLC
    20.00 %
Sunrise Beach Cities Assisted Living, LP
    20.00 %
AL U.S. Development Venture, LLC
    20.00 %
Sunrise HBLR, LLC
    20.00 %
Sunrise IV Senior Living Holdings, LLC
    20.00 %
COPSUN Clayton MO, LLC
    20.00 %
Sunrise of Aurora, LP
    20.00 %
Sunrise of Erin Mills, LP
    20.00 %
Sunrise of North York, LP(2)
    20.00 %
PS Germany Investment (Jersey) LP
    20.00 %
PS UK Investment (Jersey) LP
    20.00 %
PS UK Investment II (Jersey) LP
    20.00 %
Sunrise First Euro Properties LP
    20.00 %
Master CNL Sun Dev I, LLC
    20.00 %
Sunrise Bloomfield Senior Living, LLC
    20.00 %
Sunrise Hillcrest Senior Living, LLC
    20.00 %
Sunrise New Seasons Venture, LLC
    20.00 %
Sunrise Rocklin Senior Living, LLC
    20.00 %
Sunrise Sandy Senior Living, LLC
    20.00 %
Sunrise Scottsdale Senior Living, LLC
    20.00 %
Sunrise Staten Island SL LLC
    20.00 %
Sunrise US UPREIT, LLC
    15.40 %
SunKap Coral Gables, LLC
    15.00 %
SunKap Boca Raton, LLC
    15.00 %
Santa Monica AL, LLC
    15.00 %
Sunrise Third Senior Living Holdings, LLC
    10.00 %
Cortland House, LP
    10.00 %
AEW/Sunrise Senior Housing Portfolio, LLC
    10.00 %
Dawn Limited Partnership
    10.00 %
 
 
(1) Properties related to investments are accounted for under the profit-sharing method of accounting. See Note 7.
 
(2) Properties related to investments are accounted for under the financing method of accounting. See Note 7.


31


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Included in “Due from unconsolidated communities” are net receivables and advances from unconsolidated ventures of $81.4 million and $105.7 million at December 31, 2007 and 2006, respectively. Net receivables from these ventures relate primarily to development and management activities.
 
Summary financial information for unconsolidated ventures accounted for by the equity method is as follows (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Assets, principally property and equipment
  $ 5,183,922     $ 4,370,376     $ 3,283,725  
Long-term debt
    4,075,993       2,971,318       2,076,734  
Liabilities, excluding long-term debt
    549,628       583,008       409,986  
Equity
    558,301       816,050       797,005  
Revenue
    1,021,112       846,479       625,371  
Net income (loss)
    (15,487 )     (56,968 )     24,051  
 
Accounting policies used by the unconsolidated ventures are the same as those used by us.
 
Total management fees and reimbursed contract services from related unconsolidated ventures was $509.1 million, $390.3 million and $321.2 million in 2007, 2006 and 2005, respectively.
 
Our share of earnings and return on investment in unconsolidated communities consists of the following (in thousands):
 
                         
    December 31,  
    2007     2006     2005  
 
Sunrise’s share of earnings (losses) in unconsolidated communities
  $ 60,700     $ (11,997 )   $ (13,073 )
Return on investment in unconsolidated communities
    72,710       55,699       26,545  
Impairment of equity investments
    (24,463 )            
                         
    $ 108,947     $ 43,702     $ 13,472  
                         
 
Our investment in unconsolidated communities was less than our portion of the underlying equity in the venture by $81.5 million and $62.3 million as of December 31, 2007 and 2006, respectively.
 
 
Sunrise’s return on investment in unconsolidated communities primarily represents cash distributions from ventures arising from a refinancing of debt within ventures. We first record all equity distributions, which are not refundable either by agreement, or by law, as a reduction of our investment. Next, we record a liability if there is a contractual obligation or implied obligation to support the venture, including in our role as general partner. Any remaining distribution is recorded in income.
 
In 2007, our return on investment in unconsolidated communities was primarily the result of three venture recapitalizations. In one transaction, the majority owner of a venture sold their majority interest to a new third party, the debt was refinanced and the total cash we received and the gain recognized was $53.0 million. In another transaction, in conjunction with a sale by us of a 15% equity interest, which gain is recorded in “Gain on the sale and development of real estate and equity interests,” and the sale of the majority equity owner’s interest to a new third party, the debt was refinanced and we received total proceeds of $4.1 million relating to our retained 20% equity interest in two ventures, which we recorded as a return on investment in unconsolidated communities.


32


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
In 2006, our return on investment in unconsolidated communities was primarily the result of three venture recapitalizations. In one transaction, the majority owner of two ventures sold their majority interests to a new third party, the debt was refinanced and the total recorded return on investment to us from this combined transaction was approximately $21.6 million. In another transaction, the majority owner of a venture sold its majority interest to a new third party, the debt was refinanced and the total return on investment to us was $26.1 million.
 
In 2005, we recorded $22.4 million of return on investment from the recapitalization of four ventures for 18 communities.
 
 
In January 2007, we entered into a venture to develop assisted living communities in the United Kingdom (the “UK”) over the next four years, with us serving as the developer and then as the manager of the communities. This is our second venture in the UK. We own 20% of the venture. Property development will be funded through contributions of up to approximately $200.0 million by the partners, based upon their pro rata percentage, with the balance funded by loans provided by third-party lenders, giving the venture a total potential investment capacity of approximately $1.0 billion.
 
During 2007, we entered into two development ventures to develop and build senior living communities in the United States during 2007 and 2008, with us serving as the developer and then as the manager of the communities. We own 20% of the ventures. Property development will be funded through contributions of up to approximately $208.0 million by the partners, based upon their pro rata percentage, with the balance funded by loans provided by third party lenders, giving the ventures a total potential investment capacity of approximately $788.0 million. We will develop and manage the communities.
 
During 2007, our first UK venture in which we have a 20% equity interest sold seven communities to a venture in which we have a 10% interest. Primarily as a result of the gains on these asset sales recorded in the ventures, we recorded equity in earnings in 2007 of approximately $75.5 million. When our UK and Germany ventures were formed, we established a bonus pool in respect to each venture for the benefit of employees and others responsible for the success of these ventures. At that time, we agreed with our partner that after certain return thresholds were met, we would each reduce our percentage interests in venture distributions with such excess to be used to fund these bonus pools. During 2007, we recorded bonus expense of $27.8 million in respect of the bonus pool relating to the UK venture. These bonus amounts are funded from capital events and the cash is retained by us in restricted cash accounts. As of December 31, 2007, approximately $18.0 million of this amount was included in restricted cash. Under this bonus arrangement, no bonuses are payable until we receive distributions at least equal to certain capital contributions and loans made by us to the UK and Germany ventures. We currently expect this bonus distribution limitation will be satisfied in late 2008, at which time bonus payments would become payable.
 
In October 2000, we formed Sunrise At Home, a venture offering home health assisted living services in several East Coast markets and Chicago. In June 2007, Sunrise At Home was merged into AllianceCare. AllianceCare provides services to seniors, including physician house calls and mobile diagnostics, home care and private duty services through 24 local offices located in seven states. Additionally, AllianceCare operates more than 125 Healthy Lifestyle Centers providing therapeutic rehabilitation and wellness programs in senior living facilities. In the merger, Sunrise received approximately an 8% preferred ownership interest in AllianceCare and Tiffany Tomasso, our chief operating officer, was appointed to the Board of Directors. Our investment in AllianceCare is accounted for under the cost method.
 
During December 2007, we decided to withdraw from ventures that owned two pieces of undeveloped land in Florida. We wrote off our remaining investment balance of approximately $1.1 million in the two projects.
 
In December 2007, we contributed $4.4 million for a 20% interest in an unconsolidated venture with COP Investment Group (Conrad Properties). The venture purchased an existing building for approximately $22.0 million and will renovate the building into a senior independent living facility.


33


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
In September 2006, a venture acquired six senior living communities with a capacity for approximately 2,000 residents in Florida, operated under the Aston Gardens brand name for $450.0 million. The aggregate purchase price for the transaction was $450.0 million (which included approximately $134.0 million of debt assumption), plus $10.0 million in transaction costs for the total of $460.0 million. Our venture partner funded 75% of the equity (approximately $117.0 million) for this transaction and we funded the remaining 25% of the equity (approximately $39.0 million) with the balance of the purchase price (approximately $170.0 million) paid through financing obtained by the joint venture. We funded our $39.0 million portion of the acquisition through our existing cash balances and Bank Credit Facility. We also received an initial 20 year contract to manage these properties. In 2007 and into 2008, the operating results of the Aston Garden communities suffered due to adverse economic conditions in Florida for independent living communities including a decline in the real estate market. These operating results are insufficient to achieve compliance with the debt covenants for the mortgage debt for the properties. In July 2008, the venture received notice of default from the lender of $170.0 million of debt obtained by the venture at the time of the acquisition in September 2006. Later in July 2008, we received notice from our equity partner alleging a default under our management agreement as a result of receiving the notice from the lender. This debt is non-recourse to us. Based on our assessment, we have determined that our investment is impaired and as a result, we recorded a pre-tax impairment charge of approximately $21.6 million in the fourth quarter of 2007.
 
In June 2006, a new unconsolidated venture in which we held a 20% ownership interest acquired three communities and their management contracts from a third party. The total purchase price was $34.3 million, of which we contributed $3.8 million. During 2007, due to deteriorating performance for two of the three communities, an impairment charge of $8.9 million was recorded in the venture under SFAS No. 144, and we recorded our proportionate share of the loss, $1.8 million. In addition, we wrote-off our receivables due from the venture of approximately $1.9 million.
 
13.   Bank Credit Facility
 
On December 2, 2005, we entered into a $250.0 million secured Bank Credit Facility, which has since been reduced to $160.0 million as described below (the “Bank Credit Facility”), with a syndicate of banks. The Bank Credit Facility replaced our former credit facility. The Bank Credit Facility provides for both cash borrowings and letters of credit. It has an initial term of four years and matures on December 2, 2009, unless extended for an additional one-year period upon satisfaction of certain conditions. The Bank Credit Facility is secured by a pledge of all of the common and preferred stock issued by Sunrise Senior Living Management, Inc., Sunrise Senior Living Investments, Inc., Sunrise Senior Living Services, Inc. and Sunrise Development, Inc., each of which is our wholly-owned subsidiary, (together with us, the “Loan Parties”), and all future cash and non-cash proceeds arising therefrom and accounts and contract rights, general intangibles and notes, notes receivable and similar instruments owned or acquired by the Loan Parties, as well as proceeds (cash and non-cash) and products thereof.
 
Prior to the amendments described below, cash borrowings in US dollars initially accrued interest at LIBOR plus 1.70% to 2.25% plus a fee to participating lenders subject to certain European banking regulations or the Base Rate (the higher of the Federal Funds Rate plus 0.50% and Prime) plus 0.00% to 0.75%. The Bank Credit Facility also permits cash borrowings and letters of credit in currencies other than US dollars. Prior to the amendments described below, interest on cash borrowings in non-US currencies accrue at the rate of the Banking Federation of the European Union for the Euro plus 1.70% to 2.25%. Letters of credit fees are equal to 1.50% to 2.00% of the maximum available to be drawn on the letters of credit. We pay commitment fees of 0.25% on the unused balance of the Bank Credit Facility. Borrowings are used for general corporate purposes including investments, acquisitions and the refinancing of existing debt. There were $71.7 million of outstanding letters of credit and $100.0 million outstanding under the Bank Credit Facility at December 31, 2007. The letters of credit issued under the Bank Credit Facility expire within one year of issuance.
 
Borrowings under the Bank Credit Facility are considered short-term debt in our consolidated financial statements.


34


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
During 2006 and 2007, we entered into several amendments to our Bank Credit Facility extending the time period for furnishing quarterly and audited annual financial information to the lenders. In connection with these amendments, the interest rate applicable to the outstanding balance under the Bank Credit Facility was also increased effective July 1, 2007 from LIBOR plus 2.25% to LIBOR plus 2.50%.
 
On January 31, February 19, March 13, and July 23, 2008, we entered into further amendments to the Bank Credit Facility. These amendments, among other things:
 
  •  modified to August 20, 2008 the delivery date for the unaudited financial statements for the quarter ended March 31, 2008;
 
  •  modified to September 10, 2008 the delivery date for the unaudited financial statements for the quarter ending June 30, 2008;
 
  •  temporarily (in February 2008) and then permanently (in July 2008) reduced the maximum principal amount available under the Bank Credit Facility to $160.0 million; and
 
  •  waived compliance with financial covenants in the Bank Credit Facility for the year ended December 31, 2007 and for the fiscal quarters ended March 31, 2008 and June 30, 2008, and waived compliance with the leverage ratio and fixed charge coverage ratio covenants for the fiscal quarter ending September 30, 2008.
 
In addition, pursuant to the July 2008 amendment, until such time as we have delivered evidence satisfactory to the administrative agent that we have timely filed our Form 10-K for the fiscal year ending December 31, 2008 and that we are in compliance with all financial covenants in the Bank Credit Facility, including the leverage ratio and fixed charge coverage ratio, for the fiscal year ending December 31, 2008, and provided we are not then otherwise in default under the Bank Credit Facility:
 
  •  we must maintain liquidity of not less than $50.0 million, composed of availability under the Bank Credit Facility plus up to not more than $50.0 million in unrestricted cash and cash equivalents (tested as of the end of each calendar month), and any unrestricted cash and cash equivalents in excess of $50.0 million must be used to pay down the outstanding borrowings under the Bank Credit Facility;
 
  •  we are generally prohibited from declaring or making directly or indirectly any payment in the form of a stock repurchase or payment of a cash dividend or from incurring any obligation to do so; and
 
  •  the borrowing rate in US dollars, which was increased effective as of February 1, 2008, will remain LIBOR plus 2.75% or the Base Rate (the higher of the Federal Funds Rate plus 0.50% and Prime) plus 1.25% (through the end of the then-current interest period).
 
From and after the July 2008 amendment, we will continue to owe and pay fees on the unused amount available under the Bank Credit Facility as if the maximum outstanding amount was $160.0 million. Prior to the July 2008 amendment, fees on the unused amount were based on a $250.0 million outstanding maximum amount.
 
We paid the lenders an aggregate fee of approximately $0.9 million and $1.9 million for entering into amendments during 2007 and 2008, respectively.
 
On February 20, 2008, Sunrise Senior Living Insurance, Inc., our wholly owned insurance captive directly issued $43.3 million of letters of credit that had been issued under the Bank Credit Facility. As of June 30, 2008, we had outstanding borrowings of $75.0 million, outstanding letters of credit of $26.3 million and borrowing availability of approximately $58.7 million under the Bank Credit Facility.
 
In connection with the March 13, 2008 amendment, the Loan Parties executed and delivered a security agreement to the administrative agent for the benefit of the lenders under the Bank Credit Facility. Pursuant to the security agreement, among other things, the Loan Parties granted to the administrative agent, for the benefit of the lenders, a security interest in all accounts and contract rights, general intangibles and notes, notes receivable and


35


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
similar instruments owned or acquired by the Loan Parties, as well as proceeds (cash and non-cash) and products thereof, as security for the payment of obligations under the Bank Credit Facility arrangements.
 
Our Bank Credit Facility contains various other financial covenants and other restrictions, including provisions that: (1) require us to meet certain financial tests (for example, our Bank Credit Facility requires that we not exceed certain leverage ratios), maintain certain fixed charge coverage ratios, have a consolidated net worth of at least $450.0 million as adjusted each quarter and to meet other financial ratios, maintain a specified minimum liquidity and use excess cash and cash equivalents to pay down outstanding borrowings; (2) require consent for changes in control; and (3) restrict our ability and our subsidiaries’ ability to borrow additional funds, dispose of all or substantially all assets, or engage in mergers or other business combinations in which Sunrise is not the surviving entity, without lender consent.
 
At December 31, 2007, we were not in compliance with the following financial covenants in the Bank Credit Facility: leverage ratio (the ratio of consolidated EBITDA to total funded indebtedness of 4.25 as defined in the Bank Credit Facility) and fixed charge coverage ratio (the ratio of consolidated EBITDAR to fixed charges of 1.75 as defined in the Bank Credit Facility). Non-compliance was largely due to additional charges related to losses on financial guarantees which were identified during the 2007 audit that was completed in July 2008. Additionally, as these covenants are based on a rolling, four quarter test, we do not expect to be in compliance with these covenants for the first three quarters of 2008. These covenants were waived on July 23, 2008 through the quarter ending on September 30, 2008.
 
In the event that we are unable to furnish the lenders with all of the financial information required to be furnished under the amended Bank Credit Facility by the specified dates and are not in compliance with the financial covenants in the Bank Credit Facility, including the leverage ratio and fixed charge coverage ratio, for the quarter ending December 31, 2008, or fail to comply with the new liquidity covenants included in the July 2008 amendment, the lenders under the Bank Credit Facility could, among other things, agree to a further extension of the delivery dates for the financial information or the covenant compliance requirements, exercise their rights to accelerate the payment of all amounts then outstanding under the Bank Credit Facility and require us to replace or provide cash collateral for the outstanding letters of credit or pursue further modification with respect to the Bank Credit Facility.
 
14.   Long-Term Debt
 
Long-term debt consists of the following (in thousands):
 
                 
    December 31,  
    2007     2006  
 
Outstanding draws on Bank Credit Facility
  $ 100,000     $ 50,000  
Borrowings from Sunrise REIT
          35,112  
Mortgages, notes payable and other
    153,888       105,493  
                 
      253,888       190,605  
Current maturities
    (222,541 )     (141,923 )
                 
    $ 31,347     $ 48,682  
                 
 
 
At December 31, 2006, there was $35.1 million of borrowings from Sunrise REIT outstanding. The borrowings were not collateralized and were related to communities we were developing for Sunrise REIT. All amounts were repaid in 2007.


36


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Other Mortgage and Notes Payable
 
At December 31, 2007 and 2006, there was $153.9 million and $105.5 million, respectively, of outstanding mortgages and notes payable. Of the amount of mortgages and notes payable outstanding at December 31, 2007, $121.2 million relates to 17 existing communities and communities under development that are collateralized by the assets of the respective community. Payments of interest and some principal payments are made monthly. Interest rates range from 3.4% to 8.5% with maturities ranging from less than one year to 19 years.
 
Of the amount of mortgages and notes payable outstanding at December 31, 2006, $45.6 million was owed to third parties for five of the communities we developed for Sunrise REIT. Interest was paid monthly for three of the development communities at a rate of LIBOR plus 2.25% (7.57% at December 31, 2006) and for one of the properties at a rate of LIBOR plus 2.35% (7.67% at December 31, 2006). Interest was paid for a Canadian development property loan at a rate of Canadian Prime plus 1.05 (7.00% at December 31, 2006). All amounts were repaid in 2007.
 
At December 31, 2006, $26.7 million of the remaining other mortgages and notes payable relate to six additional communities that are collateralized by the assets of the respective community. Payments of principal and interest are made monthly. Interest rates ranged from 4.78% to 8.50% with remaining maturities ranging from less than one year to 20 years.
 
At December 31, 2007 and December 31, 2006, we consolidated debt of $24.6 million and $25.2 million, respectively, related to an entity that we consolidate as it is a VIE and we are the primary beneficiary.
 
In November 2001, we entered into a $60.0 million revolving credit facility, expandable to $100.0 million. This credit facility was to mature in November 2006, was subject to a five-year extension, accrues interest at LIBOR plus 1.20% (5.8% at December 31, 2007) and is collateralized by senior living communities. The credit facility may be converted to a fixed rate facility at any time during the term. We pay commitment fees of 0.13% on the unused portion. In September 2003, we reduced the credit facility to $16.0 million. During 2006, the maturity date was extended to November 2011 based upon the terms of the credit facility. At December 31, 2007 and 2006, $8.1 million was outstanding and two communities were collateral for the credit facility.
 
At December 31, 2007 and 2006, the net book value of properties pledged as collateral for mortgages payable was $266.8 million and $191.6 million, respectively.
 
Principal maturities of long-term debt at December 31, 2007 are as follows (in thousands):
 
         
2008
  $ 222,541  
2009
    2,027  
2010
    1,174  
2011
    1,211  
2012
    1,263  
Thereafter
    25,672  
         
    $ 253,888  
         
 
Interest paid totaled $14.1 million, $13.9 million and $13.3 million in 2007, 2006 and 2005, respectively. Interest capitalized was $9.3 million, $5.4 million and $5.6 million in 2007, 2006 and 2005, respectively.
 
We are obligated to provide annual audited financial statements and quarterly unaudited financial statements to various financial institutions that have made construction loans or provided permanent financing to entities directly or indirectly owned by us. In addition, some of these loans have financial covenant requirements that are similar to the Bank Credit Facility. In all such instances, the construction loans or permanent financing provided by financial institutions is secured by a mortgage or deed of trust on the financed community. The failure to provide our annual audited and quarterly unaudited financial statements or comply with financial covenants in accordance with the obligations of the relevant credit facilities or ancillary documents could be an event of default under such


37


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
documents, and could allow the financial institutions who have extended credit pursuant to such documents to seek remedies, including possible repayment of the loan. These loans total $117.6 million and $49.2 million at December 31, 2007 and 2006, respectively, and are classified as current liabilities as of those dates.
 
15.   Income Taxes
 
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount recognized for income tax purposes. The significant components of our deferred tax assets and liabilities are as follows (in thousands):
 
                 
    December 31,  
    2007     2006  
 
Deferred tax assets:
               
Sunrise operating loss carryforwards — federal
  $ 1,910     $ 1,910  
Sunrise operating loss carryforwards — state
    7,903       4,476  
Sunrise operating loss carryforwards — foreign
    5,650       2,515  
Sunrise At Home loss carryforwards — federal and state
          5,891  
Sunrise At Home deferred tax assets, net
          1,302  
Financial guarantees
    25,893       38,719  
Accrued health insurance
    14,872       17,159  
Self-insurance liabilities
    6,989       8,826  
Stock-based compensation
    7,636       7,518  
Deferred development fees
    29,258       5,923  
Allowance for doubtful accounts
    6,178       6,441  
Tax credits
    6,729       6,277  
Accrued expenses and reserves
    20,593       8,560  
Entrance fees
    14,228       10,661  
Other
    1,898       11,401  
                 
Gross deferred tax assets
    149,737       137,579  
Sunrise valuation allowances
    (6,165 )     (3,800 )
Foreign deferred tax valuation allowance
    (6,243 )     (2,071 )
Sunrise At Home valuation allowance
          (7,193 )
                 
Net deferred tax assets
    137,329       124,515  
                 
Deferred tax liabilities:
               
Investments in ventures
    (96,333 )     (80,093 )
Basis difference in property and equipment and intangibles
    (74,826 )     (84,599 )
Prepaid expenses
    (8,133 )     (5,932 )
Other
    (7,075 )     (2,525 )
                 
Total deferred tax liabilities
    (186,367 )     (173,149 )
                 
Net deferred tax liabilities
  $ (49,038 )   $ (48,634 )
                 
 
During 2006, the deferred tax assets and liabilities included assets and liabilities from Sunrise At Home, which was a consolidated VIE. In 2007, Sunrise At Home was merged into AllianceCare. As a result of the merger, we are no longer the primary beneficiary of Sunrise At Home and we deconsolidated Sunrise At Home as of the merger date.


38


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
During 2006, we completed the acquisition of the stock of Trinity. In connection with this acquisition, we recorded a net deferred tax liability of approximately $0.6 million related to Trinity’s acquisition date temporary differences. During 2007, as a result of a review of the goodwill related to Trinity, we recorded an impairment loss of approximately $56.7 million. Approximately one-half of the impairment charge relates to non-deductible goodwill and results in a non-deductible loss that negatively impacts the 2007 tax rate.
 
During 2007 and 2006, we provided income taxes for unremitted earnings of our Canadian foreign subsidiaries that are not considered permanently reinvested. During 2007, we also provide for income taxes for unremitted earnings of our United Kingdom foreign subsidiaries that are not considered permanently reinvested. As of December 31, 2007, we have deferred tax assets that are fully reserved with respect to our German subsidiaries.
 
At December 31, 2007 and 2006, we had a total valuation allowance against deferred tax assets of $12.4 million and $13.1 million, respectively. In 2006, we have provided a full valuation allowance against the net deferred tax assets of Sunrise At Home because it was more likely than not that sufficient taxable income will not be generated to utilize the net deferred tax assets. As of December 31, 2007 and 2006, we have a valuation allowance of $1.3 million in both years against our foreign tax credits, which we do not view as more likely than not to be utilized to offset future U.S. taxable income. As of December 31, 2007 and 2006, we provided a valuation allowance relating to our German net deferred tax assets of $6.2 million and $2.1 million, respectively, because it is more likely than not that sufficient future German taxable income will not be generated to utilize the excess of the net operating loss carryforward over the future German taxable temporary differences. At December 31, 2007 and 2006, we established a valuation allowance of $4.0 million and $1.4 million, respectively, primarily relating to state net operating losses that are no longer viewed to be more likely than not to be utilized against future state taxable income prior to expiration.
 
At December 31, 2007, we have U.S. federal net operating losses of $77.4 million, which we will elect to carryback to 2006. At December 31, 2006, we had U.S. federal net operating loss carryforwards of $5.4 million from our Trinity acquisition, which are subject to a limitation as to annual use under Internal Revenue Code section 382 and which expire in tax years from 2024 through 2025. At December 31, 2007 and 2006, we had state net operating loss carryforwards valued at $8.2 million and $4.1 million respectively which are expected to expire from 2010 through 2023. At December 31, 2007 and 2006, we had German net operating loss carryforwards to offset future foreign taxable income of $13.0 million and $5.5 million respectively, which have an unlimited carryforward period to offset future taxable income in Germany. At December 31, 2006, Sunrise At Home had net operating loss carryforwards for U.S. federal income tax purposes of approximately $16.9 million which expire at various dates through 2026.
 
At December 31, 2007 and 2006, we had Alternative Minimum Tax credits of $4.9 million and $4.9 million, respectively, which carryforward indefinitely and can be offset against future regular U.S. tax. At December 31, 2007 and 2006, we had $1.3 million and $1.3 million, respectively, of foreign tax credit carryforward as of each


39


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
reporting date which expire in 2013. The major components of the provision for income taxes attributable to continuing operations are as follows (in thousands):
 
                         
    Years Ended December 31,  
    2007     2006     2005  
 
Current:
                       
Federal
  $ (14,904 )   $ 15,837     $ 15,140  
State
    2,814       5,202       5,563  
Foreign
    2,098       26       2,096  
                         
Total current expense
    (9,992 )     21,065       22,799  
Deferred:
                       
Federal
    121       (4,178 )     27,236  
State
    (614 )     553       (337 )
Foreign
    1,226       (228 )     2,458  
                         
Total deferred expense (benefit)
    733       (3,853 )     29,357  
                         
Total tax (benefit) expense
  $ (9,259 )   $ 17,212     $ 52,156  
                         
 
Current taxes payable for 2007, 2006 and 2005 have been reduced by approximately $2.2 million, $1.9 million, and $13.4 million, respectively, reflecting the tax benefit to us of employee stock options exercised during the year. The tax benefit for these option exercises has been recognized as an increase to additional paid-in capital.
 
The differences between the amount that would have resulted from applying the domestic federal statutory tax rate (35%) to pre-tax income from continuing operations and the reported income tax expense from continuing operations recorded for each year are as follows:
 
                         
    Years Ended December 31,  
(In thousands)   2007     2006     2005  
 
(Loss) income before tax benefit (expense) taxed in the U.S. 
  $ (78,816 )   $ 38,535     $ 125,095  
(Loss) income before tax benefit (expense) taxed in foreign jurisdictions
    (718 )     (6,039 )     10,125  
                         
Total (loss) income before tax benefit (expense)
  $ (79,534 )   $ 32,496     $ 135,220  
                         
Tax at US federal statutory rate
    (35.0 )%     35.0 %     35.0 %
State taxes, net
    (4.3 )%     4.2 %     3.9 %
Work opportunity credits
    (0.6 )%     (1.3 )%     (1.2 )%
Change in valuation allowance
    8.4 %     11.1 %     1.0 %
Tax exempt interest
    (2.2 )%     (4.5 )%     (0.1 )%
Tax contingencies
    2.3 %     4.4 %     (1.0 )%
Write-off of non-deductible goodwill
    12.1 %     0.0 %     0.0 %
Foreign rate differential
    (0.8 )%     0.0 %     0.0 %
U.S. tax related to foreign earnings
    4.3 %     0.0 %     0.0 %
Other
    4.2 %     4.1 %     1.0 %
                         
      (11.6 )%     53.0 %     38.6 %
                         
 
In September 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109, Accounting for Income Taxes (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax


40


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
position taken or expected to be taken in a tax return. FIN 48 requires that we recognized in our financial statements the impact of a tax position if that position is more likely than not to be sustained on audit based on the technical merits of the position. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure.
 
We adopted the provisions of FIN 48 on January 1, 2007. There was no adjustment to our recorded tax liability as a result of adopting FIN 48. The total unrecognized tax benefits as of December 31, 2007 was $27.6 million. Included in the balance were $14.6 million of tax positions that, if recognized, would favorably impact the effective tax rate. We are under audit by the IRS for the 2006 tax year and it is possible that the amount of the liability for unrecognized tax-benefits could change during the next twelve month period. We file income tax returns, including returns for our subsidiaries, with federal, state, local and foreign jurisdictions. We have no other income tax return examinations by U.S., state, local or foreign jurisdictions, with the exception of Canada.
 
         
(In thousands)      
 
Unrecognized tax benefit at beginning of year (January 1, 2007)
  $ 25,147  
Change attributable to tax positions taken during a prior period
     
Change attributable to tax positions taken during a current period
    2,643  
Decrease attributable to settlements with taxing authorities
     
Decrease attributable to lapse in statute of limitations
    (234 )
         
Unrecognized tax benefit at end of year (December 31, 2007)
  $ 27,556  
         
 
In accordance with our accounting policy, we recognize interest and penalties related to unrecognized tax benefits as a component of tax expense. This policy did not change as a result of the adoption of FIN 48. Our consolidated statement of income for the year ended December 31, 2007 and our consolidated balance sheet as of that date include interest and penalties of $1.1 million and $3.5 million, respectively.
 
16.   Stockholders’ Equity
 
 
In December 2004, the Financial Accounting Standards Board issued FASB Statement No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”). SFAS 123(R) supersedes APB 25 and amends FASB Statement No. 95, Statement of Cash Flows. SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as expense based on their fair values. Pro forma disclosure is no longer an alternative. We adopted SFAS 123(R) on January 1, 2006, using the modified prospective method and, accordingly, the financial statements for prior periods do not reflect any restated amounts related to adoption. In accordance with SFAS 123(R), we are required to record compensation expense for all awards granted after the date of adoption and for the unvested portion of previously granted awards that remain outstanding at the date of adoption.
 
The adoption of SFAS 123(R) resulted in the recognition of incremental share-based compensation costs of $3.6 million, before tax, a reduction in net income of $1.8 million (net of tax benefits of $1.8 million) and a reduction in basic net income per share of $0.04 and diluted net income per share of $0.03 in 2006. Additionally, the adoption of SFAS 123(R) resulted in a decrease of $3.6 million in reported cash flows from operating activities and an increase of $3.6 million in reported cash flows from investing activities related to the presentation of excess tax benefits from share-based awards for the year ended December 31, 2006.


41


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
The following table illustrates the effect on net income and earnings per share as if we had applied fair value recognition provisions of SFAS 123(R) to share-based employee compensation in 2005. We have included the impact of measured but unrecognized compensation costs and excess tax benefits credited to additional paid-in capital in the calculation of diluted pro forma shares.
 
         
    Twelve Months Ended
 
    Dec. 31,  
(In thousands, except per share data)   2005  
    (Restated)  
 
Net income
  $ 83,064  
Add: Compensation expense included in net income, net of tax
    3,331  
Less: Total share-based employee compensation expense determined under fair-value method for all awards, net of tax
    (9,359 )
         
Pro forma net income
  $ 77,036  
Basic net income per share:
       
As reported
  $ 2.00  
Pro forma
  $ 1.86  
Diluted net income per share:
       
As reported
  $ 1.74  
Pro forma
  $ 1.62  
 
Stock Options
 
We have stock option plans providing for the grant of incentive and nonqualified stock options to employees, directors, consultants and advisors. At December 31, 2007, these plans provided for the grant of options to purchase up to 19,797,820 shares of common stock. Under the terms of the plans, the option exercise price and vesting provisions of the options are fixed when the option is granted. The options typically expire ten years from the date of grant and generally vest over a four-year period. The option exercise price is not less than the fair market value of a share of common stock on the date the option is granted.
 
In 1996, our Board of Directors approved a plan which provided for the potential grant of options to any director who is not an officer or employee of us or any of our subsidiaries (the “Directors’ Plan”). Under the terms of the Directors’ Plan, the option exercise price was not less than the fair market value of a share of common stock on the date the option was granted. The period for exercising an option began upon grant and generally ended ten years from the date the option was granted. All options granted under the Directors’ Plan were non-incentive stock options. There were 40,000 options outstanding under the plan at December 31, 2007. Our directors may be considered employees under the provisions of SFAS 123(R).
 
The fair value of stock options is estimated as of the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term (estimated period of time outstanding) is estimated using the historical exercise behavior of employees and directors. Expected volatility is based on historical volatility for a period equal to the stock option’s expected term, ending on the day of grant, and calculated on a monthly basis. Compensation expense is recognized using the straight-line method for options with graded vesting.
 
             
    2007   2006   2005
 
Risk free interest rate
  3.6%   4.8% - 5.2%   4.3% - 4.5%
Expected dividend yield
     
Expected term (years)
  1.0   5.1 - 9.1   3.9 - 5.6
Expected volatility
  25.5%   56.1% - 60.7%   32.3% - 62.0%


42


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
A summary of our stock option activity and related information for the year ended December 31, 2007 is presented below (share amounts are shown in thousands):
 
                         
          Weighted
    Remaining
 
          Average
    Contractual
 
    Shares     Exercise Price     Term  
 
Outstanding — beginning of year
    3,767     $ 14.96          
Granted
                   
Exercised
                   
Forfeited
    (33 )     16.27          
Expired
    (180 )     20.91          
                         
Outstanding — end of year
    3,554       14.64       3.6  
                         
Vested and expected to vest — end of year
    3,535       14.64       3.6  
                         
Exercisable — end of year
    3,502       14.56       3.5  
                         
 
The weighted average grant date fair value of options granted was $23.28 and $12.44 per share in 2006 and 2005, respectively. No options were granted or exercised in 2007. The total intrinsic value of options exercised was $9.4 million and $33.0 million for 2006 and 2005, respectively. The fair value of shares vested was $1.3 million, $5.2 million and $13.1 million for 2007, 2006 and 2005, respectively. Unrecognized compensation expense related to the unvested portion of our stock options was approximately $0.3 million as of December 31, 2007, and is expected to be recognized over a weighted-average remaining term of approximately 1.1 years.
 
In 2007, the Compensation Committee of our Board of Directors extended the exercise period of stock options that were set to expire unexercised due to the inability of the optionees to exercise the options because we were not current in our SEC filings. The Compensation Committee set the new expiration date as 30 days after we become a current filer with the SEC. As a result of this modification, we recognized $2.4 million of stock-based compensation expense.
 
We generally issue shares for the exercise of stock options from authorized but unissued shares.
 
 
We have restricted stock plans providing for the grant of restricted stock to employees and directors. These grants vest over one to ten years and some vesting may be accelerated if certain performance criteria are met. Compensation expense is recognized using the straight-line method for restricted stock with graded vesting.


43


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
A summary of our restricted stock activity and related information for the years ended December 31, 2007, 2006, and 2005 is presented below (share amounts are shown in thousands):
 
                 
          Weighted Average
 
          Grant Date
 
    Shares     Fair Value  
 
Nonvested, January 1, 2005
    531     $ 13.18  
Granted
    412       26.67  
Vested
    (101 )     13.12  
Canceled
           
                 
Nonvested, December 31, 2005
    842       19.79  
Granted
    45       35.75  
Vested
    (37 )     24.48  
Canceled
    (16 )     25.22  
                 
Nonvested, December 31, 2006
    834       20.34  
Granted
    88       33.87  
Vested
    (288 )     14.01  
Canceled
    (108 )     27.38  
                 
Nonvested, December 31, 2007
    526       24.64  
                 
 
The total fair value of restricted shares vested was $14.01 per share and $24.48 per share for 2007 and 2006, respectively. Unrecognized compensation expense related to the unvested portion of our restricted stock was approximately $8.0 million as of December 31, 2007, and is expected to be recognized over a weighted-average remaining term of approximately 3.6 years.
 
Under the provisions of SFAS 123(R), the recognition of deferred compensation (a contra-equity account representing the amount of unrecognized restricted stock expense that is reduced as expense is recognized) at the date restricted stock is granted is no longer required. Therefore, we eliminated the amount in “Deferred compensation-restricted stock” against “Additional paid-in capital” in our December 31, 2006 consolidated balance sheet.
 
Restricted stock shares are generally issued from existing shares.
 
 
In addition to equity awards under our equity award plans, to encourage greater stock ownership, we have a Bonus Deferral Program for certain executive officers. The Bonus Deferral Program provides that these executive officers may elect to receive all or a portion of their annual bonus payments, if any, in the form of fully-vested, but deferred, restricted stock units in lieu of cash (such restricted stock units are referred to as “base units”). In addition, at the time of the deferral election, each executive officer must also elect a vesting period of from two to four years and, based on the vesting period chosen, will receive additional restricted stock units equal to 20% to 40% of the deferral bonus amount (such additional restricted stock units are referred to as “supplemental units”). The supplemental units, but not the base units, are subject to the vesting period chosen by the executive and will vest in full upon conclusion of the period (assuming continued employment by the executive). Delivery of the shares of our common stock represented by both the base units and supplemental units is made to the executive officer upon the conclusion of the vesting period applicable to the supplemental units, or the first day of the next open window period under the Company’s insider trading program, if the trading window is closed on the vesting date, or, if so elected by the executive at retirement (as defined in the Bonus Deferral Program), thus further providing a


44


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
retention incentive to the named executive officers electing to participate in the program. Compensation expense is recognized using the straight-line method for restricted stock units with graded vesting.
 
 
The Board of Directors previously approved repurchase programs that expired in May 2005 providing for the repurchase of an aggregate of $200.0 million of our common stock and/or the outstanding 5.25% convertible subordinated notes that were due 2009. In November 2005, Sunrise’s Board of Directors approved a new repurchase program that provides for the repurchase of up to $50.0 million of Sunrise’s common stock. This program extended through December 31, 2007. There were no share repurchases under this program in 2007 or 2006. In 2005, 347,980 shares were repurchased at an average price of $25.03.
 
Stockholder Rights Agreement
 
We have a Stockholders Rights Agreement (“Rights Agreement”). All shares of common stock issued by us between the effective date of adoption of the Rights Agreement (April 24, 1996) and the Distribution Date (as defined below) have rights attached to them. The Rights Agreement was renewed in April 2006 and the rights expire on April 24, 2016. The Rights Agreement replaced our prior rights plan, dated as of April 25, 1996, which expired by its terms on April 24, 2006. Each right, when exercisable, entitles the holder to purchase one one-thousandth of a share of Series D Junior Participating Preferred Stock at a price of $170.00 per one one-thousand of a share (the “Purchase Price”). Until a right is exercised, the holder thereof will have no rights as a stockholder with respect to this right.
 
The rights initially attach to the common stock. The rights will separate from the common stock and a distribution of rights certificates will occur (a “Distribution Date”) upon the earlier of (1) ten days following a public announcement that a person or group (an “Acquiring Person”) has acquired, or obtained the right to acquire, beneficial ownership of 20% or more of the outstanding shares of common stock (the “Stock Acquisition Date”) or (2) ten business days (or such later date as the Board of Directors may determine) following the commencement of, or the first public announcement of the intention to commence, a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person of 20% or more of the outstanding shares of common stock.
 
In general, if a person becomes the beneficial owner of 20% or more of the then outstanding shares of common stock, each holder of a right will, after the end of the redemption period referred to below, have the right to exercise the right by purchasing for an amount equal to the Purchase Price common stock (or in certain circumstances, cash, property or other securities of us) having a value equal to two times the Purchase Price. All rights that are or were beneficially owned by the Acquiring Person will be null and void. If at any time following the Stock Acquisition Date (1) we are acquired in a merger or other business combination transaction, or (2) 50% or more of our assets or earning power is sold or transferred, each holder of a right shall have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the Purchase Price. Our Board of Directors generally may redeem the rights in whole, but not in part, at a price of $.005 per right (payable in cash, common stock or other consideration deemed appropriate by our Board of Directors) at any time until ten days after a Stock Acquisition Date. In general, at any time after a person becomes an Acquiring Person, the Board of Directors may exchange the rights, in whole or in part, at an exchange ratio of one share of common stock for each outstanding right.


45


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
17.   Net (Loss) Income Per Common Share
 
The following table summarizes the computation of basic and diluted net (loss) income per common share amounts presented in the accompanying consolidated statements of income (in thousands, except per share amounts):
 
                         
    Years Ended December 31,  
    2007     2006     2005  
          (Restated)     (Restated)  
 
Numerator for basic net (loss) income per share:
                       
Net (loss) income
  $ (70,275 )   $ 15,284     $ 83,064  
                         
Numerator for diluted net (loss) income per share:
                       
Net (loss) income
  $ (70,275 )   $ 15,284     $ 83,064  
Assumed conversion of convertible notes, net of tax
                4,376  
                         
Diluted net (loss) income
  $ (70,275 )   $ 15,284     $ 87,440  
                         
Denominator:
                       
Denominator for basic net (loss) income per common share — weighted average shares
    49,851       48,947       41,456  
Effect of dilutive securities:
                       
Employee stock options and restricted stock
          1,775       2,234  
Convertible notes
                6,695  
                         
Denominator for diluted net (loss) income per common share — weighted average shares plus assumed conversions
    49,851       50,722       50,385  
                         
Basic net (loss) income per common share
  $ (1.41 )   $ 0.31     $ 2.00  
                         
Diluted net (loss) income per common share
    (1.41 )     0.30       1.74  
                         
 
Options are included under the treasury stock method to the extent they are dilutive. Shares issuable upon exercise of stock options after applying the treasury stock method of 1,367,157, 133,500 and 524,500 for 2007, 2006 and 2005, respectively, have been excluded from the computation because the effect of their inclusion would be anti-dilutive. The impact of the convertible notes has been excluded for 2006 because the effect would be anti-dilutive.
 
18.   Commitments and Contingencies
 
 
Rent expense for office space for 2007, 2006, and 2005 was $8.4 million, $6.9 million, and $5.8 million, respectively. We lease our corporate offices, regional offices and development offices under various leases. In 1998, we entered into an agreement to lease new office space for our corporate headquarters, which expires in September 2013. The lease had an initial annual base rent of $1.2 million. In September 2003, we entered into an agreement to lease additional office space for our corporate headquarters. The new lease commenced in September 2003 and expires in September 2013. The lease has an initial annual base rent of $3.0 million. The base rent for both of these leases escalates approximately 2.5% per year in accordance with the base rent schedules.
 
In connection with the acquisition of Greystone in May 2005, we assumed a ten year operating lease that expires in 2013 with the option to extend for seven years. The lease was amended in 2006 to expand the leased space. Based on this agreement, the current annual base rent of $1.1 million will increase to $1.2 million by 2008


46


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
and then decrease in 2009 through the remainder of the lease term. Both the initial agreements and 2006 amendment provided for lease incentives for leasehold improvements for a total of $0.9 million. These assets are included in “Property and equipment, net” in the consolidated balance sheet and are being amortized over the lease term. The incentives were recorded as deferred rent and are being amortized as a reduction to lease expense over the lease term.
 
 
We have also entered into operating leases, as the lessee, for four communities. Two communities commenced operations in 1997 and two communities commenced operations in 1998. In connection with the acquisition of Karrington Health, Inc. in May 1999, we assumed six operating leases for six senior living communities and a ground lease. The operating lease terms vary from 15 to 20 years, with two ten-year extension options. We also have two other ground leases related to two communities in operation. Lease terms range from 15 to 99 years and are subject to annual increases based on the consumer price index and/or stated increases in the lease.
 
In connection with the acquisition of Marriott Senior Living Services, Inc. (“MSLS”) in March 2003, we assumed 14 operating leases and renegotiated an existing operating lease agreement for another MSLS community in June 2003. We also entered into two new leases with a landlord who acquired two continuing care retirement communities from MSLS at the same date. Fifteen of the leases expire in 2013, while the remaining two leases expire in 2018. The leases had initial terms of 20 years, and contain one or more renewal options, generally for five to 15 years. The leases provide for minimum rentals and additional rentals based on the operations of the leased community. Rent expense for operating communities subject to operating leases was $69.0 million, $62.0 million and $57.9 million for 2007, 2006 and 2005, respectively, including contingent rent expense of $8.2 million, $6.5 million, and $4.8 million for 2007, 2006, and 2005, respectively.
 
Future minimum lease payments under office, equipment, ground and other operating leases at December 31, 2007 are as follows (in thousands):
 
         
2008
  $ 68,532  
2009
    71,811  
2010
    72,185  
2011
    69,430  
2012
    68,843  
Thereafter
    376,972  
         
    $ 727,773  
         
 
 
In addition to the letters of credit discussed in Note 13 related to our Bank Credit Facility and the Sunrise Captive, we have letters of credit outstanding of $1.9 million and $1.6 million as of December 31, 2007 and 2006, respectively. These letters of credit primarily relate to our insurance programs.
 
 
At December 31, 2007, we had entered into contracts to purchase 101 development sites, for a total contracted purchase price of approximately $400.0 million, and had also entered into contracts to lease six development sites for lease periods ranging from five to 80 years. Generally, our land purchase commitments are terminable by us.


47


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
As discussed in Note 7, in conjunction with our development ventures, we have provided project completion guarantees to venture lenders and the venture itself, operating deficit guarantees to the venture lenders whereby after depletion of established reserves we guarantee the payment of the lender’s monthly principal and interest during the term of the guarantee and guarantees to the venture to fund operating shortfalls. In conjunction with the sale of certain operating communities to third parties we have guaranteed a set level of net operating income or guaranteed a certain return to the buyer. As guarantees entered into in conjunction with the sale of real estate prevent us from either being able to account for the transaction as a sale or to recognize profit from that sale transaction, the provisions of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”), do not apply to these guarantees.
 
In conjunction with the formation of new ventures that do not involve the sale of real estate, the acquisition of equity interests in existing ventures, and the acquisition of management contracts, we have provided operating deficit guarantees to venture lenders and/or the venture itself as described above, guarantees of debt repayment to venture lenders in the event that the venture does not perform under the debt agreements and guarantees of a set level of net operating income to venture partners. The terms of the operating deficit guarantees and debt repayment guarantees match the term of the underlying venture debt and generally range from three to seven years. The terms of the guarantees of a set level of net operating income range from 18 months to seven years. Fundings under the operating deficit guarantees and debt repayment guarantees are generally recoverable either out of future cash flows of the venture or upon proceeds from the sale of communities. Fundings under the guarantees of a set level of net operating income are generally not recoverable.
 
The maximum potential amount of future fundings for outstanding guarantees subject to the provisions of FIN 45, the carrying amount of the liability for expected future fundings at December 31, 2007, and fundings during 2007 are as follows (in thousands):
 
                                         
          FIN 45
    FAS 5
    Total
       
          Liability
    Liability
    Liability
       
          for Future
    for Future
    for Future
       
    Maximum Potential
    Fundings at
    Fundings at
    Fundings at
    Fundings
 
    Amount of Future
    December 31,
    December 31,
    December 31,
    during
 
Guarantee Type
  Fundings     2007     2007     2007     2007  
 
Debt repayment
  $ 16,832     $ 785     $     $ 785     $  
Operating deficit
    Uncapped       1,371       42,023       43,394       5,829  
Income support
    Uncapped       960       16,525       17,485        
Other
                  4,150       4,150        
                                         
Total
          $ 3,116     $ 62,698     $ 65,814     $ 5,829  
                                         
 
Generally, the financing obtained by our ventures is non-recourse to the venture members, with the exception of the debt repayment guarantees discussed above. However, we have entered into guarantees with the lenders with respect to acts which we believe are in our control, such as fraud, that create exceptions to the non-recourse nature of debt. If such acts were to occur, the full amount of the venture debt could become recourse to us. The combined amount of venture debt underlying these guarantees is approximately $3.0 billion at December 31, 2007. We have not funded under these guarantees, and do not expect to fund under such guarantees in the future.
 
To the extent that a third party fails to satisfy this obligation with respect to two continuing care retirement communities managed by the Company, we would be required to repay this obligation, the majority of which is expected to be refinanced with proceeds from the issuance of entrance fees as new residents enter the communities. At December 31, 2007, the remaining liability under this obligation is $56.6 million.


48


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
In the third quarter of 2005, we acquired a 20% interest in a venture and entered into management agreements for the 16 communities owned by the venture. In conjunction with this transaction, we guaranteed to fund shortfalls between actual net operating income and a specified level of net operating income up to $7.0 million per year through July 2010. We paid $12.0 million to the venture to enter into the management agreements, which was recorded as an intangible asset and is being amortized over the life of the management agreements. The $12.0 million was placed into a reserve account, and the first $12.0 million of shortfalls were to be funded from this reserve account. In late 2006 and 2007, we determined that shortfalls will exceed the amount held in the reserve account. As a result, we recorded a pre-tax charge of $22.4 million in the fourth quarter of 2006. We are continuing to receive management fees with respect to these communities.
 
 
At December 31, 2007 and June 30, 2008, we provided pre-opening and management services to eight and nine communities, respectively, in Germany. In connection with the development of these communities, we provided operating deficit guarantees to cover cash shortfalls until the communities reach stabilization. These communities have not performed as well as originally expected. In 2006, we recorded a pre-tax charge of $50.0 million as we did not expect full repayment of the loans from the funding. In 2007, we recorded an additional $16.0 million pre-tax charge based on changes in expected future cash flows. Our estimates underlying the pre-tax charge include certain assumptions as to lease-up of the communities. To the extent that such lease-up is slower than our projections, we could incur significant additional pre-tax charges in subsequent periods as we would be required to fund additional amounts under the operating deficit guarantees. Through June 30, 2008, we have funded $37.0 million under these guarantees and other loans. We expect to fund an additional $62.0 million through 2012, the date at which we estimate no further funding will be required.
 
Legal Proceedings
 
 
As previously disclosed, on September 14, 2006, we acquired all of the outstanding stock of Trinity. As a result of this transaction, Trinity became an indirect, wholly owned subsidiary of the Company. On January 3, 2007, Trinity received a subpoena from the Phoenix field office of the Office of the Inspector General of the Department of Health and Human Services (“OIG”) requesting certain information regarding Trinity’s operations in three locations for the period January 1, 2000 through June 30, 2006, a period that was prior to the Company’s acquisition of Trinity. The Company was advised that the subpoena was issued in connection with an investigation being conducted by the Commercial Litigation Branch of the U.S. Department of Justice and the civil division of the U.S. Attorney’s office in Arizona. The subpoena indicates that the OIG is investigating possible improper Medicare billing under the Federal False Claims Act (“FCA”). In addition to recovery of any Medicare reimbursements previously paid for false claims, an entity found to have submitted false claims under the FCA may be subject to treble damages plus a fine of between $5,500 and $11,000 for each false claim submitted. Trinity has complied with the subpoena and continues to supplement its responses as requested.
 
On September 11, 2007, Trinity and the Company were served with a complaint filed on September 5, 2007 in the United States District Court for the District of Arizona. That filing amended a complaint filed under seal on November 21, 2005 by four former employees of Trinity under the qui tam provisions of the FCA. The qui tam provisions authorize persons (“relators”) claiming to have evidence that false claims may have been submitted to the United States to file suit on behalf of the United States against the party alleged to have submitted such false claims. Qui tam suits remain under seal for a period of at least 60 days to enable the government to investigate the allegations and to decide whether to intervene and litigate the lawsuit, or, alternatively, to decline to intervene, in which case the qui tam plaintiff, or “relator,” may proceed to litigate the case on behalf of the United States. Qui tam relators are entitled to 15% to 30% of the recovery obtained for the United States by trial or settlement of the claims


49


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
they file on its behalf. On June 6, 2007, the Department of Justice and the U.S. Attorney for Arizona filed a Notice with the Court advising of its decision not to intervene in the case, indicating that its investigation was still ongoing. This action followed previous applications by the U.S. Government for extensions of time to decide whether to intervene. As a result, on July 10, 2007, the Court ordered the complaint unsealed and the litigation to proceed. The matter is therefore currently being litigated by the four individual relators. However, under the FCA, the U.S. Government could still intervene in the future. The amended complaint alleges that during periods prior to the acquisition by the Company, Trinity engaged in certain actions intended to obtain Medicare reimbursement for services rendered to beneficiaries whose medical conditions were not of a type rendering them eligible for hospice reimbursement and violated the FCA by submitting claims to Medicare as if the services were covered services. The relators alleged in their amended complaint that the total loss sustained by the United States is probably in the $75 million to $100 million range. On July 3, 2008, the amended complaint was revised in the form of a second amended complaint which replaced the loss sustained range of $75 to $100 million with an alleged loss by the United States of at least $100 million. The original complaint named KRG Capital, LLC (an affiliate of former stockholders of Trinity) and Trinity Hospice LLC (a subsidiary of Trinity) as defendants. The amended complaint names Sunrise Senior Living, Inc., KRG Capital, LLC and Trinity as defendants. The lawsuit is styled United States ex rel. Joyce Roberts, et al., v. KRG Capital, LLC, et al., CV05 3758 PHX-MEA (D. Ariz.).
 
On February 13, 2008, Trinity received a subpoena from the Los Angeles regional office of the OIG requesting information regarding Trinity’s operations in 19 locations for the period between December 1, 1998 through February 12, 2008. This subpoena relates to the ongoing investigation being conducted by the Commercial Litigation Branch of the U.S. Department of Justice and the civil division of the U.S. Attorney’s Office in Arizona, as discussed above. Trinity is in the process of complying with the subpoena.
 
In 2006, the Company recorded a loss of $5.0 million for possible fines, penalties and damages related to this matter. In 2007, the Company recorded an additional loss of $1.0 million.
 
 
The Internal Revenue Service is auditing our federal income tax return for the years ended December 31, 2006 and 2005 and our federal employment tax returns for 2004, 2005 and 2006. In July 2008, the IRS completed the field work with respect to their audit of our federal income tax return for the year ended December 31, 2005. We will make a payment of approximately $0.2 million for additional taxes plus interest.
 
 
We previously announced on December 11, 2006 that we had received a request from the SEC for information about insider stock sales, timing of stock option grants and matters relating to our historical accounting practices that had been raised in media reports in the latter part of November 2006 following receipt of a letter by us from the Service Employees International Union. On May 25, 2007, we were advised by the staff of the SEC that it has commenced a formal investigation. We have fully cooperated, and intend to continue to fully cooperate, with the SEC.
 
 
Two putative securities class actions, styled United Food & Commercial Workers Union Local 880-Retail Food Employers Joint Pension Fund, et al. v. Sunrise Senior Living, Inc., et al., Case No. 1:07CV00102, and First New York Securities, L.L.C. v. Sunrise Senior Living, Inc., et al., Case No. 1:07CV000294, were filed in the U.S. District Court for the District of Columbia on January 16, 2007 and February 8, 2007, respectively. Both complaints alleged securities law violations by Sunrise and certain of its current or former officers and directors based on allegedly improper accounting practices and stock option backdating, violations of generally accepted accounting principles, false and misleading corporate disclosures, and insider trading of Sunrise stock. Both sought to certify a class for the period August 4, 2005 through June 15, 2006, and both requested damages and equitable


50


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
relief, including an accounting and disgorgement. Pursuant to procedures provided by statute, two other parties, the Miami General Employees’ & Sanitation Employees’ Retirement Trust and the Oklahoma Firefighters Pension and Retirement System, appeared and jointly moved for consolidation of the two securities cases and appointment as the lead plaintiffs, which the Court ultimately approved. The cases were consolidated on July 31, 2007. Thereafter, a stipulation was submitted pursuant to which the new putative class plaintiffs filed their consolidated amended complaint (under the caption In re Sunrise Senior Living, Inc. Securities Litigation, Case No. 07-CV-00102-RBW) on June 6, 2008. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, and names as defendants the Company, Paul J. Klaassen, Teresa M. Klaassen, Thomas B. Newell, Tiffany L. Tomasso, Larry E. Hulse, Carl G. Adams, Barron Anschutz, and Kenneth J. Abod. The defendants’ responses will be filed on August 11, 2008. We intend to move to dismiss the complaint at that time and anticipate that the individual defendants will do so as well.
 
 
On January 19, 2007, the first of three putative shareholder derivative complaints was filed in the U.S. District Court for the District of Columbia against certain of our current and former directors and officers, and naming us as a nominal defendant. The three cases are captioned: Brockton Contributory Retirement System v. Paul J. Klaassen, et al., Case No. 1:07CV00143 (USDC); Catherine Molner v. Paul J. Klaassen, et al., Case No. 1:07CV00227 (USDC) (filed 1/31/2007); Robert Anderson v. Paul J. Klaassen, et al., Case No. 1:07CV00286 (USDC) (filed 2/5/2007). Counsel for the plaintiffs subsequently agreed among themselves to the appointment of lead plaintiffs and lead counsel. On June 29, 2007, the lead plaintiffs filed a Consolidated Shareholder Derivative Complaint, again naming us as a nominal defendant, and naming as individual defendants Paul J. Klaassen, Teresa M. Klaassen, Ronald V. Aprahamian, Craig R. Callen, Thomas J. Donohue, J. Douglas Holladay, William G. Little, David G. Bradley, Peter A. Klisares, Scott F. Meadow, Robert R. Slager, Thomas B. Newell, Tiffany L. Tomasso, John F. Gaul, Bradley G. Rush, Carl Adams, David W. Faeder, Larry E. Hulse, Timothy S. Smick, Brian C. Swinton and Christian B. A. Slavin. The complaint alleges violations of federal securities laws and breaches of fiduciary duty by the individual defendants, arising out of the same matters as are raised in the purported class action litigation described above. The plaintiffs seek damages and equitable relief on behalf of Sunrise. We and the individual defendants filed separate motions to dismiss the consolidated complaint. On the date that their oppositions to those motions were due, the plaintiffs instead attempted to file, over the defendants’ objections, an amended consolidated complaint that does not substantially alter the nature of their claims. The amended consolidated complaint was eventually accepted by the Court and deemed to have been filed on March 28, 2008. We and the individual defendants filed preliminary motions in response to the amended consolidated complaint on June 16, 2008. The plaintiffs also have filed a motion to lift the stay on discovery in this derivative suit. The motion has been briefed and is pending.
 
On March 6, 2007, a putative shareholder derivative complaint was filed in the Court of Chancery in the State of Delaware against Paul J. Klaassen, Teresa M. Klaassen, Ronald V. Aprahamian, Craig R. Callen, Thomas J. Donohue, J. Douglas Holladay, David G. Bradley, Robert R. Slager, Thomas B. Newell, Tiffany L. Tomasso, Carl Adams, David W. Faeder, Larry E. Hulse, Timothy S. Smick, Brian C. Swinton and Christian B. A. Slavin, and naming us as a nominal defendant. The case is captioned Peter V. Young, et al. v. Paul J. Klaassen, et al., Case No. 2770-N (CCNCC). The complaint alleges breaches of fiduciary duty by the individual defendants arising out of the grant of certain stock options that are the subject of the purported class action and shareholder derivative litigation described above. The plaintiffs seek damages and equitable relief on behalf of Sunrise. We and the individual defendants separately filed motions to dismiss this complaint on June 6, 2007 and June 13, 2007. The plaintiffs amended their original complaint on September 17, 2007. On November 2, 2007, we and the individual defendants moved to dismiss the amended complaint. In connection with the motions to dismiss, and at plaintiffs’ request, the Chancery Court issued an order on April 25, 2008 directing us to produce a limited set of documents relating to the Special Independent Committee’s findings with respect to historic stock options grants. We produced


51


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
those documents to the plaintiffs on May 16, 2008. The defendants’ motions to dismiss have been briefed and are pending.
 
In addition, two putative shareholder derivative suits were filed in August and September 2006, which were subsequently dismissed. The cases were filed in the Circuit Court for Fairfax County, Virginia, captioned Nicholas Von Guggenberg v. Paul J. Klaassen, et al., Case No. CL 200610174 (FCCC) (filed 8/11/2006); and Catherine Molner v. Paul J. Klaassen, et al., Case No. CL 200611244 (FCCC) (filed 9/6/2006). The complaints were very similar (and filed by the same attorneys), naming certain of our current and former directors and officers as individual defendants, and naming us as a nominal defendant. The complaints both alleged breaches of fiduciary duty by the individual defendants, arising out of the grant of certain stock options that are the subject of the purported class action and shareholder derivative litigation described above. The Von Guggenberg suit was dismissed pursuant to preliminary motions filed by Sunrise (the plaintiff subsequently filed a petition for appeal with the Supreme Court of Virginia, which was denied, thus concluding the case). The Molner suit was dismissed when the plaintiff filed an uncontested notice of non-suit (permitted by right under Virginia law), after the Company had filed preliminary motions making the same arguments that resulted in the dismissal of the Von Guggenberg suit. As described above, the plaintiff in Molner later refiled suit in the U.S. District Court for the District of Columbia.
 
 
Pursuant to an agreement reached between the parties in May 2008, the Company settled with no admission of fault by either party the previously disclosed litigation filed by Bradley B. Rush, the Company’s former chief financial officer, in connection with the termination of his employment. As previously disclosed, on April 23, 2007, Mr. Rush was suspended with pay. The action was taken by the board of directors following a briefing of the independent directors by WilmerHale, independent counsel to the Special Independent Committee. The Board concluded, among other things, that certain actions taken by Mr. Rush were not consistent with the document retention directives issued by the Company. These actions consisted of Mr. Rush’s deletion of all active electronic files in his user account on one of his Company-issued laptops. Mr. Rush’s employment thereafter was terminated for cause on May 2, 2007. Mr. Rush’s lawsuit asserted that his termination was part of an alleged campaign of retaliation against him for purportedly uncovering and seeking to address accounting irregularities, and it contended that his termination was not for “cause” under the Company’s Long Term Incentive Cash Bonus Plan and the terms of prior awards made to him of certain stock options and shares of restricted stock, to which he claimed entitlement notwithstanding his termination. Mr. Rush asserted five breach of contract claims involving a bonus, restricted stock and stock options. Mr. Rush also asserted a claim for defamation arising out of comments attributed to us concerning the circumstances of his earlier suspension of employment.
 
 
In addition to the lawsuits and litigation matters described above, we are involved in various lawsuits and claims arising in the normal course of business. In the opinion of management, although the outcomes of these other suits and claims are uncertain, in the aggregate they are not expected to have a material adverse effect on our business, financial condition, and results of operations.
 
19.   Related-Party Transactions
 
 
In December 2004, we closed the initial public offering of Sunrise REIT, an independent entity we established in Canada. Sunrise REIT was formed to acquire, own and invest in income producing senior living communities in Canada and the United States.
 
Concurrent with the closing of its initial public offering, Sunrise REIT issued C$25.0 million (U.S. $20.8 million at December 31, 2004) principal amount of subordinated convertible debentures to us, convertible at the rate of


52


 

 
Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
C$11.00 per unit. We held a minority interest in one of Sunrise REIT’s subsidiaries and held the convertible debentures until November 2005, but did not own any common shares of Sunrise REIT. We entered into a 30-year strategic alliance agreement that gave us the right of first opportunity to manage all Sunrise REIT communities and Sunrise REIT had a right of first offer to consider all development and acquisition opportunities sourced by us in Canada. Pursuant to this right of first offer, we and Sunrise REIT entered into fixed price acquisition agreements with respect to seven development communities at December 31, 2005. In addition, we had the right to appoint two of the eight trustees that oversaw the governance, investment guidelines, and operating policies of Sunrise REIT.
 
The proceeds from the offering and placement of the debentures were used by Sunrise REIT to acquire interests in 23 senior living communities from us and our ventures, eight of which are in Canada and 15 of which are in the United States. Three of these communities were acquired directly from us for an aggregate purchase price of approximately $40.0 million and 20 were acquired from ventures in which we participated for an aggregate purchase price of approximately $373.0 million. With respect to the three Sunrise consolidated communities, we realized “Gain on sale and development of real estate and equity interests” of $2.2 million in 2004, and deferred gain of $4.1 million, which was recognized in the fourth quarter of 2006. We contributed our interest in the 15 U.S. communities to an affiliate of Sunrise REIT in exchange for a 15% ownership interest in that entity. Sunrise REIT also acquired an 80% interest in a one of our communities that was in lease-up in Canada for a purchase price of approximately $12.0 million, with us retaining a 20% interest. We also recognized $2.1 million of “Professional fees from development, marketing and other” revenue in 2004 for securing debt on behalf of Sunrise REIT. We had seven wholly owned communities under construction at December 31, 2005, of which two were sold to Sunrise REIT in 2006, and five wholly owned communities under construction at December 31, 2006, which were to be sold to Sunrise REIT in 2007.
 
In April 2007, Ventas, Inc., a large healthcare REIT, acquired Sunrise REIT, the owner of 77 Sunrise communities. We have an ownership interest in 56 of these communities. The management contracts for these communities did not change.
 
We recognized the following in our consolidated statements of operations related to Sunrise REIT only for the period for which they were a related party (in thousands):
 
                         
    Years Ended December 31,  
    2007     2006     2005  
 
Management fees
  $ 5,518     $ 16,448     $ 11,443  
Reimbursed contract services
    77,277       130,455       70,525  
Gain on sale and development of real estate
    8,854       43,223       575  
Interest income received from Sunrise REIT convertible debentures
                1,028  
Interest incurred on borrowings from Sunrise REIT
    414       3,312       2,611  
Sunrise’s share of earnings and return on investment in unconsolidated communities
    180       4,326       718  
 
 
Sunrise Senior Living Foundation (“SSLF”) is an independent, not-for-profit organization whose purpose is to operate schools and day care facilities, provide low and moderate income assisted living housing and own and operate a corporate conference center. Paul and Teresa Klaassen, our Chief Executive Officer and director and Chief Cultural Officer and director, respectively, are the primary contributors to, and serve on the board of directors and serve as officers of, SSLF. One or both of them also serve as directors and as officers of various SSLF subsidiaries. Certain other of our employees also serve as directors and/or officers of SSLF and its subsidiaries. Since November 2006, the Klaassens’ daughter has been the Director of SSLF. She was previously employed by SSLF from June 2005 to July 2006. Since October 2007, the Klaassens’ son-in-law has also been employed by SSLF. For


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Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
many years, we provided administrative services to SSLF, including payroll administration and accounts payable processing. We also provided an accountant who was engaged full-time in providing accounting services to SSLF, including the schools. SSLF paid Sunrise $49,000 in 2006 and $84,000 in 2005 for the provision of these services. We estimate that the aggregate cost of providing these services to SSLF totaled approximately $52,000 and $81,000 for 2006 and 2005, respectively. In August 2006, SSLF hired an outside accounting firm to provide the accounting and administrative services previously provided by us. As a result, we no longer provide any significant administrative services to SSLF. Beginning January 2007, one of our employees became the full-time director of the schools operated by a subsidiary of SSLF, while continuing to provide certain services to us. Through October 2007, we continued to pay the salary and benefits of this former employee. In March 2008, SSLF reimbursed us approximately $68,000, representing the portion of the individual’s salary and benefits attributable to serving as the director of the schools.
 
Prior to April 2005, we managed the corporate conference center owned by SSLF (the “Conference Facility”) and leased the employees who worked at the Conference Facility under an informal arrangement. Effective April 2005, we entered into a contract with the SSLF subsidiary that currently owns the property to manage the Conference Facility. Under the contract, we receive a discount when renting the Conference Facility for management, staff or corporate events, at an amount to be agreed upon, and priority scheduling for use of the Conference Facility, and are to be paid monthly a property management fee of 1% of gross revenues for the immediately preceding month, which we estimate to be our cost of managing this property. The costs of any of our employees working on the property are also to be paid, in addition to the 1% property management fee. In addition, we agreed, if Conference Facility expenses exceed gross receipts, determined monthly, to make non-interest bearing loans in an amount needed to pay Conference Facility expenses, up to a total amount of $75,000 per 12-month period. Any such loan is required to be repaid to the extent gross receipts exceed Conference Facility expenses in any subsequent months. There were no loans made by us under this contract provision in 2006 or 2007. Either party may terminate the management agreement upon 60 days’ notice. Salary and benefits for our employees who manage the Conference Facility, which are reimbursed by SSLF, totaled approximately $0.3 million in both 2007 and 2006 and $0.2 million in 2005. In 2007 and 2006, we earned $6,000 in management fees. We rent the conference center for management, staff and corporate events and paid approximately $0.1 million in 2007, $0.2 million in 2006 and $0.3 million in 2005 to SSLF. The Trinity Forum, a faith-based leadership forum of which Mr. Klaassen is the past chairman and is currently a trustee, operates a leadership academy on a portion of the site on which the Conference Facility is located. The Trinity Forum does not pay rent for this space, but leadership academy fellows who reside on the property provide volunteer services at the Conference Facility.
 
SSLF’s stand-alone day care center, which provides day care services for our employees and non-Sunrise employees, is located in the same building complex as our corporate headquarters. The day care center subleases space from us under a sublease that commenced in April 2004 and expires September 30, 2013. The sublease payments, which equal the payments we are required to make under our lease with our landlord for this space, are required to be paid monthly and are subject to increase as provided in the sublease. SSLF paid Sunrise approximately $90,000, $88,000 and $86,000 in sublease payments in 2007, 2006 and 2005, respectively, under the April 2004 sublease. In January 2007, we leased additional space from our landlord and in February 2007 we and the day care center modified the terms of the day care center’s sublease to include this additional space. Rent for the additional space, payable beginning July 19, 2007, is $8,272 per month (subject to increase as provided in the sublease), which equals the payments we are required to make under our lease with our landlord for this additional space. Rent for the additional space for the period July 19, 2007 to December 2007 totaling approximately $45,000 was paid in December 2007.
 
A subsidiary of SSLF formed a limited liability company (“LLC”) in 2001 to develop and construct an assisted living community and an adult day care center for low to moderate-income seniors on property owned by Fairfax County, Virginia. In 2004, the LLC agreed to construct the project for a fixed fee price of $11.2 million to be paid by Fairfax County, Virginia upon completion of the project ($11.6 million, as adjusted plus approximately $0.3 million under a Pre-Opening Services and Management Agreement). In 2004, the LLC, we and Fairfax County entered into


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Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
an agreement pursuant to which we agreed to develop and manage the project for a fee of up to $0.2 million. In addition, we and Fairfax County entered into a Pre-Opening Services and Management Agreement for the management of the project upon opening. In February 2005, the SSLF subsidiary assigned its membership interests in the LLC to us and transferred additional development costs of approximately $0.9 million to us. These development costs, along with development costs of $0.9 million funded by us in 2004, are to be repaid to us as part of the fixed fee price to be received from Fairfax County upon completion of the community. Total construction costs for the project were $11.3 million. We have received $10.1 million through December 31, 2007 and are pursuing from Fairfax County the remaining $1.8 million outstanding, as well as the $0.3 million due under the Pre-Opening Services and Management Agreement.
 
At December 31, 2004, we had outstanding receivables from SSLF and its affiliates of $3.4 million for operating expenses and development expenses related to the Fairfax County project. SSLF was not charged interest on these outstanding receivables. At December 31, 2004, we had outstanding payables to SSLF of $1.2 million relating to advances by a subsidiary of SSLF to a venture of ours prior to 2002, which subsidiary previously had provided assisted living services at certain of our venture facilities located in Illinois. We were not charged interest on these outstanding payables. These net receivables (receivables less payables) due to us at December 31, 2004, as adjusted to give effect to our acquisition of the Fairfax County project subsequent to year-end, totaling approximately $0.5 million, were paid in full by SSLF in April 2005. In addition, during the latter part of 2005 and in 2006, we made non-interest bearing advances of working capital to SSLF totaling approximately $0.6 million and $0.2 million, respectively. These amounts were repaid by SSLF in October/November 2005 and August 2006, respectively. In addition, in August 2006, SSLF paid us approximately $52,000, representing net working capital advances made to SSLF in prior years. In 2005, we made a separate $10,000 advance which was repaid in July 2005.
 
 
We lease the real property on which our Fairfax, Virginia community is located from Paul and Teresa Klaassen pursuant to a 99-year ground lease entered into in June 1986, as amended in August 2003. Rent expense under this lease is approximately $0.2 million annually.
 
 
In June 1994, the Klaassens transferred to us property which included a residence and a Sunrise community in connection with a financing transaction. In connection with the transfer of the property, we agreed to lease back the residence to the Klaassens under a 99-year ground lease. The rent was $1.00 per month. Under the lease, the Klaassens were responsible for repairs, real estate taxes, utilities and property insurance for the residence. For approximately the past 12 years, the Klaassens have permitted the residence to be used by us for business purposes, including holding meetings and housing out of town employees. In connection with its use of the residence, we have paid the real estate taxes, utilities and insurance for the property and other expenses associated with the business use of the property, including property maintenance and management services. We paid expenses totaling approximately $0.1 million annually. For several years ending August/September 2006, the Klaassens’ son lived at the guest house on the property. In December 2007, the Klaassens terminated their 99-year ground lease for no consideration.
 
 
In January 2006, Mr. Klaassen entered into a purchase agreement with a joint venture in which we own a 30% equity interest and with which we have entered into a management services agreement. Pursuant to the purchase agreement, Mr. Klaassen has agreed to purchase for his parents a residential condominium unit at the Fox Hill condominium project that the joint venture is currently developing. The purchase price of the condominium is approximately $1.4 million. In June 2007, the purchase agreement was modified to reflect certain custom amenities upgrades to the unit for an aggregate price of approximately $0.1 million.


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Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
Service Evaluators Incorporated (“SEI”) is a for-profit company which provides independent sales and marketing analysis, commonly called “mystery shopping” services, for the restaurant, real estate and senior living industries in the United States, Canada and United Kingdom. Janine I. K. Connell and her husband, Duncan S. D. Connell, are the owners and President and Executive Vice President of SEI, respectively. Ms. Connell and Mr. Connell are the sister and brother-in-law of Mr. Klaassen and Ms. Connell is the sister-in-law of Ms. Klaassen.
 
For approximately 13 years, we have contracted with SEI to provide mystery shopping services for us. These services have included on-site visits at Sunrise communities, on-site visits to direct area competitors of Sunrise communities, telephonic inquiries, narrative reports of the on-site visits, direct comparison analysis and telephone calls. In 2005, we paid SEI approximately $0.7 million for approximately 380 communities. We paid approximately $0.7 million to SEI in 2006 for approximately 415 communities and approximately $0.5 million in 2007 for approximately 435 communities. The SEI contract is terminable upon 12 months’ notice. In August 2007, we gave SEI written notice of the termination of SEI’s contract, effective August 2008. Through August 2008, we expect to pay SEI approximately $0.4 million under SEI’s contract.
 
 
In May 2005, we acquired Greystone. Greystone’s founder, Michael B. Lanahan, was appointed chairman of our Greystone subsidiary in connection with the acquisition and he currently serves as one of our executive officers. Pursuant to the terms of the Purchase Agreement, we paid $45.0 million in cash, plus approximately $1.0 million in transaction costs, to acquire all of the outstanding securities of Greystone. We also agreed to pay up to an additional $7.5 million in purchase price if Greystone met certain performance milestones in 2005, 2006 and 2007. The first earnout payment was $5.0 million based on 2005 and 2006 results and was paid in April 2007. Mr. Lanahan’s share of such earnout payment as a former owner of Greystone was approximately $1.5 million. The remaining $2.5 million earnout is based on Greystone’s 2007 results, and was paid in April 2008. Mr. Lanahan’s share of that payment was approximately $0.3 million.
 
 
Prior to 2005, we entered into five unconsolidated ventures with a third party that provided equity to develop communities in the United States, United Kingdom and Canada. One of our then incumbent directors, Craig Callen, was a managing director of Credit Suisse First Boston LLC (“CSFB”) through April 2004. CSFB, through funds sponsored by an affiliate or subsidiary, had from time to time invested in the ventures. We recognized $1.5 million in management and professional services revenue in 2005 from these ventures. Neither we nor CSFB have an ownership interest in any of these five ventures at December 31, 2006 or since.
 
Mr. Callen held, through participation in a diversified portfolio of CSFB related investments, a 1.1375% membership interest in one of the joint ventures. In connection with the formation of Sunrise REIT in December 2004, all of the interests in this venture were acquired by us and immediately contributed to Sunrise REIT. Mr. Callen’s interest was repurchased as part of this transaction for approximately $0.1 million. Mr. Callen resigned as a director in May 2008.
 
 
Mr. Callen served as senior vice president, strategic planning and business development at Aetna, Inc. from May 2004 through November 9, 2007 and as one of our directors until his resignation on May 22, 2008. Aetna Healthcare, a subsidiary of Aetna, Inc., is Sunrise’s health plan administrator, dental plan administrator, health benefit stop-loss insurance carrier and long-term care insurance provider. Sunrise had selected Aetna as its health plan administrator prior to Mr. Callen joining Aetna. The payments made by Sunrise to Aetna Healthcare totaled $8.0 million, $9.0 million and $9.3 million for 2007, 2006 and 2005, respectively.


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Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
In July 2008, Mr. Klaassen purchased from us one of the four fractional interests in private aircrafts owned by us. The purchase price for such interest was approximately $0.3 million, which represents the current market value of the interest as furnished to us by independent appraisers. The purchase of the fractional interest was approved by the Audit Committee of our Board of Directors.
 
20.   Employee Benefit Plans
 
 
We have a 401(k) Plan (“the Plan”) covering all eligible employees. Under the Plan, eligible employees may make pre-tax contributions up to 100% of the IRS limits. The Plan provides an employer match dependent upon compensation levels and years of service. The Plan does not provide for discretionary matching contributions. Matching contributions were $1.6 million, $2.5 million and $1.4 million in 2007, 2006 and 2005, respectively.
 
 
We have an executive deferred compensation plan (“the Executive Plan”) for employees who meet certain eligibility criteria. Under the Plan, eligible employees may make pre-tax contributions in amounts up to 25% of base compensation and 100% of bonuses. We may make discretionary matching contributions to the Executive Plan. Employees vest in the matching employer contributions, and interest earned on such contributions, at a date determined by the Benefit Plan Committee. Matching contributions were $0.4 million, $0.3 million and $0.4 million in 2007, 2006 and 2005, respectively.
 
Greystone adopted an executive deferred compensation plan on January 1, 2007 for employees of Greystone who meet certain eligibility criteria. Employees may make pre-tax contributions up to 25% of base salary. Greystone may make discretionary matching contributions. Employees vest in the employer matching contributions and interest on the match date determined by the administrator. Greystone’s matching contribution was $0.2 million in 2007.
 
Chief Executive Officer Deferred Compensation Plan
 
Pursuant to Mr. Klaassen’s employment agreement, we are required to make contributions of $150,000 per year for 12 years, beginning on September 12, 2000 into a non-qualified deferred compensation account. At the end of the 12-year period, any net gains accrued or realized from the investment of the amounts contributed by us are payable to Mr. Klaassen and we will receive any remaining amounts. At December 31, 2007, we have contributed an aggregate of $0.9 million into this plan, leaving an aggregate amount of $0.9 million to be contributed. We made contributions for 2006 and 2007 in the second quarter of 2008 to bring the plan up to date.
 
21.   Fair Value of Financial Instruments
 
The following disclosures of estimated fair value were determined by management using available market information and valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts we could realize on disposition of the financial instruments. The use of different market assumptions or estimation methodologies could have an effect on the estimated fair value amounts.
 
Cash equivalents, accounts receivable, accounts payable and accrued expenses, equity investments and other current assets and liabilities are carried at amounts which reasonably approximate their fair values.
 
Fixed rate notes receivable with an aggregate carrying value of $0.6 million and $21.8 million have an estimated aggregate fair value of $0.5 million and $21.7 million at December 31, 2007 and 2006, respectively.


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Sunrise Senior Living, Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Fixed rate debt with an aggregate carrying value of $9.1 million and $55.9 million has an estimated aggregate fair value of $9.2 million and $53.7 million at December 31, 2007 and 2006, respectively. Interest rates currently available to us for issuance of debt with similar terms and remaining maturities are used to estimate the fair value of fixed rate debt. The estimated fair value of variable rate debt approximates its carrying value of $244.8 million and $134.8 million at December 31, 2007 and 2006, respectively.
 
Disclosure about fair value of financial instruments is based on pertinent information available to management at December 31, 2007 and 2006. Although management is not aware of any factors that would significantly affect the reasonable fair value amounts, these amounts have not been comprehensively revalued for purposes of these financial statements and current estimates of fair value may differ from the amounts presented herein.
 
22.   Information about Sunrise’s Segments
 
We have four operating segments for which operating results are regularly reviewed by key decision makers; domestic operations, international operations (including Canada), Greystone and Trinity. We acquired Trinity in September 2006, as discussed in Note 6. The domestic, Greystone and international segments develop, acquire, dispose and manage senior living communities. Hospice care provides palliative care and support services to terminally ill patients and their families.
 
Segment results are as follows (in thousands):
 
                                         
    For the Year Ended and as of December 31, 2007  
    Domestic     Greystone     International     Trinity     Total  
 
Operating revenues
  $ 1,491,373     $ 16,471     $ 77,555     $ 67,151     $ 1,652,550  
Interest income
    8,144       208       1,162       380       9,894  
Interest expense
    5,521             1,123       3       6,647  
Sunrise’s share of earnings and return on investment in unconsolidated communities
    31,812       1,600       75,535             108,947  
Depreciation and amortization
    47,843       4,068       886       2,483       55,280  
(Loss) income before taxes
    (13,433 )     (19,693 )     23,984       (70,392 )     (79,534 )
Investments in unconsolidated communities
    80,423             16,750             97,173  
Goodwill
    121,828       39,025