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  • 10-K (Mar 1, 2012)
  • 10-K (Feb 25, 2011)
  • 10-K (Mar 31, 2010)
  • 10-K (Feb 25, 2010)
  • 10-K (Apr 30, 2009)

 
Quarterly Reports

 
8-K

 
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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. 1)
 
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 o No þ
 
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. 1 on Form 10-K/A is being filed to amend Item 8 of the Original Form 10-K to provide the separate Rule 3-09 financial statements for PS Germany Investment (Jersey) LP 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 this venture. In addition, the Company is also amending (a) Item 8 to include unaudited 2007 financial statements for the Sunrise First Assisted Living Holdings, LLC, Sunrise Second Assisted Living Holdings, LLC and Metropolitan Senior Housing, LLC ventures and (b) 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. The Company intends to file a further amendment to the Original Form 10-K to file the remaining Rule 3-09 financial statements for Sunrise Aston Gardens Venture, LLC and Sunrise IV Senior Living Holdings, LLC.
 
In addition, Items 7 and 8 are being amended for the restatement of the 2007 Consolidated Statement of Cash Flows. 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 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.
 
We also have revised the disclosure in Items 7 and 8 regarding how the Company accounts for its investment in unconsolidated communities to clarify that all distributions of proceeds from venture refinancings received by the Company, which are not refundable by agreement or by law, are first recorded as a reduction of the Company’s investment.
 
There are no other changes to the Original Form 10-K 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.


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read together with the information contained in our consolidated financial statements, including the related notes, and other financial information appearing elsewhere herein.
 
 
Our long-range strategic objective is to grow our senior living business through a management services business model that is built on long-term management contracts. Our four primary growth drivers consist of: (1) generating revenue growth from our existing operating portfolio of owned and managed communities; (2) adding additional communities through new construction, primarily with venture partners; (3) generating profitable growth through the delivery of hospice and other ancillary services; and (4) maximizing our return on our equity investment in unconsolidated ventures and other invested capital.
 
We earn income primarily in the following ways:
 
  •  management fees for operating communities, which can also include incentive management fees;
 
  •  resident fees for communities that we own;
 
  •  development and pre-opening fees related to the development of new Sunrise communities;
 
  •  our share of income and losses for those communities in which we have an ownership interest;
 
  •  recapitalizations and sales of communities by ventures in which we have an equity interest; and
 
  •  fees for hospice services.
 
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. We owned or had an ownership interest in 261 of these communities and 178 are managed for third parties. In addition, at December 31, 2007, we provided pre-opening management and professional services to 44 communities under construction, of which 32 communities are in the United States, three communities are in Canada, eight communities are in the United Kingdom, and one community is in Germany, with a combined capacity for approximately 5,600 residents. During 2007, we opened 22 new communities with a combined resident capacity of approximately 2,600 residents, which were developed by us.
 
 
We manage and operate communities that are wholly owned by us, communities that are owned by unconsolidated ventures in which we have a minority ownership interest and communities that are wholly owned by third parties. For the communities that we manage for unconsolidated ventures and third parties, we typically are paid a base management fee of approximately five to eight percent of the community’s revenue. In addition, in certain management contracts, we have the opportunity to earn incentive management fees based on monthly or yearly operating or cash flow results. See “Liquidity and Capital Resources” for a description of debt guarantees, operating deficit guarantees and credit support arrangements provided to certain of our unconsolidated ventures or third-party owners. For the communities that we operate that are wholly owned, we receive resident and ancillary fees.
 
 
In order to grow the operating portfolio that we manage, we also develop senior living communities. We typically develop senior living communities in partnership with others. We also develop wholly owned senior living communities for ourselves, which we expect to sell to ventures or third-party owners before construction is completed. We believe we have maintained a disciplined approach to site selection and refinement of our operating model, first introduced more than 20 years ago, and are constantly searching for ways to improve our communities.
 
We enter into development ventures in order to reduce our initial capital requirements, while enabling us to enter into long-term management agreements that are intended to provide us with a continuing stream of revenue.


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When development is undertaken in partnership with others, our venture partners provide significant cash equity investments, and we take a minority interest in such ventures. Additionally, non-recourse third-party construction debt is obtained to provide the majority of funds necessary to complete development. In addition to third-party debt, we may provide financing necessary to complete the construction for these development ventures. At December 31, 2007 and June 30, 2008, there were 30 and 25 communities, respectively, under construction held in unconsolidated ventures. See “Liquidity and Capital Resources” for a description of guarantees provided to certain of our development ventures.
 
We receive fees from our development ventures for services related to site selection, zoning, design and construction oversight. These fees are recognized in “Gain on the sale and development of real estate and equity interests” in our consolidated statements of income for communities where we owned the land prior to sale to a venture or third party, and in “Professional fees from development, marketing and other” when we do not initially own the land. Services provided for employee selection, licensing, training and marketing efforts are recognized as operating revenue and are included in “Professional fees from development, marketing and other” in the consolidated statements of income. See “Liquidity and Capital Resources” for a description of development completion guarantees provided to certain of our development ventures. We also receive fees from our ventures and/or venture partners as compensation for either brokering the sale of venture assets or the sale of the majority partner’s equity interest in a venture.
 
From time to time we also develop wholly owned senior living communities. At December 31, 2007, we had seven wholly owned communities under construction with a resident capacity of approximately 690 residents. At June 30, 2008, we had six wholly owned communities under construction with a resident capacity of approximately 571 residents. We expect most of these communities to be sold to a venture or third party before construction is completed or, in some cases, upon receipt of a certificate of occupancy. We provide funding for the construction, not otherwise financed by construction loans, and capitalize the development costs associated with construction prior to the contribution of the development community to a venture or third-party owner. For communities that remain wholly owned, we often recognize operating losses during the initial one to two years prior to the community achieving stabilization.
 
 
We began to develop senior living condominium projects in 2004. By the first quarter of 2008, we had discontinued or suspended the development of all but one of our condominium development projects. See Item 1, “Business — Significant 2007 Developments — Senior Living Condominium Developments”.
 
 
The following is a summary of the results of the Special Independent Committee inquiry. For a full description of the adjustments made to restate the 2005 and prior financial statements, refer to our 2006 Form 10-K.
 
In December 2006, our Board of Directors established a Special Independent Committee to review certain allegations made by the Service Employees International Union (“SEIU”) that questioned the timing of certain stock option grants to our directors and officers over a period of time, and stock sales by certain directors in the months prior to the May 2006 announcement of our Accounting Review. In March 2007, our Board of Directors expanded the scope of the Special Independent Committee’s mandate to include the review of facts and circumstances relating to the historical accounting treatment of certain categories of transactions in the restatement, and to develop recommendations regarding any remedial measures, including those pertaining to internal controls and processes over financial reporting, that it may determine to be warranted. The Special Independent Committee deemed it necessary to understand the underlying causes for the pending restatement in order to evaluate the SEIU’s allegations related to stock sales by certain directors in the months prior to our announcement of the Accounting Review.
 
On September 28, 2007, we disclosed that the Special Independent Committee had concluded the fact-finding portion of its inquiry with respect to three issues. The first involved the timing of certain stock option grants. The second involved the facts and circumstances with respect to two significant categories of errors in the pending restatement relating to real estate accounting for the effect of preferences provided to the buyer in a partial sale,


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certain of our guarantees and commitments on the timing of sale accounting and recognition of income upon sale of real estate, and accounting for allocation of profits and losses in those ventures in which our partners received a preference on cash flow. The third involved whether directors and executive officers traded in our common stock when in possession of non-public knowledge of possible accounting errors related to these real estate transactions prior to our May 2006 announcement of our Accounting Review. With respect to these three issues, the Special Independent Committee found:
 
  •  no evidence of backdating or other intentional misconduct with respect to the grants on the 38 grant dates examined, including those specifically questioned by the SEIU, or the possible errors identified by the Special Independent Committee in the accounting for stock options;
 
  •  no evidence of an intention to reach an inappropriate accounting result with respect to the two categories of real estate accounting errors reviewed, no knowledge that these accounting errors were incorrect at the time they were made, and no evidence that information was concealed from review by the external auditors at the time the accounting judgments were made; and
 
  •  no evidence that any director or officer who traded in the months prior to the announcement of the Accounting Review had material non-public information relating to either of these two categories of real estate accounting errors.
 
The Special Independent Committee identified a number of accounting issues under GAAP in connection with certain of the option grants reviewed. As a result of the Special Independent Committee’s findings, we concluded that unintentional errors were made in connection with the accounting for a September 1998 repricing and certain other stock option grants. These errors were corrected as part of the restatement of our historical consolidated financial statements.
 
In September 28, 2007, we also disclosed that the investigation of the Special Independent Committee was continuing with respect to certain other categories of restatement items and issues, primarily related to certain accruals and reserves. In the course of reviewing the accounting that led to the restatement, the Special Independent Committee identified instances of potential inappropriate accounting with respect to certain provisions into and/or releases from certain judgmental accruals and reserves. Management was also made aware through questions from an employee of possible instances of inappropriate accounting with respect to one judgmental reserve. Management reviewed this information with the Special Independent Committee which then reviewed the judgmental reserve in question as part of its inquiry. Both of these events led to the Special Independent Committee’s decision to investigate the other categories of restatement items and issues, which was not complete on September 28, 2007. However, in order to provide information to the marketplace on the Special Independent Committee’s findings as promptly as possible, the Special Independent Committee made the decision to complete the fact finding related to the SEIU’s allegations and make the September 28, 2007 disclosure to report the results of that fact finding while continuing its inquiry with respect to certain judgmental accruals and reserves.
 
On December 20, 2007, we announced the completion of the fact-finding portion of the Special Independent Committee inquiry with respect to the last issue being reviewed by it. The Special Independent Committee identified instances of inappropriate accounting with respect to certain provisions into and/or releases from the following three judgmental accruals and reserves in certain quarters during the period of time from the third quarter of 2003 through the fourth quarter of 2005: (1) the reserve for health and dental insurance claims associated with our self-insurance program (“health and dental reserve”); (2) the corporate bonus accrual; and (3) the reserve for abandoned projects. The accounting for these reserves involves judgments and estimates. The Special Committee determined that in some instances the judgments were not supportable under GAAP and the provisions into and releases from the reserves were not made on a consistent basis, and therefore, involved inappropriate accounting. The Special Independent Committee did not reach any conclusions with respect to the underlying reason or reasons for any specific instance of inappropriate accounting. The Special Independent Committee also did not specifically quantify each instance of inappropriate accounting that it had identified. As disclosed in Item 9A of our 2006 Form 10-K, our management identified several material weaknesses in our internal control over financial reporting that our management believed contributed to the accounting errors, including those related to accruals and reserves, that were corrected as part of the restatement. These included, among others: a lack of sufficient personnel with an appropriate level of accounting knowledge, experience and training to support the size and complexity of our


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organizational structure and financial reporting requirements; a failure to set the appropriate tone around accounting and control consciousness; a lack of appropriate oversight of accounting, financial reporting and internal control matters; insufficient analysis and documentation of the application of GAAP to real estate and other transactions; a lack of written procedures for identifying and appropriately applying GAAP to the various categories of items that were corrected in the restatement; a lack of written procedures for monitoring and adjusting balances related to certain accruals and reserves; a lack of effective accounting reviews for routine and non-routine transactions and accounts; and an inability to close our books in a timely and accurate manner.
 
Before the Special Independent Committee completed its fact-finding, we had determined to restate two of the accruals and reserves — the health and dental reserve and the reserve for abandoned projects — due to accounting errors unrelated to the inappropriate accounting subsequently identified by the Special Independent Committee. Once the Special Independent Committee had identified certain instances of inappropriate accounting, and had completed its investigation, it reviewed its findings with our new financial management team. Our new financial management team was then charged with reviewing, in detail, all of the affected accounts and with quantifying and recording all the necessary adjustments to properly restate the accounts. During this process, our new financial management team did not specifically identify or categorize the adjustments between “inappropriate accounting” and other required adjustments within the identified categories. As a result of our Accounting Review, we recorded “total adjustments” (in which there was no distinct accounting impact from any instances of “inappropriate accounting” because any such impact was already subsumed within the previously required adjustments (for example, required changes in methodology)) to the health and dental reserve, the corporate bonus accrual and the reserve for abandoned projects, which are reflected in the restated financial statements. The total adjustment to the health and dental reserve and the corporate bonus accrual are reflected in the “Other Adjustments” restatement category in our 2006 Form 10-K. The total adjustments for the reserve for abandoned project costs, which was eliminated in its entirety in the restatement, is included in the “Accounting for Costs of Real Estate Projects” restatement category in our 2006 Form 10-K.
 
For information regarding remedial issues recommended by the Special Independent Committee and adopted by the Board of Directors, please refer to Item 9A in this Form 10-K.
 
 
See Item 1, “Business” for a discussion of significant developments in 2007 and 2008.
 
Restatement Related to Statement of Cash Flows Classifications and Accounting for Lease Payments and Non-Refundable Entrance Fees for Two Continuing Care Retirement Communities
 
As described in Note 3 to our consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” of this Form 10-K, the 2007 consolidated statement of cash flows has been restated primarily to reflect the 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 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. We also have in our 2007 financial statements corrected how we account for lease payments and non-refundable entrance fees for two continuing care retirement communities. The effect of the restatement was to decrease retained earnings at January 1, 2005 by approximately $7.5 million and to reduce 2005 and 2006 net income by approximately $4.0 million and $5.1 million, respectively. We have restated our financial statements to correct these errors in accordance with SFAS No. 154, Accounting Changes and Error Corrections.
 
 
We currently classify our consolidated operating revenues as follows:
 
  •  management fees related to services provided to operating and pre-opened communities for unconsolidated ventures and third-party owners;
 
  •  professional fees from development, marketing and other services;


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  •  resident fees for consolidated communities;
 
  •  hospice and other ancillary fees; and
 
  •  reimbursed contract service revenue related to unconsolidated ventures and third party owners.
 
Operating expenses are classified into the following categories:
 
  •  development and venture expense for site selection, zoning, community design, construction management and financing incurred for development communities;
 
  •  community expense for our consolidated communities, which includes labor, food, marketing and other direct community expense;
 
  •  hospice and other ancillary expense;
 
  •  lease expense for certain consolidated communities;
 
  •  general and administrative expense related to headquarters and regional staff expenses and other administrative costs;
 
  •  loss on financial guarantees and other contracts;
 
  •  provision for doubtful accounts;
 
  •  impairment of communities;
 
  •  impairment of goodwill and intangible assets;
 
  •  depreciation and amortization;
 
  •  write-off of abandoned projects;
 
  •  write-off of unamortized contract costs; and
 
  •  reimbursed contract service expense related to unconsolidated ventures and third-party owners.
 
Since 1997, we have entered into various real estate transactions, the most significant of which involved either (i) the sale of a partial interest in a development venture in which we retained an interest and entered into a management contract or (ii) the sale of mature senior living properties or a partial interest in such properties to a third party where we simultaneously entered into a management contract. In most cases, we retained some form of continuing involvement, including providing preferences to the buyer of the real estate, an obligation to complete the development, operating deficit funding obligations, support obligations or, in some instances, options or obligations to reacquire the property or the buyer’s interest in the property. We account for these transactions in accordance with FASB Statement No. 66, Accounting for Sales of Real Estate (“SFAS 66”).


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Our results of operations for each of the three years in the period ended December 31 were as follows:
 
                                         
                      Percent Change  
    Year Ended December 31,     2007 vs.
    2006 vs.
 
(In thousands, except per share amounts)
  2007     2006     2005     2006     2005  
          (Restated)     (Restated)              
 
Operating revenue:
                                       
Management fees
  $ 127,830     $ 117,228     $ 104,823       9.0 %     11.8 %
Buyout fees
    1,626       134,730       83,036       (98.8 )%     62.3 %
Professional fees from development, marketing and other
    38,855       28,553       24,920       36.1 %     14.6 %
Resident fees for consolidated communities
    402,396       381,709       341,610       5.4 %     11.7 %
Hospice and other ancillary services
    125,796       76,882       44,641       63.6 %     72.2 %
Reimbursed contract services
    956,047       911,979       911,992       4.8 %      
                                         
Total operating revenue
    1,652,550       1,651,081       1,511,022       0.1 %     9.3 %
                                         
Operating expenses:
                                       
Development and venture expense
    79,203       69,145       41,064       14.5 %     68.4 %
Community expense for consolidated communities
    290,203       276,833       251,058       4.8 %     10.3 %
Hospice and other ancillary services expense
    134,634       74,767       45,051       80.1 %     66.0 %
Community lease expense
    68,994       61,991       57,946       11.3 %     7.0 %
General and administrative
    187,325       131,473       106,601       42.5 %     23.3 %
Accounting Restatement and Special Independent Committee inquiry, SEC investigation and pending stockholder litigation
    51,707       2,600             1888.7 %     N/A  
Loss on financial guarantees and other contracts
    22,005       89,676             (75.5 )%     N/A  
Provision for doubtful accounts
    9,564       14,632       1,675       (34.6 )%     773.6 %
Impairment of owned communities
    7,641       15,730       2,472       (51.4 )%     536.3 %
Impairment of goodwill and intangible assets
    56,729                   N/A       N/A  
Write-off of abandoned development projects
    28,430       1,329       902       2039.2 %     47.3 %
Depreciation and amortization
    55,280       48,648       42,981       13.6 %     13.2 %
Write-off of unamortized contract costs
          25,359       14,609       (100.0 )%     73.6 %
Reimbursed contract services
    956,047       911,979       911,992       4.8 %     0.0 %
                                         
Total operating expenses
    1,947,762       1,724,162       1,476,351       13.0 %     16.8 %
(Loss) income from operations
    (295,212 )     (73,081 )     34,671       304.0 %     (310.8 )%
Other non-operating income (expense):
                                       
Interest income
    9,894       9,577       6,231       3.3 %     53.7 %
Interest expense
    (6,647 )     (6,204 )     (11,882 )     7.1 %     (47.8 )%
(Loss) gain on investments
          (5,610 )     2,036       (100.0 )%     (375.5 )%
Other (expense) income
    (6,089 )     6,706       3,105       (190.8 )%     116.0 %
                                         
Total other non-operating income (expense)
    (2,842 )     4,469       (510 )     (163.6 )%     (976.3 )%
Gain on the sale and development of real estate and equity interests
    105,081       51,347       81,723       104.6 %     (37.2 )%
Sunrise’s share of earnings and return on investment in unconsolidated communities
    108,947       43,702       13,472       149.3 %     224.4 %
Gain (loss) from investments accounted for under the profit sharing method
    22       (857 )     (857 )     (102.6 )%     0.0 %
Minority interests
    4,470       6,916       6,721       (35.4 )%     2.9 %
                                         
(Loss) income before provision for income taxes
    (79,534 )     32,496       135,220       (344.8 )%     (76.0 )%
Benefit from (provision for) income taxes
    9,259       (17,212 )     (52,156 )     (153.8 )%     (67.0 )%
                                         
Net (loss) income
  $ (70,275 )   $ 15,284     $ 83,064       (559.8 )%     (81.6 )%
                                         
Basic net (loss) income per share
  $ (1.41 )   $ 0.31     $ 2.00       (554.8 )%     (84.5 )%
Diluted net (loss) income per share
    (1.41 )     0.30       1.74       (570.0 )%     (82.8 )%


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The following table summarizes our portfolio of operating communities at December 31, 2007, 2006 and 2005:
 
                                         
                      Percent Change  
    As of December 31,     2007 vs.
    2006 vs.
 
    2007     2006     2005     2006     2005  
 
Total communities
                                       
Consolidated
    63       62       59       1.6 %     5.1 %
Unconsolidated
    198       180       153       10.0 %     17.6 %
Managed
    178       180       186       (1.1 )%     (3.2 )%
                                         
Total
    439       422       398       4.0 %     6.0 %
                                         
Resident capacity
    53,917       52,170       50,673       3.3 %     3.0 %
                                         
 
In 2007, we continued to capitalize on our brand and management services experience by entering into new management and professional services contracts internationally and domestically. The number of communities managed for unconsolidated ventures and third-party owners increased from 360 at December 31, 2006 to 376 at December 31, 2007, or 4%. In 2007, we increased the number of consolidated communities from 62 to 63.
 
The number of communities managed for unconsolidated ventures and third-party owners increased from 339 in 2005 to 360 in 2006, or 6%. In 2006, we increased the number of consolidated communities from 59 to 62 due to the acquisition of three CCRCs, the opening of one community that was later sold to a venture, the disposition of two acquired communities and the acquisition of our non-operating community in New Orleans, Louisiana, that was damaged during Hurricane Katrina, which was previously owned by an unconsolidated venture. Additionally, 24 management contracts were terminated. In September 2006, we acquired Trinity as the first step in our strategy to offer hospice services to our residents and their families.
 
We had a net loss of $(70.3) million in 2007, or $(1.41) per share (diluted). Net income was $15.3 million in 2006, or $0.30 per share (diluted) and $83.1 million, or $1.74 per share (diluted) in 2005. Large and unusual items included in net (loss)/income for the three years included the following:
 
                         
(In millions)
  2007     2006     2005  
 
Buyout of Five Star management contracts
  $     $ 135     $ 83  
Write-off of intangible assets associated with buyout of Five-Star management contracts
          (25 )     (15 )
Loss on guarantees related to our Germany venture
    (16 )     (50 )      
Loss on guarantees related to The Fountains venture
          (22 )      
Impairment of Trinity goodwill and intangible assets
    (57 )            
Accounting Restatement, Special Independent Committee inquiry, SEC investigation and pending stockholder litigation
    (52 )     (3 )      
Loss on guarantees related to the condominium project
    (6 )     (17 )      
Write-off of other condominium projects
    (21 )            
Write-down of Aston Gardens and other equity investments
    (25 )            
                         
Net impact on (loss) income from operations
    (177 )     18       68  
Real estate gains from prior years recognized in the current period
    85       35       81  
Venture recapitalizations
    57       48       17  
                         
Net impact on (loss) income before benefit from (provision for) income taxes
  $ (35 )   $ 101     $ 166  
                         


9


 

Operating Revenue
 
 
2007 Compared to 2006
 
Management fees revenue was $127.8 million in 2007 compared to $117.2 million in 2006, an increase of $10.6 million, or 9.0%. This increase was primarily comprised of:
 
  •  $7.2 million from fees associated with existing North American communities primarily due to increases in rates;
 
  •  $3.1 million of incremental revenues from existing international communities;
 
  •  $3.8 million of incremental revenues from 31 new communities managed in 2007 for unconsolidated ventures and third parties;
 
  •  $5.1 million in incremental incentive management fees; and
 
  •  $6.6 million decrease due to contract terminations.
 
2006 Compared to 2005
 
Management fees revenue was $117.2 million in 2006 compared to $104.8 million in 2005, an increase of $12.4 million, or 11.8%. This increase was primarily comprised of:
 
  •  $6.9 million of incremental revenues in 2006 from 31 management contracts obtained in 2005 from the Greystone and The Fountains acquisitions that were included for a full year in 2006;
 
  •  $7.7 million from increased fees associated with existing communities due to increases in rates and occupancy;
 
  •  $4.8 million of incremental revenues from 36 new communities managed in 2006 for unconsolidated ventures and third parties that were included for a full year in 2006;
 
  •  $5.1 million of incremental revenues from international communities;
 
  •  $2.3 million decrease in guarantee amortization due to the expirations of guarantees in 2006; and
 
  •  $9.7 million decrease due to contract terminations in 2005.
 
 
In 2007, two management contracts were bought out for a fee of $1.6 million. In 2006, Five Star Quality Care, Inc. (“Five Star”) bought out 18 contracts for a total buyout fee of $134.7 million. In 2005, Five Star bought out 12 contracts for a total buyout fee of $83.0 million.
 
 
Professional fees from development, marketing and other were as follows:
 
                         
(In millions)
  2007     2006     2005  
 
North America
  $ 8.2     $ 4.5     $ 2.9  
International
    18.9       12.5       14.8  
Greystone
    11.8       11.6       7.2  
                         
    $ 38.9     $ 28.6     $ 24.9  
                         


10


 

2007 Compared to 2006
 
Professional fees from development, marketing and other revenue was $38.9 million in 2007 compared to $28.6 million in 2006, an increase of $10.3 million, or 36.1% due primarily to the following:
 
  •  $5.2 million in fees paid to us by our ventures or venture partners as compensation for either brokering the sale of venture assets or the sale of the majority partner’s equity interest in a venture;
 
  •  $3.2 million in North American and international development fees from 23 communities under development in 2007 compared to 17 communities under development in 2006; and
 
  •  $2.6 million of fees generated by a Greystone seed capital venture. These fees are earned when the initial development services are successful and permanent financing for the project is obtained.
 
2006 Compared to 2005
 
Professional fees from development, marketing and other revenue was $28.6 million in 2006 compared to $24.9 million in 2005, an increase of $3.7 million, or 14.6% primarily due to $2.8 million of fees paid to us by our ventures or venture partners as compensation for either brokering the sale of venture assets or the sale of the majority partner’s equity interest in a venture.
 
 
2007 Compared to 2006
 
Resident fees for consolidated communities were $402.4 million in 2007 compared to $381.7 million in 2006, an increase of $20.7 million, or 5.4%. This increase was primarily comprised of:
 
  •  $17.3 million from existing communities due to an increase in the average daily rate and fees for other services; and
 
  •  $3.4 million from the acquisition of one community.
 
2006 Compared to 2005
 
Resident fees for consolidated communities were $381.7 million in 2006 compared to $341.6 million in 2005, an increase of $40.1 million, or 11.7%. This increase was primarily comprised of:
 
  •  $37.6 million from existing consolidated communities of which $34.2 million is due to increases in rate and $4.3 million is due to increases in occupancy;
 
  •  $4.1 million from the acquisition of three consolidated communities; and
 
  •  $1.3 million decrease from the disposition of two consolidated communities in 2006.
 
 
In the UK and Germany, our wholly-owned subsidiaries provide resident care services to residents of communities owned by joint ventures. Revenues were $13.6 million, $4.8 million and $0.6 million in 2007, 2006 and 2005, respectively. In 2007, there was an average of 12 care companies operating the first half of the year and an average of 16 care companies operating the second half of the year. In 2006, there was an average of eight care companies operating during the year and in 2005 there were three care companies operating during the year.
 
North American operations include revenues for hospice care from our Trinity acquisition; private duty home health services provided by our At Home venture, and providing resident care services to residents of communities owned by joint ventures or third party owners managed by Sunrise. We provide care services in states we operate in where the care services providers are licensed separately from the room and board provider. Revenues were $112.2 million, $72.1 million and $44.0 million in 2007, 2006 and 2005, respectively. In 2007, the $40.1 million increase was primarily driven by the full year of operation for Trinity, partially offset by the June 2007 disposition of Sunrise At Home. In 2006, the $28.1 million increase was primarily due to Trinity acquired in September 2006 and


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the full year results of resident care revenues from care providers acquired with the Fountains acquisition in 2005. The majority of hospice services are paid for through Medicare, with payments subject to specific limitations.
 
 
Reimbursed contract services were $956.0 million in 2007 and $912.0 million in both 2006 and 2005. The increase of 4.8% in 2007 was due primarily to a 4.4% increase in the number of communities managed, from 360 to 376. There was no change in 2006 to 2005 primarily due to the fact that, while the number of managed communities declined due to the Five Star contract buyouts; this decline was offset by acquisitions and new community openings.
 
Operating Expenses
 
 
2007 Compared to 2006
 
Development and venture expense was $79.2 million in 2007 as compared to $69.1 million in 2006. The increase in development and venture expense of $10.1 million, or 14.5%, was primarily comprised of $8.9 million in salaries and benefits due primarily to an increase in the number of communities under development from 39 at December 31, 2006 to 44 at December 31, 2007 and an increase in the number of employees in the North American development organization, from 162 at December 31, 2006 to 221 at December 31, 2007.
 
2006 Compared to 2005
 
Development and venture expense was $69.1 million in 2006 as compared to $41.1 million in 2005. The increase in development and venture expense of $28.1 million, or 68.4%, was primarily comprised of:
 
  •  $13.0 million from activity of Greystone that was included for a full year in 2006;
 
  •  $10.0 million from North American development. There were 29 North American communities under development in 2006 compared to 28 in 2005; and
 
  •  $3.0 million from European development. The increase was primarily due to continuing development in the United Kingdom and the weakening of the U.S. dollar against the British pound and Euro from 2005 to 2006.
 
 
2007 Compared to 2006
 
Community expense for consolidated communities was $290.2 million in 2007 as compared to $276.8 million in 2006. The increase in community and ancillary expense of $13.4 million, or 4.8%, was primarily comprised of:
 
  •  $11.4 million increase from existing communities resulting primarily from increased labor costs; and
 
  •  $2.0 million increase from the acquisition of one community.
 
2006 Compared to 2005
 
Community expense for consolidated communities was $276.8 million in 2006 as compared to $251.1 million in 2005. The increase in community and ancillary expense of $25.7 million, or 10.3%, was primarily comprised of:
 
  •  $22.8 million from existing communities resulting primarily from increased labor costs;
 
  •  $4.0 million from the acquisition of three communities;
 
  •  $1.0 million decrease from the closing of two communities in 2005.
 
 
In the UK and Germany, our wholly-owned subsidiaries provide resident care services to residents of communities owned by joint ventures. Expenses (primarily labor and related costs) were $15.3 million, $6.0 million and $1.1 million in 2007, 2006 and 2005, respectively. In 2007, there was an average of 12 care companies operating


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the first half of the year and an average of 16 care companies operating the second half of the year. In 2006, there was an average of eight care companies operating during the year and in 2005 there were three care companies operating during the year.
 
North American costs include labor, variable patient costs, and administrative costs to provide these services for hospice, private duty home health services and assistance with activities of daily living. Expenses were $119.3 million, $68.8 million and $44.0 million in 2007, 2006 and 2005, respectively. The increase in 2007 was driven by the full year results of Trinity and higher care services costs due to increased volume, partially offset by the reduction in Sunrise At Home due to the disposition. The increase in costs in 2006 was driven by the Trinity acquisition in September and higher care service costs due to increased volume.
 
 
2007 Compared to 2006
 
Community lease expense was $69.0 million in 2007 as compared to $62.0 million in 2006. The increase in community lease expense of $7.0 million, or 11.3%, was primarily a result of new international communities and increases in contingent rent. Contingent rent was $8.2 million in 2007 as compared to $6.5 million in 2006.
 
2006 Compared to 2005
 
Community lease expense was $62.0 million in 2006 as compared to $57.9 million in 2005. The increase in community lease expense of $4.1 million, or 7.0%, was primarily a result of increases in contingent rent. Contingent rent was $6.5 million in 2006 as compared to $4.8 million in 2005.
 
 
2007 Compared to 2006
 
General and administrative expense was $187.3 million in 2007 as compared to $131.5 million in 2006. The increase in general and administrative expense of $55.8 million, or 42.5%, was primarily comprised of:
 
  •  $29.2 million increase in bonus expense primarily relating to gains at one of our ventures. 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. See Item 1, “Business — Significant 2007 Developments — Ventures”.
 
  •  $8.9 million increase in legal expense related to the Trinity OIG investigation, our exploration of strategic alternatives and the settlement of litigation;
 
  •  $2.6 million increase related to costs associated with potential acquisitions that we decided not to pursue;
 
  •  $9.0 million increase related to the implementation of outsourcing of our payroll processing function to ADP; and
 
  •  $5.7 million increase in salaries, employee benefits and travel costs as the result of additional employees to support 17 additional communities in 2007.


13


 

 
2006 Compared to 2005
 
General and administrative expense was $131.5 million in 2006 as compared to $106.6 million in 2005. The increase in general and administrative expense of $24.9 million, or 23.3%, was primarily comprised of:
 
  •  $9.0 million in salaries, employee benefits, travel and related costs associated with additional employees to support the increased number of communities we manage;
 
  •  $5.0 million loss for possible damages related to the Trinity OIG investigation and qui tam action;
 
  •  $5.1 million of expense to support new communities in Canada, the UK and Germany; and
 
  •  $1.8 million in transition costs for the terminated Five Star contracts.
 
 
During 2007, we incurred legal and accounting fees of approximately $51.7 million related to the Accounting Review, the Special Independent Committee inquiry, the SEC investigation and responding to various shareholder actions compared to approximately $2.6 million in 2006.
 
 
Loss on financial guarantees and other contracts was $22.0 million in 2007. We recorded an additional $16.0 million loss related to operating deficit shortfalls in Germany discussed below due to changes in expected cash flows due to slower than projected lease up and an additional $6.0 million loss related to construction cost overrun guarantees on a condominium project discussed below.
 
Loss on financial guarantees and other contracts in 2006 includes a $50.0 million loss related to funding of operating deficit shortfalls in Germany and $22.4 million related to income support guarantees. Also in 2006, we recorded a $17.2 million loss related to construction cost overrun guarantees on a condominium project. There were no losses on financial guarantees in 2005. See Item 1, “Business — Significant 2007 Developments”.
 
 
2007 Compared to 2006
 
Provision for doubtful accounts was $9.6 million in 2007 as compared to $14.6 million in 2006. The decrease of $5.0 million is primarily due to the write-off of $8.0 million of a receivable in 2006 resulting from prior fundings under a guarantee which were deemed to be uncollectible partially offset by 2007 write-offs of operating advances to four ventures.
 
2006 Compared to 2005
 
Provision for doubtful accounts was $14.6 million in 2006 as compared to $1.7 million in 2005. The increase of $12.9 million is primarily due to $8.0 million write-off of a receivable in 2006 resulting from prior fundings under a guarantee which were previously deemed to be collectible.
 
 
Impairment losses of owned communities were $7.6 million in 2007, $15.7 million in 2006 and $2.5 million in 2005 related to communities whose carrying amounts are not fully recoverable. These owned communities were primarily small senior living communities acquired between 1996 and 2006.
 
 
Impairment of goodwill and intangible assets was $56.7 million in 2007 related to the write-down of Trinity goodwill and other Trinity intangibles. See Item 1, “Business — Significant 2007 Developments — Trinity Hospice”.


14


 

 
The write-off of abandoned projects was $28.4 million in 2007 and $1.3 million in 2006. The increase primarily relates to the $21.0 million write-off of capitalized development costs for four senior living condominium projects due to adverse economic conditions.
 
 
Depreciation and amortization expense by segment was as follows:
 
                         
(In thousands)   2007     2006     2005  
 
North America
  $ 47,843     $ 44,115     $ 40,791  
Greystone
    4,068       3,462       1,992  
International (including Canada)
    886       240       198  
Hospice
    2,483       831        
                         
    $ 55,280     $ 48,648     $ 42,981  
                         
 
Depreciation expense 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 to consolidated financial statements.
 
2007 Compared to 2006
 
Depreciation and amortization expense was $55.3 million in 2007 as compared to $48.6 million in 2006. The increase in depreciation and amortization expense of $6.7 million, or 13.6%, was primarily comprised of $5.8 million from fixed assets placed in service and the acceleration of certain asset lives, $4.0 million increase in amortization due to an acceleration of certain management contract lives and $1.3 million from a full year of amortization expense as the result of the Trinity acquisition in 2006. The increases were partially offset by a $4.5 million decrease related to the sales of communities.
 
2006 Compared to 2005
 
Depreciation and amortization expense was $48.6 million in 2006 as compared to $43.0 million in 2005. The increase in depreciation and amortization expense of $5.6 million, or 13.2%, was primarily comprised of $6.7 million from fixed assets and software placed in service.
 
 
Write-off of unamortized contract costs was $25.4 million in 2006 and $14.6 million in 2005. These costs relate to the buyout of Five Star management contracts.
 
 
2007 Compared to 2006
 
Interest income remained consistent between years as average cash balances remained relatively unchanged from 2006 to 2007. Included in interest income is $3.5 million and $2.1 million in 2007 and 2006, respectively, from our insurance captive. Interest income from the insurance captive does not affect our net income but rather reduces premiums paid by our communities, and therefore, is offset by reductions in community expense for consolidated communities and reimbursed contract services. Interest expense increased $0.4 million in 2007 as compared to 2006 due to an increase of $4.1 million related to mortgages and other debt and $0.3 million increase in loan amortization partially offset by an increase of $4.0 million in capitalized interest due to increased development activity. Other income (expense) decreased from income of $6.7 million in 2006 to a loss of $6.1 million in 2007 due primarily to a $1.5 million performance termination cure payment made in 2007 and $1.7 million in foreign exchange losses as a result of the weakening U.S. dollar against the British pound and the Euro in 2007. 2006 had income of $5.0 million related to the settlement of the MSLS acquisition and $1.9 million of income earned from collection of a fully-reserved receivable.


15


 

2006 Compared to 2005
 
Interest income increased $3.3 million in 2006 as compared to 2005. Interest expense decreased $5.7 million in 2006 compared to 2005 as a result of lower outstanding debt resulting from the redemption of our 5.25% convertible subordinated notes in 2006 and decreased borrowings from Sunrise REIT, which was partially offset by increased borrowings under our Bank Credit Facility and higher mortgages and notes payable.
 
During 2006, we had a $5.6 million loss on investments as compared to a gain on investments of $2.0 million in 2005. In 2006, we wrote down a $5.6 million note receivable due to non-collectability. In 2005, we realized a gain of $2.0 million on the sale of our investment in Sunrise REIT debentures.
 
Other income increased approximately $3.6 million in 2006 from 2005 primarily as a result of $5.0 million of other income recorded in conjunction with our purchase of MSLS, which was partially offset by foreign exchange losses.
 
 
Gain on the sale and development of real estate and equity interests fluctuates depending on the timing of dispositions of communities and the satisfaction of certain operating contingencies and guarantees. Gains in 2007, 2006 and 2005 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 sale
  $ 105.1     $ 51.3     $ 81.7  
                         
 
During 2007, 2006 and 2005, we recognized pre-tax gains of approximately $85.2 million, $35.3 million and $81.3 million, respectively, related to previous sales of real estate from 2002 through 2004 where sale accounting was not initially achieved due to guarantees and other forms of continuing involvement. The gain was recognized in the year those guarantees were released.
 
 
                         
    December 31,  
(In millions)
  2007     2006     2005  
 
Sunrise’s share of earnings (losses) in unconsolidated communities
  $ 60.7     $ (12.0 )   $ (13.1 )
Return on investment in unconsolidated communities
    72.7       55.7       26.5  
Impairment of equity investments
    (24.5 )            
                         
    $ 108.9     $ 43.7     $ 13.4  
                         
 
During 2007, our share of earnings in unconsolidated communities increased significantly primarily related to one venture in the UK During 2007, our UK venture in which we have a 20% equity interest sold seven communities to a different UK venture in which we have a 10% interest. As a result of the gains on these asset sales recorded in the ventures, we recorded earnings in unconsolidated communities of approximately $75.5 million.
 
Excluding this gain, Sunrise’s share of losses in unconsolidated communities, which is primarily the result of pre-opening expenses and operating losses during the initial lease-up period, remained consistent between years.
 
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


16


 

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 the venture, which we recorded as a return on investment in unconsolidated communities.
 
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 2007, we wrote-off equity investments in four unconsolidated ventures. The majority of the charge related to our investment in Aston Gardens, a venture which acquired six senior living communities in Florida in September 2006. 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. See Item 1, “Business — Significant 2007 Developments — Aston Gardens”.
 
 
Our effective tax rate was (11.6)%, 53.0% and 38.6% in 2007, 2006 and 2005, respectively. The effective rate in 2007 was impacted by the write-off of goodwill related to Trinity for which there was no tax basis and revisions to the valuation allowance for federal tax assets. See note 15 to the consolidated financial statements for detailed reconciliations of the statutory tax rate to the effective tax rate.
 
Realization of net deferred tax assets of $137.3 million and $124.5 million at December 31, 2007 and 2006, respectively, is primarily dependent on our ability to generate sufficient taxable income in future periods.
 
 
 
We had $138.2 million and $82.0 million of unrestricted cash and cash equivalents at December 31, 2007 and 2006, respectively.
 
To date, we have financed our operations primarily with cash generated from operations and both short-term and long-term borrowings. At June 30, 2008, we had 31 communities under construction in North America and Europe and seven communities which we were developing through our Greystone subsidiary on behalf of third parties. We estimate that it will cost approximately $0.7 billion to complete the 31 communities we had in North America and Europe under construction as of June 30, 2008. 28 of these communities are either in ventures or committed to ventures and it is expected that the remaining three communities will be put into ventures before the end of 2008. Sunrise’s remaining equity commitments for these projects as of June 30, 2008 is estimated to be as much as $7.0 million. We estimate that existing construction loan financing commitments and existing credit


17


 

facilities, together with cash generated from operations, will be sufficient to fund communities under construction as of June 30, 2008.
 
As of June 30, 2008, we had entered into contracts to purchase or lease 86 additional development sites, for a total contracted purchase price of approximately $410 million. Generally, our land purchase commitments are terminable by Sunrise and a substantial portion of our $18.0 million in land deposits is refundable.
 
Our previously disclosed development plan for 2008 included a development pipeline of 3,200 to 3,400 units. Based on the current capital market conditions and our focus on our strategic plan, this number will decrease by up to 50 percent with many starts deferred until 2009.
 
We do not have firm commitments to cover our full 2008 development plan, and no assurance can be made that we will be able to obtain this financing. We do not intend to begin construction on new projects without a capital partner and without committed debt financing. We are regularly in negotiations with lenders and venture partners to secure the financing required to fund development activities.
 
Additional financing resources will be required to complete the development and construction of these communities and to refinance existing indebtedness. Based on current market conditions related to construction debt financing we may be constrained in our ability to begin construction on all units in our revised 2008 plan and, accordingly, we may be required to defer some projects from 2008 to 2009. We are regularly in negotiations with lenders and venture partners to secure the financing required to fund development activities. We do not have firm commitments to cover our full 2008 development plan, and no assurance can be made that we will be able to obtain this financing. We do not intend to begin construction on new projects without a capital partner and without committed debt financing.
 
 
At December 31, 2007, we had $253.9 million of outstanding debt with a weighted average interest rate of 6.75%. Of the outstanding debt we had $9.1 million of fixed-rate debt with a weighted average interest rate of 7.28% and $244.8 million of variable rate debt with a weighted average interest rate of 6.73%. At December 31, 2007, we had $222.5 million of debt that was classified as a current liability, although only $3.5 million of that debt is due in 2008. We consider borrowings under the Bank Credit Facility (see below) to be short-term as we intend to repay all borrowings within one year. In addition 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 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 in accordance with the obligations of the relevant credit facilities or ancillary documents could be an event of default under such documents, and could allow the financial institutions who have extended credit pursuant to such documents to seek remedies including possible repayment of the loan. $117.6 million of these loans have been classified as current liabilities as of December 31, 2007.
 
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, interest on cash borrowings in non-US dollars accrued 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% at 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


18


 

investments, acquisitions and the refinancing of existing debt. We had an outstanding balance of $100.0 million in borrowing and $71.8 million of outstanding letters of credit 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. Our available borrowing capacity on the Bank Credit Facility at December 31, 2007 was $78.3 million. Our available borrowing capacity on the Bank Credit Facility at June 30, 2008 was $58.7 million.
 
During 2006 and 2007, as a result of the delay in completing our Accounting Review, 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 on the new outstanding maximum amount of $160.0 million. Prior to the July 2008 amendment, fees on the unused amount were based on a $250.0 million outstanding maximum amount.
 
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. Taking into account the new liquidity covenants included in the July 2008 amendment to the Bank Credit Facility described above, we believe this availability, including unrestricted cash balances of approximately $75.0 million at June 30, 2008, will be sufficient to support our operations over the next twelve months.


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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 and have a consolidated net worth of at least $450.0 million as adjusted each quarter and to meet other financial ratios and 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 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.
 
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 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.
 
We paid the lenders an aggregate fee of approximately $0.9 million and $1.9 million for entering into the amendments during 2007 and 2008, respectively.
 
 
On May 7, 2008, 16 of our wholly-owned subsidiaries (the “Borrowers”) incurred mortgage indebtedness in the aggregate principal amount of approximately $106.7 million from Capmark Bank (“Lender”) as lender and servicer pursuant to 16 separate cross-collateralized, cross-defaulted mortgage loans (collectively, the “mortgage loans”). Shortly after the closing, the Lender assigned the mortgage loans to Fannie Mae. The mortgage loans bear interest at a variable rate equal to the “Discount” (which is the difference between the loan amount and the price at which Fannie Mae is able to sell its three-month rolling discount mortgage backed securities) plus 2.27% per annum, require monthly principal payments based on a 30-year amortization schedule (using an interest rate of 5.92%) and mature on June 1, 2013.
 
In connection with the mortgage loans, we entered into interest rate protection agreements that provide for payments to us in the event the LIBOR rate exceeds 5.6145%, pursuant to an interest rate cap purchased on May 7, 2008, by each Borrower from SMBC Derivative Products Limited. The LIBOR rate approximates, but is not exactly equal to the “Discount” rate that is used in determining the interest rate on the mortgage loans; consequently, in the event the “Discount” rate exceeds the LIBOR rate, payments under the interest rate cap may not afford the Borrowers complete interest rate protection. The Borrowers purchased the rate cap for an initial period of three years for a cost of $0.3 million (including fees) and have placed in escrow the amount of $0.7 million to


20


 

purchase additional interest rate caps to cover years four and five of the mortgage loans which amount will be returned to us in the event the mortgage loans are prepaid prior to the end of the third loan year.
 
Each mortgage loan is secured by a senior housing facility owned by the applicable Borrower (which facility also secures the other 15 mortgage loans as well), as well as the interest rate cap described above. In addition, our management agreement with respect to each of the facilities is subordinate to the mortgage loan encumbering such facility. In connection with the mortgage loans, we received net proceeds of approximately $103.1 million (after payment of lender fees, third party costs, escrows and other amounts), $53.0 million of which was used to pay down amounts outstanding under our Bank Credit Facility. See Note 24 to our Consolidated Financial Statements included in Item 8 of this Form 10-K for additional information.
 
 
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 these guarantees 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 (“FIN 45”), Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, 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        
Income support
    Uncapped       960       16,525       17,485       5,829  
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 the 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.


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Below is a discussion of the significant guarantees that have impacted our income statement, financial position or cash flows or are reasonably expected to impact our profitability, financial position or cash flows in the future.
 
 
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. $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. See Item 1, “Business — Significant 2007 Developments — Senior Living Condominium Developments”.
 
 
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, which we estimate to be approximately $9.0 million in 2008, with respect to these communities. See Item 1, “Business — Significant 2007 Developments — The Fountains”.
 
 
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. See Item 1, “Business — Significant 2007 Developments — Germany Venture.”
 
 
We guarantee the $25.0 million senior component of public project finance bonds issued by the Camden County Investment Authority. The proceeds of the bond issuance were used to acquire and renovate a CCRC located in New Jersey for which we manage the community pursuant to a management agreement. This venture is consolidated as a VIE. See Note 8 to our Consolidated Financial Statements. As indicated in Note 8, we provide operating deficit guarantees for non-consolidated VIEs.


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Our current contractual obligations include long-term debt, operating leases for our corporate and regional offices, operating leases for our communities, and building and land lease commitments. In addition, we have commitments to fund ventures in which we are a partner. See Note 18 to our Consolidated Financial Statements for a discussion of our commitments.
 
Principal maturities of long-term debt, equity investments in unconsolidated entities and future minimum lease payments at December 31, 2007 are as follows (in thousands):
 
                                         
    Payments due by period  
                            More
 
          Less Than
                Than
 
Contractual Obligations
  Total     1 Year     1-3 Years     4-5 Years     5 Years  
 
Long-term debt
  $ 153,888     $ 122,541     $ 3,203     $ 2,474     $ 25,670  
Bank Credit Facility
    100,000       100,000                    
Equity investments in unconsolidated entities
    61,123       22,105       38,792       226        
Operating leases
    727,773       68,532       143,997       138,272       376,972  
                                         
Total
  $ 1,042,784     $ 313,178     $ 185,992     $ 140,972     $ 402,642  
                                         
 
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 if we are unable to obtain zoning approval. At June 30, 2008, there were $18.0 million in deposits related to 86 land purchases with a total contracted purchase price of approximately $410.0 million.
 
We consider borrowings under the Bank Credit Facility to be short-term as we intend to repay all borrowings within one year. In addition, 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 (a) to subsidiaries directly or indirectly owned by us that own our consolidated portfolio of senior living communities and (b) to venture entities that own senior living communities managed by us and in which we hold a minority equity interest, pursuant to the terms of the credit facilities with respect to the loans to such entities or pursuant to documents ancillary to such credit facilities (e.g., operating deficit guarantees, etc.). In some cases, we are also subject to financial covenants that are the same as the leverage ratio and fixed charge coverage ratio covenants in our 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 quarterly unaudited financial statements or to 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 documents, and could allow the financial institutions who have extended credit pursuant to such documents to seek the remedies provided for in such documents. In the instances in which we have guaranteed the repayment of the principal amount of the credit extended by these financial institutions, we could be required to repay the loan. All of these loans ($117.6 million) have been classified as current liabilities as of December 31, 2007.
 
 
Our primary sources of cash from operating activities are from management fees, professional fees, from monthly fees and other billings from services provided to residents of our consolidated communities and distributions of operating earnings from unconsolidated ventures. The primary uses of cash for our ongoing operations include the payment of community operating and ancillary expenses for our consolidated and managed communities. Changes in operating assets and liabilities such as accounts receivable, prepaids and other current assets, and accounts payable and accrued expenses will fluctuate based on the timing of payment to vendors. Reimbursement for these costs from our managed communities will vary as some costs are pre-funded, such as payroll, while others are reimbursed after they are incurred. Therefore, there will not always be a correlation between increases and decreases of accounts payable and receivables for our managed communities.


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In 2007, 2006 and 2005, we billed and collected $28.2 million, $21.6 million and $14.4 million, respectively, of Greystone development fees, of which $26.4 million, $15.1 million and $13.0 million, respectively, was deferred and will be recognized when the contract is completed. Included in the $74.4 million of deferred gains on the sale of real estate and deferred revenues at December 31, 2007 is $54.5 million related to Greystone and $19.9 million of cash received related to our real estate transactions for Sunrise development properties that are accounted for in accordance with SFAS No. 66, Accounting for Sales of Real Estate.
 
Net cash provided by operating activities was $128.5 million and $117.5 million in 2007 and 2006, respectively. In 2007, cash flows provided by operations was primarily due to distributions from equity method investments from venture recapitalizations which offset the loss from operations. In 2006, cash flows provided by operations was positively influenced by a significant increase in self-insurance liabilities, which were offset by a significant increase in due from unconsolidated communities. We have placed emphasis on improved management of amounts due from unconsolidated communities and expect to see reductions in this working capital item in future periods.
 
Net cash provided by operating activities was $117.5 million and $190.0 million in 2006 and 2005, respectively. In 2006, cash flows provided by operations was positively influenced by a significant increase in self-insurance liabilities, which were offset by a significant increase in due from unconsolidated communities. We have placed emphasis on improved management of amounts due from unconsolidated communities and expect to see reductions in this working capital item in future periods. In 2005, cash flows provided by operations were significantly influenced by an increase in accounts payable and accrued expenses.
 
Net cash used in investing activities was $248.5 million and $258.9 million in 2007 and 2006, respectively. In 2007, we increased our capital expenditures to $245.5 million, primarily related to spending on the development of senior living communities. This use of cash was partially offset by $60.4 million of proceeds from sales of communities to ventures. We also made $29.3 million of contributions to ventures that are developing senior living communities. Finally we acquired one community, Connecticut Ave., for $50.0 million. In 2006, we acquired Trinity, a 25% interest in Aston Gardens and the Raiser portfolio. We made significant contributions to ventures that were building unconsolidated senior living communities and made significant investments in consolidated communities while receiving distributions from unconsolidated communities of $72.6 million.
 
Net cash used in investing activities was $258.9 million and $168.5 million in 2006 and 2005, respectively. In 2006, we acquired Trinity, a 25% interest in Aston Gardens and the Raiser portfolio. We made significant contributions to ventures that were building unconsolidated senior living communities and made significant investments in consolidated communities while receiving distributions from unconsolidated communities of $72.6 million. In 2005, we acquired Greystone and The Fountains using cash of $46.5 million and $29.0 million, respectively, acquired property for $134.3 million and contributed $64.1 million to unconsolidated senior living communities. These uses of cash in 2005 were partially offset by $56.2 million from the disposition of property and $9.3 million of distributions received from unconsolidated senior living communities.
 
Net cash provided by financing activities was $176.3 million and $78.3 million in 2007 and 2006, respectively. Activities included additional borrowings in 2007 and 2006 of $243.6 million and $154.1 million, respectively, offset by debt repayments in 2007 and 2006 of $66.1 million and $90.8 million, respectively. The additional borrowings under our Bank Credit Facility were used to fund our operations and continued development of senior living communities.
 
Net cash provided by financing activities was $78.3 million and $34.0 million in 2006 and 2005, respectively. Activities included additional borrowings of $154.1 million and $149.5 million, offset by debt repayments of $90.8 million and $137.3 million in 2006 and 2005, respectively. The additional borrowings under our Bank Credit Facility were used to fund our continued development of senior living communities and refinance existing debt. We repurchased approximately $8.7 million of our common stock and received proceeds of $29.1 million from the exercise of stock options in 2005.


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In July 2002, our Board of Directors authorized the repurchase of outstanding shares of our common stock up to an aggregate purchase price of $50.0 million over the subsequent 12 months. In May 2003, our Board of Directors expanded the repurchase program to an aggregate purchase price of $150.0 million to repurchase outstanding shares of common stock and/or our outstanding 5.25% convertible subordinated notes due 2009. In March 2004, our Board of Directors authorized the additional repurchase of outstanding shares of our common stock and/or our outstanding convertible subordinated notes up to an aggregate purchase price of $50.0 million. At December 31, 2005, each of these preceding authorizations had expired to the extent not utilized. In November 2005, our Board of Directors approved a new repurchase plan that provided for the repurchase of up to $50.0 million of our common stock and/or the outstanding convertible subordinated notes. This plan extended through December 31, 2007 and was not renewed. There were no share repurchases in 2007 or 2006. In 2005, 347,980 shares were repurchased at an average price of $25.03.
 
 
We are exposed to market risk from changes in interest rates primarily through variable rate debt. The fair market value estimates for debt securities are based on discounting future cash flows utilizing current rates offered to us for debt of the same type and remaining maturity. The following table details by category the principal amount, the average interest rate and the estimated fair market value of our debt (in thousands):
 
                 
Maturity Date
  Fixed Rate
    Variable Rate
 
Through December 31,
  Debt     Debt  
 
2008
  $ 4,074     $ 218,467  
2009
    1,147       880  
2010
    159       1,015  
2011
    171       1,040  
2012
    183       1,080  
Thereafter
    3,347       22,325  
                 
Total Carrying Value
  $ 9,081     $ 244,807  
                 
Average Interest Rate
    7.3 %     6.7 %
                 
Estimated Fair Market Value
  $ 9,207     $ 244,807  
                 
 
Notes receivable as of December 31, 2007 consist of the following two notes (dollars in thousands):
 
                 
    Interest Rate     2007  
 
Note V with international venture
    4.37 %   $ 592  
Promissory Note XIV
    Euribor + 4.25 %     8,837  
                 
            $ 9,429  
                 
Estimated fair market value
          $ 9,336  
                 
 
Note V is fixed rate instruments and Promissory Note XIV is a floating rate instrument.
 
In addition, we also are exposed to currency risk. At December 31, 2007, we had net U.S. dollar equivalent assets/(liabilities) of $9.9 million, $34.4 million and $(70.3) million in Canadian dollars, British pounds and Euros, respectively.
 
 
We consider an accounting estimate to be critical if: 1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and 2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates than we


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reasonably could have used in the current period, would have a material impact on our financial condition or results of operations.
 
Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors. In addition, there are other items within our financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could have a material impact on our financial statements.
 
 
Nature of Estimates Required — Goodwill.  Goodwill is not amortized, but is subject to periodic assessments of impairment. We test goodwill for impairment annually during the fourth quarter, or when changes in circumstances indicate that the carrying value may not be recoverable. Recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second step of the process involves a comparison of the implied fair value of goodwill (based on a purchase price allocation methodology) with its carrying value. If the carrying value of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. Restoration of a previously-recognized goodwill impairment loss is not allowed.
 
Nature of Estimates Required — Intangibles and Long-Lived Assets.  Intangibles and long-lived asset groups are tested for recoverability when changes in circumstances indicate the carrying value may not be recoverable. Events that trigger a test for recoverability include material adverse changes in the projected revenues and expenses, significant underperformance relative to historical or projected future operating results, and significant negative industry or economic trends. A test for recoverability also is performed when management has committed to a plan to sell or otherwise dispose of an asset group and the plan is expected to be completed within a year. Recoverability of an asset group is evaluated by comparing its carrying value to the future net undiscounted cash flows expected to be generated by the asset group. If the comparison indicates that the carrying value of an asset group is not recoverable, an impairment loss is recognized. The impairment loss is measured by the amount by which the carrying amount of the asset group exceeds the estimated fair value. When an impairment loss is recognized for assets to be held and used, the adjusted carrying amount of those assets is depreciated over its remaining useful life. Restoration of a previously-recognized long-lived asset impairment loss is not allowed.
 
Assumptions and Approach Used.  We estimate the fair value of a reporting unit, intangible asset, or asset group based on market prices (i.e., the amount for which the reporting unit, intangible asset or asset group could be bought by or sold to a third party), when available. When market prices are not available, we estimate the fair value using the income approach and/or the market approach. The income approach uses cash flow projections. Inherent in our development of cash flow projections are assumptions and estimates derived from a review of our operating results, approved business plans, expected growth rates, cost of capital, and tax rates. We also make certain assumptions about future economic conditions, interest rates, and other market data. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates can change in future periods.
 
Changes in assumptions or estimates could materially affect the determination of fair value of a reporting unit, intangible asset or asset group and therefore could affect the amount of potential impairment of the asset. The following key assumptions to our income approach include:
 
  •  Business Projections — We make assumptions regarding the levels of revenue from communities and services. We also make assumptions about our cost levels (e.g., capacity utilization, labor costs, etc.). Finally, we make assumptions about the amount of cash flows that we will receive upon a future sale of the communities using estimated cap rates. These assumptions are key inputs for developing our cash flow projections. These projections are derived using our internal business plans and budgets;
 
  •  Growth Rate — A growth rate is used to calculate the terminal value of the business, and is added to budgeted earnings before interest, taxes, depreciation and amortization. The growth rate is the expected rate at which earnings are projected to grow beyond the planning period;


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  •  Economic Projections — Assumptions regarding general economic conditions are included in and affect our assumptions regarding pricing estimates for our communities and services. These macro-economic assumptions include, but are not limited to, industry projections, inflation, interest rates, price of labor, and foreign currency exchange rates; and
 
  •  Discount Rates — When measuring a possible impairment, future cash flows are discounted at a rate that is consistent with a weighted average cost of capital for a potential market participant. The weighted average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise.
 
The market approach is one of the other primary methods used for estimating fair value of a reporting unit, asset, or asset group. This assumption relies on the market value (market capitalization) of companies that are engaged in the same or similar line of business.
 
As a result of our current projections regarding the daily census and projected revenue for Trinity, we recorded an expense of $56.7 million related to the impairment of Trinity goodwill and intangible assets in 2007. See Item 1, “Business — Significant 2007 Developments — Trinity Hospice”.
 
In addition, in 2007, 2006, and 2005, we recorded impairment expense of $7.6 million, $15.7 million, and $2.5 million related to two, four, and one communities, respectively, and in 2007, we wrote-off $35.7 million of investments in ventures.
 
Nature of Estimates Required — Investments in Ventures.  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. The equity interest in these ventures generally ranges from 10% to 50%.
 
Our investments in ventures accounted for using the equity and cost methods of accounting are impaired when it is determined that there is “other than a temporary” decline in the fair value as compared to the carrying value of the venture or for equity method investments when individual long-lived assets inside the venture meet the criteria specified above. A commitment to a plan to sell some or all of the assets in a venture would cause a recoverability evaluation for the individual long-lived assets in the venture and possibly the venture itself. Our evaluation of the investment in the venture would be triggered when circumstances indicate that the carrying value may not be recoverable due to loan compliance causes, significant under performance relative to historical or projected future operating performance and significant industry or economic trends.
 
Assumptions and Approach Used.  The assumptions and approach for the evaluation of the individual long-lived assets inside the venture are described above. Our approach for evaluation of an investment in a venture would be based on market prices, when available, or an estimate of the fair value using the market approach. The assumptions and risks related are identical to the disclosure for goodwill, intangible assets and long-lived assets described above.
 
Loss Reserves for Self-Insured Programs
 
Nature of Estimates Required.  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”). The design and purpose of a large deductible insurance program is to reduce the overall premium and claims 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 a wholly owned captive insurance subsidiary, Sunrise Senior Living Insurance, Inc. (“SSLII”). SSLII issues policies of insurance to and receives premiums from Sunrise Senior Living, Inc. that are reimbursed through expense allocation to each operated community and us. SSLII 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 also offer our employees an option to participate in self-insured health and dental plans. The cost of our employee health and dental benefits, net of employee contributions, is shared by us and the communities based on


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the respective number of participants working directly either at our corporate headquarters or at the communities. Funds collected are used to pay the actual program costs which include estimated annual claims, third-party administrative fees, network provider fees, communication costs, and other related administrative costs incurred by us. 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.
 
Assumptions and Approach Used for Self-Insured Risks.  We record outstanding losses and expenses for the Self-Insured Risks and for our health and dental plans based on the recommendations of an independent actuary and management’s judgment. 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. While a single value is recorded on Sunrise’s balance sheet, loss reserves are based on estimates of future contingent events and as such contain inherent uncertainty. A quantification of this uncertainty would reflect a range of reasonable favorable and unfavorable scenarios. Sunrise’s annual estimated cost for Self-Insured Risks is determined using management judgment including actuarial analyses at various confidence levels. The confidence level is the likelihood that the recorded expense will exceed the ultimate incurred cost.
 
Sensitivity Analysis for Self-Insured Risks.  The recorded liability for Self-Insured Risks was approximately $142.2 million at December 31, 2007. This liability would be approximately $130.1 million if it were based on the “expected value” assuming a 50% confidence level.
 
We share any revisions to prior estimates with the communities participating in the insurance programs based on their proportionate share of any changes in estimates. Accordingly, the impact of changes in estimates on Sunrise’s income from operations would be much less sensitive than the difference above.
 
Assumptions and Approach Used for Health and Dental Plans.  For our self-insured health and dental plans, we 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 and is based on the recommendations of an independent actuary. The variability in the liability for unpaid claims including incurred but not yet reported claims is much less significant than the self-insured risks discussed above because the claims are more predictable as they generally are known within 90 days and the high and the low end of the range of estimated cost of individual claims is much closer than the workers’ compensation and employers’ liability risks, automobile liability risk, employment practices liability risk and general and professional liability risks discussed above.
 
Sensitivity Analysis for Self-Insured Health and Dental Plan Costs.  The liability for self-insured incurred but not yet reported claims for the self-insured health and dental plan is included in “Accrued expenses” in the consolidated balance sheets and was $9.9 million and $9.7 million at December 31, 2007 and 2006, respectively. We believe that the liability for outstanding losses and expenses is appropriate to cover the ultimate cost of losses incurred at December 31, 2007, but actual claims may differ. The difference between the recorded liability for self-insured incurred but not yet reported claims for the health and dental plan is $0.5 million higher than the expected value (the liability computed using a 50% confidence level). We record any subsequent changes in estimates in the period in which they are determined and will share with the communities participating in the insurance programs based on their proportionate share of any changes in estimates.
 
 
Nature of Estimates Required.  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%.
 
We review all of our ventures to determine if they are variable interest entities (“VIEs”). If a venture meets the requirements and is a VIE, we must then determine if we are the primary beneficiary of the VIE. Estimates are required for the computation and probability of estimated cash flows, expected losses and expected residual returns of the VIE to determine if we are the primary beneficiary of the VIE and therefore required to consolidate the venture.


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Assumptions.  In determining whether we are the primary beneficiary of a VIE, we must make assumptions regarding cash flows of the entity, expected loss levels and expected residual return levels. The probability of various cash flow possibilities is determined from business plans, budgets and entity history if available. These cash flows are discounted at the risk-free interest rate. Computations are then made based on the estimated cash flows of the expected losses and residual returns to determine if the entity is a variable interest entity, and, if so, to determine the primary beneficiary. Changes in estimated cash flows and the probability factors could change the determination of the primary beneficiary and whether there is a requirement to consolidate a VIE.
 
 
Nature of Estimates Required.  Deferred tax assets and liabilities are recognized based on the future tax consequences attributable to temporary differences that exist between the financial statement carrying value of assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards on a taxing jurisdiction basis. We measure deferred tax assets and liabilities using enacted tax rates that will apply in the years in which we expect the temporary differences to be recovered or paid.
 
SFAS No. 109, Accounting for Income Taxes (“SFAS No. 109”), requires a reduction of the carrying amounts of deferred tax assets by recording a valuation allowance if, based on the available evidence, it is more likely than not (defined by SFAS No. 109 as a likelihood of more than 50 percent) such assets will not be realized. The valuation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns and future profitability. Our accounting for deferred tax consequences represents our best estimate of those future events. Changes in our current estimates, due to unanticipated events or otherwise, could have a material impact on our financial condition and results of operations.
 
Assumptions and Approach Used.  In assessing the need for a valuation allowance, we consider both positive and negative evidence related to the likelihood of realization of the deferred tax assets. If, based on the weight of available evidence, it is more likely than not the deferred tax assets will not be realized, we record a valuation allowance. The weight given to the positive and negative evidence is commensurate with the extent to which the evidence may be objectively verified. As such, it is generally difficult for positive evidence regarding projected future taxable income exclusive of reversing taxable temporary differences to outweigh objective negative evidence of recent financial reporting losses. SFAS No. 109 states that a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome in determining that a valuation allowance is not needed against deferred tax assets.
 
This assessment, which is completed on a taxing jurisdiction basis, takes into account a number of types of evidence, including the following:
 
  •  Nature, frequency, and severity of current and cumulative financial reporting losses — A pattern of objectively measured recent financial reporting losses is a source of negative evidence. In certain circumstances, historical information may not be as relevant due to changed circumstances;
 
  •  Sources of future taxable income — Future reversals of existing temporary differences are verifiable positive evidence. Projections of future taxable income exclusive of reversing temporary differences are a source of positive evidence only when the projections are combined with a history of recent profits and can be reasonably estimated; and
 
  •  Tax planning strategies — If necessary and available, tax planning strategies would be implemented to accelerate taxable amounts to utilize expiring carryforwards. These strategies would be a source of additional positive evidence and, depending on their nature, could be heavily weighted.
 
See Note 15 of the Notes to the Consolidated Financial Statements for more information regarding deferred tax assets.
 
A return to profitability in certain of our operations would result in a reversal of a portion of the valuation allowance relating to realized deferred tax assets, but we may not change our judgment of the need for a full valuation allowance on our remaining deferred tax assets. In that case, it is likely that we would reverse some or all of the remaining deferred tax asset valuation allowance. However, since we have heavily weighted recent financial


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reporting losses and given no weight to subjectively determined projections of future taxable income exclusive of reversing temporary differences, we have concluded as of December 31, 2007 and 2006 that it is more likely than not certain deferred tax assets will not be realized (in whole or in part), and accordingly, we have recorded a full valuation allowance against the net deferred tax assets.
 
At December 31, 2007 and 2006, our deferred tax assets, net of the valuation allowances of $12.4 million and $13.1 million, respectively, were $137.3 million and $124.5 million, respectively. These net deferred tax assets related to operations where we believed it was more likely than not that these net deferred tax assets would be realized through future taxable earnings. Accordingly, no valuation allowance has been established on our remaining net deferred tax assets. We will continue to assess the need for a valuation allowance in the future. Changes in our current estimates, due to unanticipated events or otherwise, could have a material impact on our financial condition and results of operations.
 
 
Liabilities for tax contingencies are recognized based on the requirements of FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FASB Statement No. 109 regarding the calculation and disclosure of reserves for uncertain tax positions. FIN 48 requires us to analyze the technical merits of our tax positions and determine the likelihood that these positions will be sustained if they were ever examined by the taxing authorities. If we determine that it is unlikely that our tax positions will be sustained, a corresponding liability is created and the tax benefit of such position is reduced for financial reporting purposes.
 
Evaluation and Nature of Estimates Required.  The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step in the evaluation process is recognition. The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information.
 
The second step in the evaluation process is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which:
 
(a) the threshold is met (for example, by virtue of another taxpayer’s favorable court decision);
 
(b) the position is “effectively settled” by virtue of the closing of an examination where the likelihood of the taxing authority reopening the examination of that position is remote; or
 
(c) the relevant statute of limitations expires.
 
Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
 
Interest and Penalties.  FIN 48 requires us to accrue interest and penalties that, under relevant tax law, we would incur if the uncertain tax positions ultimately were not sustained. Accordingly, under FIN 48, interest would start to accrue for financial statement purposes in the period in which it would begin accruing under relevant tax law, and the amount of interest expense to be recognized would be computed by applying the applicable statutory rate of interest to the difference between the tax position recognized in accordance with FIN 48 and the amount previously taken or expected to be taken in a tax return. Penalties would be accrued in the first period in which the position was taken on a tax return that would give rise to the penalty.
 
Assumptions.  In determining whether a tax benefit can be recorded, we must make assessments of a position’s sustainability and the likelihood of ultimate settlement with a taxing authority. Changes in our assessments would cause a change in our recorded position and changes could be significant. As of December 31, 2007, we had a recorded liability for possible losses on uncertain tax positions of $14.6 million.


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When we enter into guarantees in connection with the sale of real estate, we may be prevented from initially either accounting for the transaction as a sale of an asset or recognizing in earnings the profit from the sale transaction. For guarantees that are not entered into in conjunction with the sale of real estate, 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 which require us to make various assumptions to determine the fair value. On a quarterly basis, we review and evaluate the estimated liability based upon 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 for that contingent loss. 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 2006, we recorded a loss of $50.0 million for our expected loss on the operating deficit guarantees we have for our German communities and a loss of $22.0 million for our expected loss on a guarantee of a specified level of net operating income to the Fountains venture. Due to continued deteriorating operating performance of our communities in Germany in 2007 we revised our estimated liability for operating deficit guarantees and as a result, we recorded additional expense of $16.0 million. Because our loss on the operating deficit guarantees for our German communities is based on projections spanning numerous years it is highly susceptible to future adverse change and such changes could have a material impact on our financial condition and results of operations.
 
Assumptions and Approach Used.  For the German operating deficit guarantees, we calculated the estimated loss on financial guarantees based on projected operating losses and an assumed sale of the community after the operations have stabilized. The assumed sale value uses estimated cap rates. For the Fountains guarantee of net operating income, we calculated the estimated loss based on projected cash flows during the remaining term of the guarantee. Inherent in our development of cash flow projections are assumptions and estimates derived from a review of our operating results, approved business plans, expected growth rates, cost of capital, and tax rates. We also make certain assumptions about future economic conditions, interest rates, and other market data. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates can change in future periods.
 
Changes in assumptions or estimates could materially affect the determination of fair value of an asset. The following key assumptions to our income approach include:
 
  •  Business Projections — We make assumptions regarding the levels of revenue from communities and services. We also make assumptions about our cost levels (e.g., capacity utilization, labor costs, etc.). Finally, we make assumptions about the amount of cash flows that we will receive upon a future sale of the communities using estimated cap rates. These assumptions are key inputs for developing our cash flow projections. These projections are derived using our internal business plans and budgets;
 
  •  Growth Rate — A growth rate is used to calculate the terminal value of the business, and is added to budgeted earnings before interest, taxes, depreciation and amortization. The growth rate is the expected rate at which earnings are projected to grow beyond the planning period;
 
  •  Economic Projections — Assumptions regarding general economic conditions are included in and affect our assumptions regarding pricing estimates for our communities and services. These macro-economic assumptions include, but are not limited to, industry projections, inflation, interest rates, price of labor, and foreign currency exchange rates; and
 
  •  Discount Rates — When measuring a possible loss, future cash flows are discounted at a rate that is consistent with a weighted average cost of capital for a potential market participant. The weighted average cost of capital is an estimate of the overall after-tax rate of return required by equity and debt holders of a business enterprise.
 
In 2006, we recorded a loss of $17.2 million for our expected loss due to the completion guarantee for our condominium project under construction. Due to continued deterioration of the condominium project in 2007, we revised our estimated liability for the completion guarantee and as a result, we recorded additional expense of


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$6.0 million. Accordingly, changes in our current estimates, due to unanticipated events or otherwise, could have a material impact on our financial condition and results of operations.
 
Assumptions and Approach Used in Calculating our Loss on Completion Guarantees.  The computation of our expected loss on our completion guarantee involves the use of various estimating techniques to determine total estimated project costs at completion. Contract estimates involve various assumptions and projections relative to the outcome of future events over a period of time including the nature and complexity of the work to be performed, the cost and availability of materials and the impact of delays. These estimates are based on our best judgment. A significant change in one or more of these estimates could affect the ultimate cost of our condominium development project. We review our contract estimates at least quarterly to assess revisions in contract values and estimated costs at completion. We have recorded our best estimate of our loss but it is reasonably possible that our possible loss could exceed amounts recorded.
 
 
Litigation is subject to uncertainties and the outcome of individual litigated matters is not predictable with assurance. Various legal actions, claims and proceedings are pending against us, some for specific matters describe in Note 18 to the financial statements and others arising in the ordinary course of business. We have established loss provisions for matters in which losses are probable and can be reasonably estimated. In other instances, we are not able to make a reasonable estimate of any liability because of uncertainties related to the outcome and/or the amount or range of losses. At December 31, 2007, we have recorded an accrual of $6.0 million for our estimated exposure to loss related to the Trinity OIG Investigation and qui tam action discussed in Note 18 to the Consolidated Financial Statements. We have not recorded any loss related to our possible exposure to shareholder litigation as a potential loss is not probable or estimable. Changes in our current estimates, due to unanticipated events or otherwise, could have a material impact on our financial condition and results of operations.
 
 
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 is an interpretation of FASB Statement No. 109, Accounting for Income Taxes, and it seeks to reduce the 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 taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted FIN 48 as of January 1, 2007, and applied its provisions to all tax positions upon initial adoption. Only tax positions that meet a “more likely than not” threshold at the effective date may be recognized or continue to be recognized. There was no adjustment to our recorded tax liability as a result of adopting FIN 48.
 
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 Sunrise 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 its financial statements.
 
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.
 
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


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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 Sunrise 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 a business combination to be recorded at “full fair value”. The standard is effective for us as of January 1, 2009, and earlier adoption is prohibited.
 
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 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 for us as of January 1, 2009. We are currently evaluating the impact that SFAS No. 160 will have on our financial statements.
 
 
Management fees from communities operated by us for third parties and resident and ancillary fees from owned senior living communities are significant sources of our revenue. These revenues are affected by daily resident fee rates and community occupancy rates. The rates charged for the delivery of senior living services are highly dependent upon local market conditions and the competitive environment in which the communities operate. In addition, employee compensation expense is the principal cost element of community operations. Employee compensation, including salary and benefit increases and the hiring of additional staff to support our growth initiatives, have previously had a negative impact on operating margins and may again do so in the foreseeable future.
 
Substantially all of our resident agreements are for terms of one year, but are terminable by the resident at any time upon 30 days notice, and allow, at the time of renewal, for adjustments in the daily fees payable, and thus may enable us to seek increases in daily fees due to inflation or other factors. Any increase would be subject to market and competitive conditions and could result in a decrease in occupancy of our communities. We believe, however, that the short-term nature of our resident agreements generally serves to reduce the risk to us of the adverse effect of inflation. There can be no assurance that resident and ancillary fees will increase or that costs will not increase due to inflation or other causes.


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    Page
 
Item 8.  Financial Statements and Supplementary Data
       
       
Sunrise Senior Living, Inc.
       
Report of Independent Registered Public Accounting Firm
    35  
Consolidated Balance Sheets
    36  
Consolidated Statements of Income
    37  
Consolidated Statements of Changes in Stockholders’ Equity
    38  
Consolidated Statements of Cash Flows
    39  
Notes to Consolidated Financial Statements
    40  
PS UK Investment (Jersey) LP
       
Report of Independent Auditors
    95  
Consolidated Income Statement
    96  
Consolidated Balance Sheet
    97  
Consolidated Statement of Changes in Partners Capital
    98  
Consolidated Statement of Cash Flows
    99  
Notes to Consolidated Financial Statements
    100  
AL US Development Venture, LLC
       
Independent Auditors’ Report
    121  
Consolidated Balance Sheets
    122  
Consolidated Statements of Operations
    123  
Consolidated Statements of Changes in Members’ Capital (Deficit)
    124  
Consolidated Statements of Cash Flows
    125  
Notes to Consolidated Financial Statements
    126  
Sunrise First Assisted Living Holdings, LLC
       
Independent Auditors’ Report
    132  
Consolidated Balance Sheets
    133  
Consolidated Statements of Operations
    134  
Consolidated Statements of Changes in Members’ (Deficit) Capital
    135  
Consolidated Statements of Cash Flows
    136  
Notes to Consolidated Financial Statements
    137  
Sunrise Second Assisted Living Holdings, LLC
       
Independent Auditors’ Report
    142  
Consolidated Balance Sheets
    143  
Consolidated Statements of Operations
    144  
Consolidated Statements of Changes in Members’ (Deficit) Capital
    145  
Consolidated Statements of Cash Flows
    146  
Notes to Consolidated Financial Statements
    147  
Metropolitan Senior Housing, LLC
       
Report of Independent Auditors
    152  
Consolidated Balance Sheets
    153  
Consolidated Statements of Operations
    154  
Consolidated Statements of Changes in Members’ (Deficit) Capital
    155  
Consolidated Statements of Cash Flows
    156  
Notes to Consolidated Financial Statements
    157  
PS Germany Investment (Jersey) LP
       
Report of Independent Auditors
    164  
Consolidated Income Statement
    165  
Consolidated Balance Sheet
    166  
Consolidated Statement of Changes in Partners’ Capital
    167  
Consolidated Statement of Cash Flows
    168  
Notes to Consolidated Financial Statements
    169  
Sunrise Aston Gardens Venture, LLC*
       
Sunrise IV Senior Living Holdings*
       
 
 
* To be filed by amendment as soon as these financial statements become available. See Item 1B, “Unresolved Staff Comments”.


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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.
 
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 Investment under FASB Statement No. 66, Accounting for Sales of Real Estate for Sales of 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


35


 

SUNRISE SENIOR LIVING, INC.
 
 
                 
    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.


36


 

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.


37


 

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.


38


 

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.


39


 

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


40


 

 
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).


41


 

 
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.


42


 

 
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.


43


 

 
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.


44


 

 
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.


45


 

 
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.


46


 

 
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


47


 

 
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


48


 

 
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


49


 

 
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  


50


 

 
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.


51


 

 
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.


52


 

 
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.


53


 

 
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


54


 

 
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.


55


 

 
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.


56


 

 
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.


57


 

 
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.


58


 

 
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