UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission file number: 1-16499

 

SUNRISE SENIOR LIVING, INC.

(Exact name of registrant as specified in its charter)

 

 

 

7902 Westpark Drive

McLean, Virginia 22102

(Address of principal executive offices)

 

(703) 273-7500

 

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

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

 

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

 

(Do not check if a smaller reporting company)

 

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

 

There were 51,565,282 shares of the Registrant’s common stock outstanding at October 31, 2009.

 

 

SUNRISE SENIOR LIVING, INC.

Form 10-Q
For the Quarterly Period Ended September 30, 2009

TABLE OF CONTENTS

 

 

SUNRISE SENIOR LIVING, INC.

 

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying notes

SUNRISE SENIOR LIVING, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See accompanying notes

SUNRISE SENIOR LIVING, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying notes.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements

(Unaudited)

 

 

Our accompanying unaudited consolidated financial statements include all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the three and nine month periods ended September 30, 2009 and 2008 pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read together with our consolidated financial statements and the notes thereto for the year ended December 31, 2008 included in our 2008 Form 10-K, as amended on March 31, 2009. Operating results are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. We have reclassified certain amounts to conform with the current period presentation.

 

The accompanying consolidated financial statements have been prepared on the basis of us continuing as a going concern. In our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission (“SEC”) on March 2, 2009, we disclosed that there was substantial doubt regarding our ability to continue as a going concern. In response, we have undertaken or expect to commence certain efforts to reduce expenses and preserve liquidity including: (i) extending the term of our Bank Credit Facility to December 2, 2010 (subject to certain conditions as discussed more fully in Note 6); (ii) seeking to reduce operating costs; (iii) seeking to restructure the terms of our other indebtedness including extension of scheduled maturity dates; and (iv) pursuing sales of selected assets. No assurance can be given that we will be successful in achieving any of these efforts.

 

 

New Accounting Standards

 

We adopted provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Fair Value Measurements Topic for non-financial assets and liabilities on January 1, 2009. We had previously adopted the other provisions of fair value measurement for financial assets and liabilities on January 1, 2008. The provisions are required to be applied prospectively as of the beginning of the first fiscal year in which the provisions are applied. Adoption of these provisions of the ASC did not have a material impact on our reported consolidated financial position, results of operations or cash flows.

 

We adopted provisions of the ASC Business Combination Topic on January 1, 2009. These provisions require most identifiable assets, liabilities, non-controlling interests and goodwill acquired in business combinations to be recorded at “full fair value.” Transaction costs are no longer be included in the measurement of the business acquired and instead should be expensed as incurred. These provisions apply prospectively to business combinations occurring on or after 2009.

 

We adopted provisions of the ASC Consolidation Topic on January 1, 2009. These provisions establish new accounting and reporting requirements for a non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, these provisions require 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 is now included in consolidated net income on the face of the income statement. The provisions also clarify that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions. In addition, the provisions require 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. The provisions also include expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. Adoption of the provisions under

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

the Consolidation Topic regarding non-controlling interests on January 1, 2009 did not have a material impact on our reported consolidated financial position, results of operations or cash flows.

 

On January 1, 2009, we adopted provisions of the ASC Derivative and Hedging Topic which provides guidance on certain disclosures about credit derivatives and certain guarantees. Adoption of these provisions did not have a material impact on our reported consolidated financial position, results of operations or cash flows.

 

We adopted provisions of the ASC Investments — Equity Method and Joint Venture Topic effective on January 1, 2009. The intent of these provisions is to clarify the accounting for certain transactions and impairment considerations related to equity method investments. The adoption of these provisions did not have a material impact on our reported consolidated financial position, results of operations or cash flows.

 

We adopted each of the following provisions to the ASC in the second quarter of 2009. These provisions did not have a material impact on our reported consolidated financial position, results of operations or cash flows.

 

In April 2009, we adopted provisions of the ASC Investments — Debt and Equity Securities Topic which modifies the other-than-temporary impairment guidance for debt securities through increased consistency in the timing of impairment recognition and enhanced disclosures related to the credit and non-credit components of impaired debt securities that are not expected to be sold. In addition, increased disclosures are required for both debt and equity securities regarding expected cash flows, credit losses, and an aging of securities with unrealized losses.

 

In April 2009, we adopted provisions of the ASC Financial Instruments Topic which requires fair value disclosures for financial instruments that are not reflected in the consolidated balance sheets at fair value. Prior to these provisions, the fair values of those assets and liabilities were disclosed only once each year. With the adoption of these provisions, we are now required to disclose this information on a quarterly basis, providing quantitative and qualitative information about fair value estimates for all financial instruments not measured in the consolidated balance sheets at fair value.

 

In April 2009, we adopted provisions of the ASC Fair Value Measurements Topic which clarifies the methodology used to determine fair value when there is no active market or where the price inputs being used represent distressed sales. These provisions also reaffirm the objective of fair value measurement, which is to reflect how much an asset would be sold for in an orderly transaction. They also reaffirm the need to use judgment to determine if a formerly active market has become inactive, as well as to determine fair values when markets have become inactive.

 

In May 2009, we adopted provisions of the ASC Subsequent Events Topic. These provisions establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before the financial statements are issued or available to be issued.

 

In the third quarter of 2009, we adopted the ASC as the single source of authoritative nongovernmental generally accepted accounting principles. The adoption of the ASC did not have a material impact on our consolidated financial position, results of operations or cash flows.

 

Future Adoption of Accounting Standards

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (“SFAS 167”). SFAS 167 requires an analysis to be performed to determine whether a variable interest entity gives an enterprise a controlling financial interest in a variable interest entity. The analysis identifies the primary beneficiary of a variable interest entity. Additionally, SFAS 167 requires ongoing assessments as to whether an enterprise is the primary beneficiary and eliminates the quantitative approach of FIN 46(R) in determining the primary beneficiary. SFAS 167 is effective for us January 1, 2010. We are currently evaluating whether SFAS 167 will have a material impact on our consolidated financial position, results of operations or cash flows.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

In August 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, Fair Value Measurements and Disclosures (Topic 820) — Measuring Liabilities at Fair Value (“ASU 2009-05”). ASU 2009-05 amends the Fair Value Measurement Topic by providing additional guidance clarifying the measurement of liabilities at fair value including how the price of a traded debt security should be considered in estimating the fair value of the issuer’s liability. ASU 2009-05 is effective for us for the fourth quarter of 2009. We are currently evaluating whether ASU 2009-05 will have a material impact on our consolidated financial position, results of operations or cash flows.

 

In October 2009, the FASB issued ASU 2009-13, Revenue Recognition (Topic 605) — Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). It requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices. It eliminated the use of the residual method of allocation and requires the relative-selling-price method in all circumstances in which an entity recognized revenue for an arrangement with multiple deliverables subject to ASU 605-25. ASU 2009-13 is effective for us for the year beginning January 1, 2011. We are currently evaluating whether ASU 2009-13 will have a material impact on our consolidated financial position, results of operations or cash flows.

 

 

Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the ASC Fair Value Measurements Topic establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels. These levels, in order of highest priority to lowest priority, are described below:

 

Level 1:  Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

 

Level 2:  Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

 

Level 3:  Unobservable inputs are used when little or no market data is available.

 

Auction Rate Securities, Marketable Securities and Interest Rate Caps

 

The following table details the auction rate securities, marketable securities and interest rate caps measured at fair value as of September 30, 2009 (in thousands):

 

 

At September 30, 2009, we held investments in five Student Loan Auction-Rate Securities (“SLARS”), four with a face amount of $8.0 million and one with a face amount of $6.4 million, for a total of $38.4 million. These SLARS are issued by non-profit corporations and their proceeds are used to purchase portfolios of student loans. The SLARS holders are repaid from cash flows resulting from the student loans in a trust estate. The student loans are 98% guaranteed by the Federal government against default. The interest rate for these five SLARS are reset every 7 to 35 days. The interest rates at September 30, 2009 ranged from 0.63% to 0.88%. Uncertainties in the credit markets have prevented us and other investors from liquidating our holdings of auction rate securities in recent

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

auctions. We classify our investments in auction rate securities as trading securities and carry them at fair value. The fair value of the securities at September 30, 2009 was determined to be $31.5 million and we recorded unrealized gains (losses) of $0.1 million and $0.7 million for the three months ended September 30, 2009 and 2008, respectively, and $0.9 million and $(4.0) million for the nine months ended September 30, 2009 and 2008, respectively.

 

Due to the lack of actively traded market data, the valuation of these securities was based on Level 3 unobservable inputs. These inputs include an analysis of sales discounts realized in the secondary market, as well as assumptions about risk after considering recent events in the market for auction rate securities. The discount range of SLARS in the secondary market ranged from 16% to 38% at September 30, 2009 with an average SLARS discount on closed deals of 23% at September 30, 2009.

 

In October 2009, $8.0 million of our auction rate securities were called and redeemed at par. These securities were carried at an estimated fair value of $6.4 million on our consolidated balance sheet as of September 30, 2009. As a result, we will recognize a gain on the redemption of those securities of $1.6 million in the fourth quarter of 2009. The proceeds from the disposition of these securities will be reflected as restricted cash as it relates to our insurance reserves.

 

The following table reconciles the beginning and ending balances for the auction rates securities using fair value measurements based on significant unobservable inputs for the nine months ended September 30, 2009 (in thousands):

 

 

At September 30, 2009, we have an investment in marketable securities related to a consolidated entity in which we have control but no ownership interest. The fair value of the investment is approximately $2.2 million. The valuation was based on Level 1 data.

 

At September 30, 2009, we have interest rate caps relating to mortgage debt for 16 of our wholly owned communities. The fair value of the interest rate caps is approximately $0.1 million at September 30, 2009. The valuation was based on Level 2 prevailing market data.

 

German Assets Held for Sale, Assets Held for Sale and Assets Held and Used

 

German Assets Held for Sale

 

The German assets held for sale at September 30, 2009 consists of the following (in thousands):

 

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Assets Held for Sale

 

Other assets held for sale with a lower of carrying value or fair value less estimated costs to sell consists of the following (in thousands):

 

 

In the second quarter of 2009, we recorded our land parcels held for sale at the lower of their carrying value or fair value less estimated costs to sell. We used appraisals, market knowledge and broker opinions of value to determine fair value. As the carrying value of some of the assets was in excess of the fair value less estimated costs to sell, we recorded a charge of $1.3 million which is included in operating expenses under impairment of long-lived assets.

 

In the third quarter of 2009, all of the criteria were met for additional parcels of land, two closed construction sites and a closed property to be classified as assets held for sale. We recorded them at the lower of their carrying value or fair value less estimated costs to sell. We used appraisals, market knowledge and brokers opinions of value to determine fair value. As the carrying value of some of the assets was in excess of the fair value less estimated costs to sell, we recorded a charge of $0.8 million which is included in operating expenses under impairment of long-lived assets.

 

Assets Held and Used

 

In the second quarter of 2009, we recorded impairment charges of $15.8 million related to certain operating communities that are held and used as the carrying value of these assets was in excess of the fair value. We also recorded impairment charges of $7.9 million for certain land parcels held and used as the carrying value of these assets was in excess of the fair value. We used appraisals and recent sales to estimate fair value of all of these assets. The charges are included in operating expenses under impairment of long-lived assets.

 

In the third quarter of 2009, we recorded impairment charges of $9.1 million related to certain operating communities that are held and used as the carrying value of these assets was in excess of the fair value. We used an appraisal for one community and applied a cost of capital rate to the communities’ average net operating income to arrive at fair value for all the other communities. The impairment charge is included in operating expenses under impairment of long-lived assets.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Fair Value Measurements of German Assets Held for Sale, Assets Held for Sale and Assets Held and Used

 

Upon designation as assets held for sale, we recorded the assets at the lower of carrying value or their fair value less estimated costs to sell. The following table details only assets held for sale and assets held and used where fair value was lower than the carrying value and an impairment loss was recorded (in thousands):

 

 

Other Fair Value Information

 

Cash equivalents, accounts receivable, notes receivable, accounts payable and accrued expenses, equity investments and other current assets and liabilities are carried at amounts which reasonably approximate their fair values. At September 30, 2009, the carrying amount of our cost method investment is $5.5 million. The fair value of the cost method investment was not estimated as there were no events or changes in circumstances that may have a significant adverse effect on the fair value of the investment, and we determined that it is not practicable to estimate the fair value of the investment.

 

The fair value of our debt has been estimated based on current rates offered for debt with the same remaining maturities and comparable collateralizing assets. Changes in assumptions or methodologies used to make estimates may have a material effect on the estimated fair value. We have applied Level 2 and Level 3 type inputs to determine the estimated fair value of our debt. Note that debt is reflected on the face of our consolidated balance sheets at the stated value, except for the German debt which was initially recorded at fair value at September 1, 2008. The following table details by category the principal amount, the average interest rate and the estimated fair market value of our debt (in thousands):

 

 

Disclosure about fair value of financial instruments is based on pertinent information available to us at September 30, 2009.

 

 

During the first quarter of 2009, a U.K. venture in which we have a 20% interest sold three communities to a different U.K. venture in which we have a 10% interest. As a result of the gains on these asset sales recorded in the venture, we recorded earnings in unconsolidated communities of $19.0 million. When the first U.K. venture was formed, we established a bonus pool in respect to the venture for the benefit of employees and others responsible for the success of the venture. At the time, we agreed with our venture partner that after certain return thresholds were met, we would each reduce our percentage interests in the venture distributions with such excess to be used to fund

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

these bonus pools. During the first quarter of 2009, we recorded bonus expense of $1.1 million with respect to the bonus pool relating to the U.K. venture. We did not record any additional bonus expense related to this venture in the second and third quarters of 2009.

 

In March 2009, a venture in which we have a 20% interest received a notice of default from its lender for alleged violation of financial covenants and other matters. Based on the notice of default from the lender and poor rental experience in the venture, we considered our equity to be other than temporarily impaired and wrote off the balance, $1.1 million, in March 2009. In addition, based on discussions with the lender as of March 31, 2009, we believed that the lender did not intend to fund to the venture the amount that would be necessary to repay our receivables and accordingly, any repayment of our receivables from advances we made to the venture would need to be from excess proceeds from the ultimate sale of the community after the loan has been repaid. We did not believe that collectability of our receivable was reasonably assured and we wrote-down the carrying value of our receivable, $5.4 million, to zero in March 2009. We made additional advances of $0.8 million in the second and third quarters of 2009 which are fully reserved at September 30, 2009. In the third quarter of 2009, the residents were relocated to other senior living facilities and the facility was shut down. The lender is in the process of foreclosing on the asset.

 

Summarized S-X Rule 3-09 Income Statement Information

 

The following is summarized income statement information for an equity investee, PS UK Investment (Jersey) LP, a U.K. venture in which we own a 20% interest, for which annual audited financial statements are expected to be required for the year 2009 under S-X Rule 3-09 (in thousands):

 

 

The venture is treated as a partnership for federal income tax purposes. No provision for federal income taxes is made since taxable income or loss passes through and is reportable by the venture’s members.

 

 

Accounts payable and accrued expenses consist of the following (in thousands):

 

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

 

 

Bank Credit Facility

 

On March 23, 2009, we entered into the Eleventh Amendment to our Bank Credit Facility. The Eleventh Amendment, among other matters, suspended until May 1, 2009 the obligation of the lenders under the Bank Credit Facility to (1) advance any additional proceeds of the loans to the borrowers under the Bank Credit Facility or (2) issue any new letters of credit. However, the lenders agreed to renew certain scheduled outstanding letters of credit in accordance with the annual renewal provisions of such letters of credit. The Eleventh Amendment also waived compliance with certain financial covenants of the Bank Credit Facility through April 29, 2009 and the applicability of certain cross-default provisions through April 30, 2009.

 

The Eleventh Amendment also permanently reduced the aggregate commitments of the lenders under the Bank Credit Facility from $160.0 million to $118.0 million (outstanding borrowings of $93.5 million plus outstanding letters of credit of $24.5 million at the time of the Eleventh Amendment).

 

On April 28, 2009, we entered into the Twelfth Amendment to the Bank Credit Facility. The significant terms include:

 

 

On October 19, 2009, we entered into the Thirteenth Amendment to the Bank Credit Facility. The significant terms include:

 

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

 

 

 

 

We have no borrowing availability under the Bank Credit Facility, and we have significant scheduled debt maturities in 2009 and 2010 and significant long-term debt that is in default. We are endeavoring to extend debt maturity dates, re-finance debt and obtain waivers from applicable lenders. We are engaged in discussions with various venture partners and third parties regarding the sale of certain assets with the purpose of increasing liquidity and reducing obligations to enable us to continue operations.

 

In April 2009, we received federal income tax refunds of $20.8 million which was used to pay down the Bank Credit Facility and $1 million of the proceeds from the sale of our equity interest and receivable from the Aston Gardens venture was also used to pay down the Bank Credit Facility. In June 2009, $2.5 million of proceeds from an agreement with Trinity’s prior owners (Note 12) was used to pay down the Bank Credit Facility. At September 30, 2009, the outstanding borrowings under the Bank Credit Facility were $68.9 million. On October 19, 2009, after paying $6.0 million of principal in connection with the Thirteenth Amendment, the outstanding borrowings under the Bank Credit Facility were $62.9 million.

 

Debt

 

At September 30, 2009, we had $624.6 million of outstanding debt with a weighted average interest rate of 3.13% as follows (in thousands):

 

 

 

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

 

Of the outstanding debt we had $5.3 million of fixed-rate debt with a weighted average interest rate of 6.82% and $619.3 million of variable rate debt with a weighted average interest rate of 3.10%.

 

Debt that is in default at September 30, 2009 consists of the following (in thousands):

 

 

 

 

We are working with our lenders to either re-schedule certain of these obligations or obtain waivers.

 

For debt that is not in default, we have scheduled debt maturities as follows (in thousands):

 

 

 

 

Sunrise ventures have total debt of $4.2 billion with near-term scheduled debt maturities of $69.7 million in 2009 and $576.1 million in 2010. Of this $4.2 billion of debt, there is long-term debt that is in default of $1.4 billion. The debt in the ventures is non-recourse to us with respect to principal payment guarantees and we and our venture partners are working with the venture lenders to obtain covenant waivers. However, in certain cases, we have provided operating deficit and completion guarantees to the lenders or ventures. We have minority non-controlling interests in these ventures. See Note 12 of the Notes to Consolidated Financial Statements of our 2008 Form 10-K, as amended, for a list of our ventures and our related ownership interest.

 

 

We accounted for the sale of three communities in 2004 under the profit-sharing method of accounting as we provided a guarantee 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 communities for an extended period of time. The guarantee expired in the second quarter of 2009 and we recorded a gain of approximately $8.9 million. In addition, we recognized gains of approximately $2.3 million and $9.9 million during the three and nine months ended September 30, 2009, respectively, relating to transactions which recognition of gain had been previously deferred due to various forms of continuing involvement and are being accounted for under the basis of performance method of accounting.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

 

 

The (provision for) benefit from income taxes related to continuing operations was $(1.0) million and $33.2 million for the three months ended September 30, 2009 and 2008, respectively, and $1.4 million and $49.5 million for the nine months ended September 30, 2009 and 2008, respectively. Our effective tax (rate) benefit from continuing operations was (2.63)% and 46.9% for the three months ended September 30, 2009 and 2008, respectively, and 1.56% and 37.6% for the nine months ended September 30, 2009 and 2008, respectively. At December 31, 2008, we determined that deferred tax assets in excess of reversing tax liabilities were not likely to be realized and we recorded a valuation allowance on net deferred tax assets. Income tax expense of $4.8 million attributable to gains in discontinued operations recorded in the first quarter of 2009 reversed in the second quarter due to current period losses in discontinued operations. As of September 30, 2009, we are continuing to offset our net deferred tax asset by a full valuation allowance.

 

The IRS is currently examining our U.S. federal income tax returns for 2005 through 2008. There are no income tax returns under audit by the Canadian government with the years after 2004 remaining open and subject to audit. The German government is currently auditing income tax returns for the years 2006 through 2008. During the third quarter, the 2003-2005 German audits were closed resulting in no significant adjustments. There are no returns under audit by the U.K. government with years after 2004 remaining open and subject to audit. At this time, we do not expect the results from any income tax audit to have a material impact on our financial statements; however, it is reasonably possible that the amount of the FIN 48 state liability for unrecognized tax benefits could decrease by $2 to $3 million during the remainder of 2009.

 

 

In February 2009, we granted 14 employees non-qualified stock options to purchase 360,000 shares of common stock at a price of $0.77. One-third of the options vest yearly beginning in 2010. In 2009, 131,998 shares of restricted stock have vested.

 

In addition in May 2009, we accelerated the vesting of our former chief financial officer’s stock options and restricted stock per the terms of his separation agreement (refer to Note 11). The options expire 12 months after the termination of his consulting term, which can be up to nine months after his termination date of May 29, 2009. 70,859 shares of restricted stock and 750,000 options vested. We recorded non-cash compensation expense of $0.8 million as a result of the vesting acceleration.

 

In August 2009, we granted three employees non-qualified stock options to purchase 150,000 shares of common stock at a price of $2.34. These options vest one-third per year beginning in 2010.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

 

 

Guarantees

 

The maximum potential amount of future fundings for outstanding guarantees, the carrying amount of the liability for expected future fundings at September 30, 2009 and fundings during 2009 are as follows (in thousands):

 

 

Aston Gardens

 

In July 2008, we received notice of default from our equity partner alleging a default under our management agreement for six communities as a result of the venture’s receipt of a notice of default from a lender. In December 2008, the venture’s debt was restructured and we entered into an agreement with our venture partner under which we agreed to resign as managing member of the venture and manager of the communities when we are released from various guarantees provided to the venture’s lender.

 

At loan inception, we provided the lender a guarantee of monthly principal and interest payments and during 2008 we made payments under this guarantee since the venture did not have enough available cash flow to cover the default interest payments. Advances under this guarantee are recoverable in the form of a loan in a capital or refinancing event prior to the repayment of capital to the partners but subordinate to the repayment of the debt. Through April 30, 2009, the date we sold our equity interest in Aston Gardens, we had funded $7.0 million under this guarantee which was fully reserved at the time of sale.

 

On April 30, 2009, we sold our 25% equity interest in the venture and were released from all guarantee obligations. Our management contract was terminated on April 30, 2009. We received proceeds of approximately $4.8 million for our equity interest and our receivable from the venture for fundings under the operating deficit guarantees. We received management fees of $3.2 million and $3.7 million in 2008 and 2007, respectively.

 

Fountains

 

In 2008, the Fountains venture, in which we hold a 20% interest, failed to comply with the financial covenants in the venture’s loan agreement. The lender has been charging a default rate of interest (5.51% at September 30, 2009) since April 2008. At loan inception, we provided the lender a guarantee of operating deficits including payments of monthly principal and interest payments, and in 2008 we funded payments under this guarantee as the venture did not have enough available cash flow to cover the full amount of the interest payments at the default rate. Advances under this guarantee are recoverable in the form of a loan to the venture, which must be repaid prior to the repayment of equity capital to the partners, but is subordinate to the repayment of other venture debt. Through September 30, 2009, we have funded $14.2 million under this operating deficit guarantee which also has been written-down to zero. These advances under the operating deficit guarantee are in addition to the $12.8 million we have funded under our income support guarantee to our venture partner, which has been written-down to zero.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

In January 2009, we informed the venture’s lenders and our venture partner that we were suspending payment of default interest and payments under the income support guarantee, and that we would seek a comprehensive restructuring of the loan, our operating deficit guarantees and our income support guarantee. Our failure to pay default interest on the loan was an additional default of the loan agreement. In October 2009, we entered into agreements with our venture partner, as well as with the lender to release us from all claims that our venture partner and the lender had against us prior to the date of the agreements and from all of our future funding obligations in connection with the Fountains portfolio.

 

Pursuant to the agreements relating to the Fountains portfolio, the lender and our venture partner released us from all past and future funding commitments in connection with the Fountains portfolio, as well as from all other liabilities prior to the date of the agreements arising under the Fountains joint venture, loan and management agreements, including obligations under operating deficit and income support obligations. We will retain certain management and operating obligations going forward during a temporary transition period.

 

In exchange for these releases, we have, among other things:

 

 

The contributed vacant land parcels were carried on our consolidated balance sheet at a book value of $12.9 million at September 30, 2009, in addition to a guarantee liability of $12.9 million both of which will be written off upon closing of the transaction resulting in no gain or loss.

 

Senior Living Condominium Project

 

In 2006, we sold a majority interest in one condominium venture and one related 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). The $10.0 million is recoverable as a loan from the venture. Through September 30, 2009, we have paid $50.7 million in cost overruns. Construction of this project is now complete. We account for the condominium and assisted living ventures under the profit-sharing method of accounting, and our investment carrying value at September 30, 2009 is $13.5 million for the two ventures, which includes our $10.0 million recoverable loan and advances we have made to the ventures. We recorded a loss of $2.9 million and $9.9 million from the two ventures in the three and nine months ended September 30, 2009, respectively. The pace of sales of condominium units and prices could impact the recovery of our investment carrying value. The weak economy in the Washington, D.C. area will require us to implement more aggressive marketing and sales plans. No assurance can be given that additional pre-tax charges will not be required in subsequent periods with respect to this condominium venture.

 

In July 2009, the lender notified us that an event of default had occurred. The event of default was related to providing certain financial information for the venture that the lender had previously requested. In October 2009, we received a notice of default related to the nonpayment of interest. We are in discussions with the lender on these matters.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Agreements with Marriott International, Inc.

 

Our agreements with Marriott International, Inc. (“Marriott”) related to our purchase of Marriott Senior Living Services, Inc. in 2003 provide that Marriott has the right to demand that we provide cash collateral security for Assignee Reimbursement Obligations, as defined in the agreements, in the event that our implied debt rating is not at least B- by Standard and Poors or B1 by Moody’s Investor Services. Assignee Reimbursement Obligations relate to possible liability with respect to leases assigned to us in 2003 and entrance fee obligations assumed by us in 2003 that remain outstanding (approximately $53.4 million at September 30, 2009). Marriott has informed us that they reserve all of their rights to issue a Notice of Collateral Event under the Assignment and Reimbursement Agreement.

 

Other

 

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 or voluntary bankruptcy of the venture, that create exceptions to the non-recourse nature of debt. If such acts were to occur, the full amount of the venture debt could become recourse to us. The combined amount of venture debt underlying these guarantees is approximately $3.3 billion at September 30, 2009. We have not funded under these guarantees, and do not expect to fund under such guarantees in the future.

 

To the extent that a third party fails to satisfy an obligation with respect to two continuing care retirement communities we manage, we would be required to repay this obligation, the majority of which is expected to be refinanced with proceeds from the issuance of entrance fees as new residents enter the communities. At September 30, 2009, the remaining liability under this obligation is $45.2 million. We have not funded under these guarantees, and do not expect to fund under such guarantees in the future.

 

Legal Proceedings

 

HCP, Inc.

 

In June 2009, various affiliates of HCP, Inc. and their associated tenant entities filed nine complaints in the Delaware Court of Chancery naming the Company and several of its subsidiaries as defendants. The complaints allege monetary and non-monetary defaults under a series of owner and management agreements that govern nine portfolios comprised of 64 properties with annual management fees of approximately $25.4 million in 2008 and $15.5 million for the nine months ended September 30, 2009. We have $18.5 million of unamortized management contract intangibles relating to these contracts. In each case, the plaintiffs include (a) the HCP affiliates that own various assisted living community properties that are managed by Sunrise, and (b) certain tenant entities alleged to be independent from HCP that lease those properties from HCP affiliates and have management agreements with Sunrise. The complaints assert claims for (1) declaratory judgment; (2) injunctive relief; (3) breach of contract; (4) breach of fiduciary duties; (5) aiding and abetting breach of fiduciary duty; (6) equitable accounting; and (7) constructive trust. The complaints seek equitable relief, including a declaration of a right to terminate the agreements, disgorgement, unspecified money damages, and attorneys’ fees. Plaintiffs filed a motion to expedite the proceedings. Following briefing by the parties, the Delaware Court of Chancery on July 9, 2009 denied the Plaintiff’s motion. In July 2009, various affiliates of HCP, Inc. and their associated tenant entities refiled a complaint, which had been voluntarily withdrawn in the Delaware actions, in the federal district court for the Eastern District of Virginia (the “Virginia action”). On August 17, 2009, Sunrise answered all of the complaints in both jurisdictions and asserted counterclaims.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Trinity OIG Investigation and Qui Tam Action

 

As previously disclosed, on September 14, 2006, we acquired all of the outstanding stock of Trinity Hospice Inc. (“Trinity”). As a result of this transaction, Trinity became an indirect, wholly owned subsidiary of the Company. On January 3, 2007, Trinity received a subpoena from the Phoenix field office of the OIG requesting certain information regarding Trinity’s operations in three locations for the period January 1, 2000 through June 30, 2006, a period that was prior to the Company’s acquisition of Trinity. The Company was advised that the subpoena was issued in connection with an investigation being conducted by the Commercial Litigation Branch of the U.S. Department of Justice and the civil division of the U.S. Attorney’s office in Arizona. The subpoena indicates that the OIG is investigating possible improper Medicare billing under the FCA. In addition to recovery of any Medicare reimbursements previously paid for false claims, an entity found to have submitted false claims under the FCA may be subject to treble damages plus a fine of between $5,500 and $11,000 for each false claim submitted. Trinity has complied with the subpoena and continues to supplement its responses as requested.

 

On September 11, 2007, Trinity and the Company were served with a complaint filed on September 5, 2007 in the United States District Court for the District of Arizona. That filing amended a complaint filed under seal on November 21, 2005 by four former employees of Trinity under the qui tam provisions of the FCA. On July 3, 2008, an amended complaint was revised in the form of a second amended complaint which replaced the loss sustained range of $75 million to $100 million with an alleged loss by the United States of at least $100 million. The original complaint named KRG Capital, LLC (an affiliate of former stockholders of Trinity) and Trinity Hospice LLC (a subsidiary of Trinity) as defendants. The second amended complaint names Sunrise Senior Living, Inc., KRG Capital, LLC, aka KRG Capital Partners, LLC, KRG Capital, LLC, KRG Capital Fund II, L.P., KRG Capital Fund II (PA), L.P., KRG Capital Fund II (FF), L.P., KRG Co-Investment, L.L.C., American Capital Strategies, LTD, and Trinity as defendants. On October 21, 2008, the United States, through the Civil Division of the U.S. Department of Justice, and the U.S. Attorney’s Office for the District of Arizona, filed a motion with the District Court to intervene in the pending case, but only as the case relates to defendant Trinity Hospice, Inc.

 

All parties entered into a settlement agreement on June 3, 2009 which was subsequently approved by the District Court. The lawsuit is styled United States ex rel. Joyce Roberts, et al., v. KRG Capital, LLC, et al., CV05 3758 PHX-MEA (D. Ariz.).

 

On February 13, 2008, Trinity received a subpoena from the Los Angeles regional office of the OIG requesting information regarding Trinity’s operations in 19 locations for the period between December 1, 1998 through February 12, 2008. It is anticipated that further response to this subpoena, as well as the subpoena issued by the OIG Phoenix field office noted above, will be unnecessary upon final closure of the Qui Tam action.

 

IRS Audit

 

The Internal Revenue Service is auditing our federal income tax returns for the years ended December 31, 2005 through 2008. In July 2008, our 2005 federal income tax return audit was settled with the IRS, resulting in a tax liability of approximately $0.2 million. In January 2009, the IRS reopened the audit of our 2005 federal income tax return as a result of a refund claim filed with our 2007 federal income tax return relating to the 2007 net operating loss carryback for which we were seeking reimbursement of a certain portion of the federal income taxes we had paid in 2005.

 

In February 2009, we settled with the IRS on our employment tax audits and paid a penalty of $0.2 million in November 2008 for the years 2004, 2005, and 2006. The IRS determined that we were liable for payroll tax deposit penalties on stock option exercises during 2004, 2005, and 2006 for certain withholdings that were made after the prescribed due dates.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

SEC Investigation

 

We previously announced on December 11, 2006 that we had received a request from the SEC for information about insider stock sales, timing of stock option grants and matters relating to our historical accounting practices that had been raised in media reports in the latter part of November 2006 following receipt of a letter by us from the Service Employees International Union. On May 25, 2007, we were advised by the staff of the SEC that it had commenced a formal investigation. We have fully cooperated, and intend to continue to fully cooperate, with the SEC. The Company has commenced discussions with the SEC staff concerning potential resolution of the matter and conclusion of the investigation.

 

Putative Class Action Litigation

 

Two putative securities class actions, styled United Food & Commercial Workers Union Local 880-Retail Food Employers Joint Pension Fund, et al. v. Sunrise Senior Living, Inc., et al., Case No. 1:07CV00102, and First New York Securities, L.L.C. v. Sunrise Senior Living, Inc., et al., Case No. 1:07CV000294, were filed in the U.S. District Court for the District of Columbia on January 16, 2007 and February 8, 2007, respectively. Both complaints alleged securities law violations by Sunrise and certain of its current or former officers and directors based on allegedly improper accounting practices and stock option backdating, violations of generally accepted accounting principles, false and misleading corporate disclosures, and insider trading of Sunrise stock. Both sought to certify a class for the period August 4, 2005 through June 15, 2006, and both requested damages and equitable relief, including an accounting and disgorgement. Pursuant to procedures provided by statute, two other parties, the Miami General Employees’ & Sanitation Employees’ Retirement Trust and the Oklahoma Firefighters Pension and Retirement System, appeared and jointly moved for consolidation of the two securities cases and appointment as the lead plaintiffs, which the Court ultimately approved. The cases were consolidated on July 31, 2007. Thereafter, a stipulation was submitted pursuant to which the new putative class plaintiffs filed their consolidated amended complaint (under the caption In re Sunrise Senior Living, Inc. Securities Litigation, Case No. 07-CV-00102-RBW) on June 6, 2008. The complaint alleges violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, and names as defendants the Company, Paul J. Klaassen, Teresa M. Klaassen, Thomas B. Newell, Tiffany L. Tomasso, Larry E. Hulse, Carl G. Adams, Barron Anschutz, and Kenneth J. Abod.

 

On February 27, 2009, Sunrise and its current or former directors or officers who were named individually as defendants entered into an agreement. The settlement calls for the certification by the court of a class consisting of persons (with certain exceptions) who purchased Sunrise common stock between February 26, 2004 and July 28, 2006, and payment of $13.5 million in cash into an interest-bearing escrow account by March 6, 2009.

 

Concurrently with entering into the settlement agreement, Sunrise and the Individual Defendants also are entering into agreements and releases with two of its insurance carriers, which provided primary and excess insurance coverage, respectively, under certain Directors’ and Officers’ Liability insurance policies for the relevant periods. The two insurance carriers are combining to pay $13.4 million toward the settlement amount, which will exhaust the coverage limits under the primary policy (after taking account of prior payments for related defense costs), but will not exhaust coverage limits under the excess policy. These payments pursuant to the settlement were made under the then applicable policies and, therefore, do not reduce the amount of insurance proceeds available under current policies now in effect. Sunrise and the Individual Defendants have provided releases to the carrier. Taking into account the insurance contribution, the net cost of the settlement of the putative securities class action lawsuit to Sunrise is expected to be approximately $0.1 million. No amounts are to be paid by the Individual Defendants.

 

The settlement agreement was approved by the U.S. District Court for the District of Columbia on June 26, 2009 and follows the settlement agreement entered into on February 19, 2009 by Sunrise and the individuals named as defendants in two putative stockholder derivative actions brought by certain alleged stockholders of Sunrise for the

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

benefit of the company, entitled In re Sunrise Senior Living Derivative Litigation, Inc., Case No. 1:07CV00143-RBW and Young, et al. v. Klaassen, et al., Case No. 2770-N (CCNCC) which settlement agreement and related funding arrangements are described in greater detail below.

 

Putative Shareholder Derivative Litigation

 

On January 19, 2007, the first of three putative shareholder derivative complaints was filed in the U.S. District Court for the District of Columbia against certain of our current and former directors and officers, and naming us as a nominal defendant. Counsel for the plaintiffs subsequently agreed among themselves to the appointment of lead plaintiffs and lead counsel. On June 29, 2007, the lead plaintiffs filed a Consolidated Shareholder Derivative Complaint, again naming us as a nominal defendant, and naming as individual defendants Paul J. Klaassen, Teresa M. Klaassen, Ronald V. Aprahamian, Craig R. Callen, Thomas J. Donohue, J. Douglas Holladay, William G. Little, David G. Bradley, Peter A. Klisares, Scott F. Meadow, Robert R. Slager, Thomas B. Newell, Tiffany L. Tomasso, John F. Gaul, Bradley G. Rush, Carl Adams, David W. Faeder, Larry E. Hulse, Timothy S. Smick, Brian C. Swinton and Christian B. A. Slavin. The consolidated case is captioned: In re Sunrise Senior Living Derivative Litigation, Inc, Case No. 1:07CV00143 (the “District of Columbia action”). The consolidated complaint alleges violations of federal securities laws and breaches of fiduciary duty by the individual defendants, arising out of the same matters as are raised in the purported class action litigation described above. The plaintiffs seek damages and equitable relief on behalf of Sunrise. We and the individual defendants filed separate motions to dismiss the consolidated complaint. Subsequently, the plaintiffs filed an amended consolidated complaint that did not substantially alter the nature of their claims. The amended consolidated complaint was accepted by the Court and deemed to have been filed on March 28, 2008. We and the individual defendants filed motions to dismiss the amended consolidated complaint on June 16, 2008. The plaintiffs also filed a motion to lift the stay on discovery in this derivative suit. The motion was denied after briefing.

 

On March 6, 2007, a putative shareholder derivative complaint was filed in the Court of Chancery in the State of Delaware against Paul J. Klaassen, Teresa M. Klaassen, Ronald V. Aprahamian, Craig R. Callen, Thomas J. Donohue, J. Douglas Holladay, David G. Bradley, Robert R. Slager, Thomas B. Newell, Tiffany L. Tomasso, Carl Adams, David W. Faeder, Larry E. Hulse, Timothy S. Smick, Brian C. Swinton and Christian B. A. Slavin, and naming us as a nominal defendant. The case is captioned Peter V. Young, et al. v. Paul J. Klaassen, et al., Case No. 2770-N (CCNCC) (the “Delaware action”). The complaint alleges breaches of fiduciary duty by the individual defendants arising out of the grant of certain stock options that are the subject of the purported class action and shareholder derivative litigation described above. The plaintiffs seek damages and equitable relief on behalf of Sunrise. We and the individual defendants separately filed motions to dismiss this complaint on June 6, 2007 and June 13, 2007. The plaintiffs amended their original complaint on September 17, 2007. On November 2, 2007, we and the individual defendants moved to dismiss the amended complaint. In connection with the motions to dismiss, and at plaintiffs’ request, the Chancery Court issued an order on April 25, 2008 directing us to produce a limited set of documents relating to the Special Independent Committee’s findings with respect to historic stock option grants. We produced those documents to the plaintiffs on May 16, 2008. Supplemental briefing on defendants’ motions to dismiss has been completed and, while the motions were pending, the plaintiffs requested that the Chancery Court stay the action, at least temporarily. The defendants did not oppose that request, and the Chancery Court granted an indefinite stay of proceedings on November 19, 2008, and directed the parties to provide a further status report by February 1, 2009. Following the parties’ status report, in which it was proposed that the stay remain in place, the Chancery Court extended the stay on February 17, 2009, and directed the parties to provide a further report by May 4, 2009.

 

On February 19, 2009, the Company and the individual defendants entered into an agreement to settle the District of Columbia and Delaware actions. Under the terms of this settlement, the Company, in addition to corporate governance measures that it already has implemented or is in the process of implementing, has agreed to (1) require independent directors to certify that they are independent under the rules of the New York Stock

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Exchange and to give prompt notification of any changes in their status that would render them no longer independent and (2) implement a minimum two-year vesting period, with appropriate exceptions, for stock option awards to employees. In addition, Paul J. Klaassen, the Company’s non-executive chairman, and the Company have agreed that the 700,000 stock options granted to Mr. Klaassen in conjunction with his previous employment agreement executed in September 2000 will be repriced from (a) $8.50 per share, the price set on September 11, 2000 by the Compensation Committee of the Company’s Board based on the prior day’s closing price, to (b) $13.09 per share, the closing price on the business day prior to November 10, 2000, the date on which the Company’s full Board approved the terms of the employment agreement. The agreement also provides that if plaintiffs in the District of Columbia action apply to the court for an award of attorneys’ fees and expenses, the Company and/or its insurers will pay the amount so awarded, not to exceed $1.0 million, within 10 days following final approval of the settlement and the fee and expense award. Plaintiffs in the Delaware action will not make any separate application for an award of fees or expenses. The amount of attorneys’ fees and expenses that the court awards to plaintiffs is to be funded by one of the Company’s directors’ and officers’ liability insurance carriers under an applicable policy of insurance. No amounts are to be paid by the Company or by the individual defendants in the District of Columbia and Delaware actions. The settlement was approved by the U.S. District Court for the District of Columbia on June 26, 2009. On August 4, 2009, the court in the Delaware action entered an order formally dismissing that action.

 

Other Pending Lawsuits and Claims

 

In addition to the lawsuits and litigation matters described above, we are involved in various lawsuits and claims arising in the normal course of business. In the opinion of management, although the outcomes of these other suits and claims are uncertain, in the aggregate they are not expected to have a material adverse effect on our business, financial condition, and results of operations.

 

 

In May 2009, we announced a plan to continue to reduce corporate expenses through reorganization of our corporate cost structure, including a reduction in spending related to, among other areas, administrative processes, vendors, and consultants. The plan is designed to reduce our annual recurring general and administrative expenses (including expenses previously classified as venture expense) by over $20 million, from our 2009 budgeted annual recurring level of approximately $120 million (after the sale of Greystone, which is presented in discontinued operations in our financial statements) to approximately $100 million, and to reduce our centrally administered services which are charged to the communities by approximately $1.5 million. Under the plan, approximately 150 positions will be eliminated. As of September 30, 2009, we have eliminated 114 positions and will be eliminating an additional 49 positions by early 2010. We have recorded severance expense of $5.6 million as a result of the plan through September 30, 2009 and expect to record an additional $0.6 million through early 2010. These costs are incremental to the restructuring plan implemented by us in 2008, which provided for the elimination of 165 positions and corresponding expense reductions.

 

In May 2009, we entered into a separation agreement with our chief financial officer, Richard Nadeau, in connection with this plan. Pursuant to the separation agreement, Mr. Nadeau’s employment with us terminated effective as of May 29, 2009. Pursuant to Mr. Nadeau’s employment agreement, Mr. Nadeau received severance benefits that included a lump sum cash payment of $1.4 million. In addition, Mr. Nadeau received a bonus in the amount of $0.5 million and Mr. Nadeau’s outstanding and unvested stock options, restricted stock and other long-term equity compensation awards were fully vested, resulting in a non-cash compensation expense to us of $0.8 million.

 

In September 2009, we terminated a portion of our lease on our corporate headquarters in McLean, Virginia. We recorded a charge of $2.7 million related to the termination.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

The following table reflects the activity related to our severance and restructuring plans during the nine months ended September 30, 2009:

 

 

Included in the above table is legal and professional fees of $4.3 million, $3.7 million and $4.6 million in the first, second and third quarters, respectively, relating to corporate restructuring.

 

 

German Assets Held for Sale

 

We own nine communities (two of which are closed) in Germany. The debt related to these communities has partial recourse to us as the debt for four of the communities of €50.0 million ($73.0 million at September 30, 2009) has a stipulated release price for each community and for the remaining five communities, we have provided guarantees to the lenders of the repayment of the monthly interest payments and principal amortization and operating shortfalls until the maturity dates of the loans. As a result of the violation of a covenant in one of the loan documents, one of the lenders has asserted that we are effectively obligated to repay a portion of the principal at this time. Subsequent to September 30, 2009, in connection with the German debt restructure, we have settled with this lender. The face amount of the total debt related to the German communities at September 30, 2009 is $219.3 million.

 

In January 2009, we informed the lenders to our German communities and the Hoesel land, an undeveloped land parcel, that our German subsidiary was suspending payment of principal and interest on all loans for our German communities and that we would seek a comprehensive restructuring of the loans and our operating deficit guarantees. As a result of the failure to make payments of principal and interest on the loans for our German communities, we are in default of the loan agreements but have entered into standstill agreements with the lenders pursuant to which the lenders have agreed not to foreclose on the communities that are collateral for their loans or to commence or prosecute any action or proceeding to enforce their demand for payment by us pursuant to our operating deficit agreements until the earliest of the occurrence of certain other events relating to the loans.

 

In October 2009, we entered into a restructuring agreement, in the form of a binding term sheet, with two of our lenders to seven of the nine communities, to settle and compromise their claims against us, including under operating deficit and principal repayment guarantees provided by us in support of our German subsidiaries. These two lenders contended that these claims had an aggregate value of approximately $121.6 million. The binding term sheet contemplates that, on or before the first anniversary of the execution of definitive documentation for the restructuring, certain other of our identified lenders may elect to participate in the restructuring with respect to their asserted claims. The claims being settled by the two lenders represent approximately 77.5 percent of the aggregate amount of claims asserted by the lenders that may elect to participate in the restructuring transaction.

 

The restructuring agreement provides that the electing lenders will release and discharge us from certain claims they may have against us. We will issue to the lenders that elect to participate in the restructuring on or before

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

the first execution of the definitive documentation, their pro rata share of up to an aggregate of 5 million shares of our common stock and will grant mortgages for the benefit of all electing lenders on certain of our unencumbered North American properties. Following the first execution of the definitive documentation for the restructuring, we will pursue the sale of such mortgaged properties and distribute the net sale proceeds to the electing lenders. We have guaranteed that, within 30 months of the first execution of the definitive documentation for the restructuring, the electing lenders will receive a minimum of $58.3 million from the net proceeds of any such sale, which equals 80 percent of the most recent aggregate appraised value of these properties. If the electing lenders do not receive at least $58.3 million by such date, we will make payment to cover any shortfall or, at such lenders’ option, convey to them the remaining unsold properties.

 

In addition, we will market for sale the German assisted living communities subject to loan agreements with the electing lenders and will remain responsible for all costs of operating, preserving and maintaining these communities until the earlier of either their sale or December 31, 2010.

 

The closing of the transaction, including the execution of the definitive documentation, the release of claims and the issuance of Sunrise common stock, is conditioned upon receipt of consent for the transaction from Bank of America, N.A., as the administrative agent under our Bank Credit Facility, on or before November 11, 2009. In accordance with the binding term sheet, definitive documentation shall be executed as soon as reasonably possible (but no later than 40 days) after the receipt of such required consent.

 

We continue to be liable under certain operating deficit and repayment guarantees for the Klein Flottbeck and Wiesbaden communities, and certain principal repayment guarantees for the Hoesel land which is not part of the restructuring agreement.

 

As of September 30, 2009, we have classified the German communities as assets held for sale. During the second quarter of 2009, we classified the German communities as assets held for sale as all of the following criteria were met:

 

 

Upon designation as assets held for sale, we recorded the assets at the lower of their carrying value or their fair value less estimated costs to sell. We used the average of the bids received to date in the determination of fair value. As the carrying value of a majority of the assets was in excess of the fair value less estimated costs to sell, during the second quarter of 2009 we recorded a charge of $52.4 million which is included in discontinued operations. Also, upon designation as assets held for sale, the results of operations for the German communities are reported as discontinued operations.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

The German assets held for sale at September 30, 2009 consists of the following (in thousands):

 

 

Discontinued Operations

 

In March 2009, we sold our Greystone subsidiary and our interests in Greystone seed capital partnerships to an entity controlled by Michael Lanahan and Paul Steinhoff, two senior executives of the Greystone subsidiary. Total consideration was (i) $2,000,000 in cash at closing; (ii) $5,700,000 in short-term notes, (iii) a $6,000,000 7-year note (iv) a $2,500,000 note payable, and (v) 35% of the net proceeds received by the seed capital investors for each of the seed capital interests purchased from us. We collected $5.7 million of short-term notes through September 30, 2009.

 

As Greystone’s contracts were multiple element arrangements and there was not sufficient objective and reliable evidence of the fair value of undelivered elements at each billing milestone, revenue recognition was deferred until the completion of the development contract. The sale of Greystone generated a book gain resulting from the realization of previously deferred revenue. The sale of Greystone generated a tax loss of approximately $40 million. Due to the uncertainty of collectability of the $6.0 million note, initial gain recognition is not appropriate and gain will be recognized as payment is received. The $2.5 million note payable is contingent on future income of Greystone and gain will be recognized when the contingency is resolved and consideration is received.

 

In the fourth quarter of 2008, we determined not to provide any additional funding to our Trinity subsidiary due to our review of our future cash requirements. As of December 31, 2008, Trinity had ceased operations. In order to resolve and settle the claims among us and Trinity’s prior owners, in June 2009, we entered into a settlement agreement with the former majority stockholders of Trinity, which, among other matters, provides for the release and discharge of all claims and causes of action between the parties to the settlement agreement. In consideration of the settlement agreement, the former majority stockholders of Trinity paid us an aggregate amount of approximately $9.8 million. The parties to the settlement agreement also agreed to cooperate to achieve voluntary dismissal of certain litigation matters.

 

We had previously recorded a receivable of $2.7 million from the former stockholders of Trinity for various liabilities relating to events occurring prior to our purchase of Trinity. Accordingly, $2.7 million of the proceeds were applied against the receivable and the remaining amount of $7.1 million has been recorded as income from discontinued operations.

 

In December 2008, two wholly owned communities were sold to unrelated third parties for which we have no continuing involvement. In the second quarter of 2009, a wholly owned community ceased operations. All three of these communities are classified as discontinued operations. In the third quarter of 2009, a wholly owned community was sold to an unrelated third party for approximately $2.0 million. We received $0.3 million of cash and a note receivable for $1.7 million, recognizing gain of $0.3 million. We have no continuing involvement with this property.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

The results of operations for our German communities, Greystone, Trinity and the four communities have been reclassified to discontinued operations. The following amounts related to our German communities, Greystone, Trinity and the four communities have been segregated from continuing operations and reported as discontinued operations (in thousands):

 

 

 

The following table summarizes the computation of basic and diluted net loss per share amounts presented in the accompanying consolidated statements of operations (in thousands, except per share data):

 

 

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Options and restricted stock are included under the treasury stock method to the extent they are dilutive. Shares issuable upon exercise of stock options of 4,668,152 and 3,239,297 for the three months ended September 30, 2009 and 2008, respectively, and 4,751,099 and 3,261,235 for the nine months ended September 30, 2009 and 2008, respectively, have been excluded from the computation because the effect of their inclusion would be anti-dilutive.

 

 

Effective in 2009, we changed our operating segments.  In 2008, we reported five operating segments: domestic operations, international operations (Canada and the United Kingdom), Germany, Greystone and Trinity. We now have six operating segments for which operating results are regularly reviewed by our chief operating decision makers:

 

North American Management, which is the results from the management of third party, joint venture and wholly owned/leased Sunrise senior living communities in the United States and Canada.

 

North American Development, which is the results from the development of Sunrise senior living communities in the United States and Canada.

 

Equity Method Investments, which is the results from our investment in domestic and international ventures.

 

Consolidated (Wholly Owned/Leased), which is the results from the operation of wholly owned and leased Sunrise senior living communities in the United States and Canada net of an allocated management fee of $6.9 million and $7.8 million for the three months ended September 30, 2009 and 2008, respectively, and $20.6 million and $21.2 million for the nine months ended September 30, 2009 and 2008, respectively.

 

United Kingdom, which is the results from the development and management of Sunrise senior living communities in the United Kingdom.

 

Germany, which is the results from the management of nine (two of which are closed) Sunrise senior living communities in Germany through September 1, 2008. The operation of nine Sunrise senior living communities after September 1, 2008 when we began consolidating the communities are included in discontinued operations.

 

The old North American segment was split into the new North American Management, North American Development, Equity Method Investments and Consolidated (Wholly Owned/Leased) segments. Results from Canadian operations are now included in the North American Management and Wholly Owned/Leased segments, while previously they were included in the International segment. The operating results from the United Kingdom development and management activities are now its own separate segment. The Germany segment remains unchanged. Greystone, which was sold in March 2009, and Trinity, which ceased operations in December 2008, are now reported as discontinued operations.

 

Our historical segment reporting has been restated to reflect the changes made in 2009.

 

Sunrise Senior Living, Inc.

 

Notes to Consolidated Financial Statements — (Continued)

(Unaudited)

 

Segment results are as follows (in thousands):