Item 1.
Business
Overview
We are a provider of senior living services in the United States, Canada, the United Kingdom and Germany. Founded in 1981 and incorporated in Delaware in 1994, Sunrise began with a simple but innovative vision - to create an alternative senior living option that would emphasize quality of life and quality of care. We offer a full range of personalized senior living services, including independent living, assisted living, care for individuals with Alzheimer’s and other forms of memory loss, nursing and rehabilitative care. In the past, we also developed senior living communities for ourselves, for ventures in which we retained an ownership interest and for third parties. Due to current economic conditions, we have suspended all new development.
At December 31, 2009, we operated 384 communities, including 335 communities in the United States, 15 communities in Canada, 27 communities in the United Kingdom and seven communities in Germany, with a total unit capacity of approximately 40,400. Of the 384 communities that we operated at December 31, 2009, 20 were wholly owned, 27 were under operating leases, one was consolidated as a variable interest entity, 201 were owned in unconsolidated ventures and 135 were owned by third parties. During 2009, we opened 23 new communities, with a combined unit capacity of approximately 2,100.
During 2009, we continued to reduce overhead costs; restructure, repay and extend maturities of some of our debt; and sell assets to generate liquidity (as more fully discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations). Our focus in 2010 will be on: (1) operating high-quality assisted living and memory care communities in North America, Germany and the United Kingdom; (2) increasing occupancy and improving the operating efficiency of our communities; (3) improving the operating efficiency of our corporate operations; (4) generating liquidity; (5) divesting of non-core assets; and (6) reducing our operational and financial risk.
We continue to reduce our financial obligations and reach negotiated settlements with various creditors. We are unable to borrow additional funds under our Bank Credit Facility. We are seeking waivers with respect to existing defaults under many of our debt obligations to avoid acceleration of these obligations. We have been successful in reducing our exposure related to our German communities, our Fountains portfolio and our Aston Gardens venture, each discussed in more detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations. However, we continue to have significant debt maturing in 2010 and 2011 and there can be no assurance that we will be able to extend this debt or obtain additional financing. The existence of these factors raise substantial doubt about our ability to continue as a going concern and our auditors have modified their report with respect to the 2009 consolidated financial statements to include a going concern reference.
The Senior Living Industry
The senior living industry encompasses a broad spectrum of senior living service and care options, which include independent living, assisted living and skilled nursing care.
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Independent living is designed to meet the needs of seniors who choose to live in an environment surrounded by their peers where they receive services such as housekeeping, meals and activities, but are not reliant on assistance with activities of daily living (for example, bathing, eating and dressing), although some residents may contract out for those services.
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Assisted living meets the needs of seniors who seek housing with supportive care and services including assistance with activities of daily living, Alzheimer’s care and other services (for example, housekeeping, meals and activities).
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Skilled nursing meets the needs of seniors whose care needs require 24-hour skilled nursing services or who are receiving rehabilitative services following an adverse event (for example, a broken hip or stroke).
In all of these settings, seniors may elect to bring in additional care and services as needed, such as home-health care (except in a skilled nursing setting) and end-of-life or hospice care.
The senior living industry is highly fragmented and characterized predominantly by numerous local and regional senior living operators. Senior living providers may operate freestanding independent living, assisted living or skilled nursing residences, or communities that feature a combination of senior living options such as continuing care retirement communities (“CCRCs”), which typically consist of large independent living campuses with assisted living and skilled nursing sections. The level of care and services offered by providers varies along with the size of communities, number of residents served and design of communities (for example, purpose-built communities or refurbished structures).
Senior Living Services
Throughout our history, we have advocated a resident-centered approach to senior living and offered a broad range of service and care options to meet the needs of our residents. In select communities, we offer independent living services, which include housing, meals, transportation, activities and housekeeping, and in some communities, we provide licensed skilled nursing services for residents who require 24-hour skilled nursing care. The majority of our communities currently provide assisted living services, which offer basic care and services for seniors who need assistance with some activities of daily living.
Assisted Living
Upon a resident’s move-in to an assisted living community, we assess each resident, generally with input from a resident’s family and physician, and develop an individualized service plan for the resident. This individual service plan includes the selection of resident accommodations and a determination of the appropriate level of care and service for such resident. The service plan is periodically reviewed and updated by us and communicated to the resident and the resident’s family or responsible party.
We offer a choice of care levels in our assisted living communities based on the frequency and level of assistance and care that a resident needs or prefers. Most of our assisted living communities also offer a Reminiscence neighborhood, which provides specially designed accommodations, service and care to support cognitively impaired residents, including residents with Alzheimer’s disease. By offering a full range of services, we are better able to accommodate residents’ changing needs as they age and develop further physical or cognitive frailties. Daily resident fee schedules are generally revised annually. Fees for additional care are revised when a change in care arises.
Basic Assisted Living
Our basic assisted living program includes:
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assistance with activities of daily living, such as eating, bathing, dressing, personal hygiene and grooming;
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three meals per day served in a common dining room;
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coordination of special diets;
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emergency call systems in each unit;
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transportation to stores and community services;
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assistance with coordination of physician care, physical therapy and other medical services;
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health promotion and related programs;
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housekeeping services; and
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social and recreational activities.
Medication Management
Many of our assisted living residents also require assistance with their medication. To the extent permitted by state law, the medication management program includes the storage of medications, the distribution of medications as directed by the resident’s physician and compliance monitoring. Generally, we charge an additional daily fee for this service although some communities bundle this service into their base rate.
Assisted Living Extended Levels of Care
We also offer various levels of care for assisted living residents who require more frequent or intensive assistance or increased care or supervision. We charge an additional daily fee based on increased staff hours of care and services provided. These extended levels of care allow us, through consultation with the resident, the resident’s family and the resident’s personal physician, to create an individualized care and supervision program for residents who might otherwise have to move to a more medically intensive community.
Reminiscence Care
We believe our Reminiscence neighborhoods distinguish us from many other senior living providers. Our Reminiscence neighborhoods provide a specialized environment, extra attention, and care programs and services designed to meet the special needs of people with Alzheimer’s disease and other cognitive impairments. Specially trained staff members provide basic care and other specifically designed care and services to these residents in separate areas of our communities. Residents pay a higher daily rate based on additional staff hours of care and services provided. Approximately 23.3% of our residents participated in the Reminiscence program on December 31, 2009.
Independent Living and Skilled Nursing
In some of our communities, we offer independent living for residents, and in other communities, we offer skilled nursing care. Independent living offers the privacy and freedom of home combined with the convenience and security of on-call assistance and a maintenance-free environment. Skilled nursing care offers a range of rehabilitative therapies to promote our residents’ emotional health and physical well-being. We have team members specially trained to serve residents in these communities in compliance with the appropriate state and federal regulatory requirements.
Other Services
While we serve the vast majority of a resident’s needs with our own staff, some services, such as hospice care, physician care, infusion therapy, physical and speech therapy and other ancillary care services may be provided to residents in our communities by third parties. Our staff members assist residents in locating qualified providers for such health care services.
Managed Communities
In addition to communities we manage for ourselves, we manage 201 communities in which we have a minority ownership interest and 135 communities for third-party owners.
As of December 31, 2009, we managed 79 communities for Ventas, Inc. (“Ventas”), 75 communities for HCP, Inc. (“HCP”) and 52 communities for a privately owned capital partner.
Our management agreements have initial terms generally ranging from five to 30 years with various performance conditions and have management fees generally ranging from five to eight percent of community revenues. In addition, in certain management contracts, we have the opportunity to earn incentive management fees based on monthly or yearly operating results. Certain of these management contracts may be terminated if we are unable to achieve stated performance thresholds.
Property Information
On December 31, 2009, we operated 384 senior living communities with a unit capacity of approximately 40,400. No communities were under construction on December 31, 2009. We manage communities that we own or lease, communities in which we have an ownership interest and communities owned by third parties.
The following tables summarize our portfolio of operating communities on December 31, 2009. “Consolidated” communities consist of communities which we own or lease. “Variable Interest Entities” consists of communities in ventures of which we are the primary beneficiary and are consolidated in our financial statements for 2009. “Unconsolidated Ventures” consist of communities in which we own an equity interest but that are not consolidated in our financial statements for 2009, as applicable. “Managed” communities consist of communities which are wholly owned by third parties. “Total Unit Capacity” means the number of units that can be occupied in a community. While most of our units are single-occupancy, we do have a number of semi-private rooms, particularly in our skilled nursing and Reminiscence areas.
Operating Communities
Company Operations
Operating Structure
We have six operating segments for which operating results are separately and regularly reviewed by key decision makers: North American Management, North American Development, Equity Method Investments, Consolidated (Wholly Owned/Leased), United Kingdom and Germany (part of which is included in discontinued operations).
North American Management includes the results from the management of third party, venture and wholly owned/leased Sunrise senior living communities in the United States and Canada.
North American Development includes the results from the development of Sunrise senior living communities in the United States and Canada.
Equity Method Investments includes the results from our investment in domestic and international ventures.
Consolidated (Wholly Owned/Leased) includes 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 $21.9 million, $22.2 million and $22.2 million for 2009, 2008 and 2007, respectively.
United Kingdom includes the results from the development and management of Sunrise senior living communities in the United Kingdom.
Germany includes the results from the management of nine (two of which have been 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.
Our international headquarters are in McLean, Virginia, with two smaller regional offices located in the U.K. and Germany to support local operations. Our North American international headquarters provide centralized operational functions to support our operating communities and company growth. As a result, our community-based team members are able to focus on delivering excellent care and service consistent with our resident-centered operating philosophy.
Senior Living Operations
For our senior living business, regional and community-based team members are responsible for executing our strategy in local markets. This includes overseeing all aspects of community operations: local marketing and sales activities; resident care and services; the hiring and training of community-based team members; and compliance with applicable local and state regulatory requirements.
Our North American operations are organized into four geographic regions: Northeast, Southeast, Midwest and West. Senior team members are based in each of these regions for close oversight of community operations in these locations. A similar organizational structure is in place in the United Kingdom.
Each region is headed by a vice president of operations with extensive experience in the health care and senior living industries, who oversees operations. Each region is supported by sales/marketing specialists, resident care specialists, a human resource specialist, a facilities specialist, a dining specialist and a financial analyst.
The international headquarters functions include establishing strategy, systems, policies and procedures related to: resident care and services; team member recruitment, training, development, benefits and compensation; facility services; dining; sales and marketing strategy and support; corporate communications; accounting and finance management, including billing and collections, accounts payable, general finance and accounting and tax planning and compliance; legal; asset management; community design; and real estate development.
Community Staffing
We believe that the quality and size of our communities, along with our strong service-oriented culture, our competitive compensation philosophy and our training and professional growth opportunities, have enabled us to attract high-quality, professional team members. Each of our communities has an executive director responsible for the day-to-day operations of the community, including quality of care, resident services, sales and marketing, financial performance and regulatory compliance. The executive director is supported by department heads, who oversee the care and services provided to residents in the community by “care managers,” as well as other specialists such as a nurse, who is responsible for coordinating the services necessary to meet residents’ health care needs, and a director of community relations, who is responsible for selling and marketing our services. Other key positions include the dining services coordinator, the activities coordinator and the maintenance coordinator.
Care managers, who work on full-time, part-time and flex-time schedules, provide most of the hands-on resident care, such as bathing, dressing and other personalized care services. As permitted by state law, care managers who complete a special training program also supervise the storage and distribution of medications. The use of care managers to provide substantially all services to residents has the benefits of consistency and continuity in resident care. As such, in most cases, the same care manager assists the resident in dressing, dining and
coordinating daily activities to encourage seamless and consistent care for residents. The number of care managers working in a community varies according to the number of residents and their needs.
We believe that our communities can be most efficiently managed by maximizing direct resident and staff contact. Team members involved in resident care, including the administrative staff, are trained in the care manager duties and participate in supporting the care needs of the residents.
Staff Education and Training
All of our team members receive specialized and ongoing training. We pride ourselves on attracting highly dedicated, experienced personnel. To support this effort, we offer a full schedule of educational programs, job aids and other learning tools to equip every team member with the appropriate skills that are required to ensure high-quality resident care. All managers and direct-care staff must complete a comprehensive orientation and the core curriculum, which consists of basic resident-care procedures, Alzheimer’s care, communication systems, and activities and dining programming. For the supervisors of direct-care staff, additional training provides education in medical awareness and management skills.
For executive directors and department managers, we have developed the “Getting Started 1-2-3” program, which offers a structured curriculum to support those either newly hired or promoted to these positions. This program provides them with the tools, support and training necessary for the first 180 days on the job, including a self-study program, one-to-one training experience and a series of group trainings with scenario-based opportunities to solve multiple business case challenges. The program also includes three meetings with a supervisor to review the individual’s progress at 30 days, 60 days and 180 days into the position.
Quality Improvement Processes
We coordinate quality assurance programs at each of our communities through our corporate headquarters staff and through our regional offices. Our commitment to quality assurance is designed to achieve a high degree of resident and family member satisfaction with the care and services we provide.
Sales and Marketing
Our sales and marketing strategy supports the Sunrise brand and is intended to create awareness of and preference for our unique products and services among potential residents, family members and key community referral sources such as hospital discharge planners, physicians, clergy, area agencies for the elderly, skilled nursing communities, home health agencies, social workers, financial planners and consultants, and others. A marketing team from headquarters supports the field and communities by developing overall strategies, systems, processes and programs for promoting Sunrise in local markets, and monitors the success of the marketing efforts.
Each community has at least one dedicated sales person responsible for community-specific sales efforts. The community-based sales staff and executive director are supported by an area sales manager who is responsible for coaching, development, and performance management of community sales staff, as well as supporting the development and implementation of the local marketing strategy.
Competition
We are a large global provider of senior living services. We compete with numerous organizations such as Brookdale Senior Living, Inc., Assisted Living Concepts, Inc., Capital Senior Living Corp., Emeritus Corp. and Five Star Quality Care, Inc., that provide similar senior living alternatives, such as other senior living providers, home health care agencies, community-based service programs, retirement communities and convalescent centers. We have experienced and expect to continue to experience competition in our efforts to develop and operate senior living communities. This competition could limit our ability to attract residents or expand our senior living business, which could have a material adverse effect on our revenues and earnings. Please see our risk factor sections “Risks Related to the Senior Living Industry” under Item 1A.
Item 1A. “Risk Factors” for more details related to the effects of competition on our business.
Government Regulation
Senior Living. Senior living communities are generally subject to regulation and licensing by federal, state and local health and social service agencies, and other regulatory authorities. Although requirements vary from state to state and community to community, in general, these requirements may include or address:
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personnel hiring, education, training, and records;
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administration and supervision of medication;
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the provision of limited nursing services;
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admission and discharge criteria;
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documentation, reporting and disclosure requirements;
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staffing requirements;
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monitoring of resident wellness;
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physical plant specifications;
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furnishing of resident units;
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food and housekeeping services;
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emergency evacuation plans; and
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resident rights and responsibilities.
In several of the states in which we operate or intend to operate, laws may require a certificate of need before a senior living community can be opened. In most states, senior living communities are also subject to state or local building codes, fire codes, and food service licensing or certification requirements.
Independent living communities are unregulated and not subject to state or federal inspection. However, communities that feature a combination of senior living options such as CCRCs, consisting of independent living campuses with a promise of future assisted living and/or skilled nursing services and an entrance fee requirement, are regulated by state government, usually the state’s department of insurance. CCRCs are subject to state regulation of minimum standards to ensure financial solvency and are required to give annual disclosure regarding such things as the community’s financial standing, the contractual obligations of services to the residents, residents’ rights and costs to residents to reside in the community.
Communities licensed to provide skilled nursing services generally provide significantly higher levels of resident assistance. Communities that are licensed, or will be licensed, to provide skilled nursing services may participate in federal health care programs, including the Medicare and Medicaid programs. In addition, some licensed assisted living communities may participate in state Medicaid-waiver programs. Such communities must meet certain federal and/or state requirements regarding their operations, including requirements related to physical environment, resident rights, and the provision of health services. Communities that participate in federal health care programs are entitled to receive reimbursement from such programs for care furnished to program beneficiaries and recipients.
Senior living communities that include assisted living facilities, nursing facilities, or home health care agencies are subject to periodic surveys or inspections by governmental authorities to assess and assure compliance with regulatory requirements. Such unannounced surveys may occur annually or bi-annually, or can occur following a state’s receipt of a complaint about the community. As a result of any such inspection, authorities may allege that the senior living community has not complied with all applicable regulatory requirements. Typically, senior living communities then have the opportunity to correct alleged deficiencies by implementing a plan of correction. In other cases, the authorities may enforce compliance through imposition of fines, imposition of a provisional or conditional license, suspension or revocation of a license, suspension or denial of admissions, loss of certification as a provider under federal health care programs, or imposition of other sanctions. Failure to comply with applicable requirements could lead to enforcement action that can materially and adversely affect business and revenues. Like other senior living communities, we have received notice of deficiencies from time to time in the ordinary course of business. However, we have not, to date, faced enforcement action that has had a material adverse effect on our revenues.
Regulation of the senior living industry is evolving. Future regulatory developments, such as mandatory increases in the scope of care given to residents, revisions to licensing and certification standards, or a determination that the care provided by one or more of our communities exceeds the level of care for which the community is licensed, could adversely affect or increase the cost of our operations. Increases in regulatory requirements, whether
through enactment of new laws or regulations or changes in the application of existing rules, could also adversely affect our operations. Furthermore, there have been numerous initiatives on the federal and state levels in recent years for reform affecting payment of health care services. Some aspects of these initiatives could adversely affect us, such as reductions in Medicare or Medicaid program funding.
Other. We are also subject to certain federal and state laws that regulate financial arrangements by health care providers, such as the Federal Anti-Kickback Law. This law makes it unlawful for any person to offer or pay (or to solicit or receive) “any remuneration...directly or indirectly, overtly or covertly, in cash or in kind” for referring or recommending for purchase any item or service which is eligible for payment under a federal health care program, including, for example, the Medicare and Medicaid programs. Authorities have interpreted this statute very broadly to apply to many practices and relationships between health care providers and sources of patient referral. If a health care provider were to violate the Anti-Kickback Law, it may face criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as Medicare and Medicaid. Similarly, health care providers are subject to the False Claims Act with respect to their participation in federal health care reimbursement programs. Under the False Claims Act, the government or private individuals acting on behalf of the government may bring an action alleging that a health care provider has defrauded the government and seek treble damages for false claims and the payment of additional monetary civil penalties. Many states have enacted similar anti-kickback and false claims laws that may have a broad impact on health care providers and their payor sources. Under provisions of the Deficit Reduction Act of 2005, Congress has encouraged all states to adopt false claims laws that are substantially similar to the federal law. While we endeavor to comply with all laws that regulate the licensure and operation of our senior living communities, it is difficult to predict how our revenue could be affected if it were subject to an action alleging such violations.
We are also subject to federal and state laws designed to protect the confidentiality of patient health information. The U.S. Department of Health and Human Services has issued rules pursuant to the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) relating to the privacy of such information. In addition, many states have confidentiality laws, which in some cases may exceed the federal standard. We have adopted procedures for the proper use and disclosure of residents’ health information in compliance with the relevant state and federal laws, including HIPAA.
Employees
At December 31, 2009, we had approximately 37,600 employees, also referred to as team members throughout this 2009 Form 10-K, of which approximately 500 were employed at our corporate headquarters. We believe employee relations are good. A portion of the employees at one Sunrise community in Canada voted to be represented by a union in 2006. Currently approximately 90 employees are covered by a contract effective until March 31, 2011.
Website
Our Internet website is http://www.sunriseseniorliving.com. The information contained on our website is not incorporated by reference into this report and such information should not be considered as part of this report. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.
We file annual, quarterly and current reports, proxy statements and other information with the SEC. You may access and read our SEC filings over the Internet at the SEC’s website at http://www.sec.gov. This uniform resource locator is an inactive textual reference only and is not intended to incorporate the contents of the SEC website into this Form 10-K.
You may read and copy any document we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. You may also request copies of the documents that we file with the SEC by writing to the SEC’s Office of Public Reference at the above address, at prescribed rates. Please call the SEC at (800) 732-0330 for further information on the operations of the Public Reference Room and copying charges.
Item 1A.
Risk Factors
In connection with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, set forth below are cautionary statements identifying important factors that could cause actual events or results to differ materially from any forward-looking statements made by or on behalf of us, whether oral or written. We wish to ensure that any forward-looking statements are accompanied by meaningful cautionary statements in order to maximize to the fullest extent possible the protections of the safe harbor established in the Private Securities Litigation Reform Act of 1995. Accordingly, any such statements are qualified in their entirety by reference to, and are accompanied by, the following important factors that could cause actual events or results to differ materially from our forward-looking statements. If any of the following risks actually occur, our business, financial condition or results of operations could be negatively affected, and the trading price of our common stock could decline.
These forward-looking statements are based on management’s present expectations and beliefs about future events. As with any projection or forecast, these statements are inherently susceptible to uncertainty and changes in circumstances. There may be additional risks and uncertainties not presently known to us or that we currently deem immaterial that also may impair our business operations. You should not consider this list to be a complete statement of all potential risks or uncertainties.
We have separated the risks into the following categories:
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Liquidity risks;
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Risks related to our business operations;
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Risks related to the pending SEC investigation and other pending litigation;
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Risks related to the senior living industry; and
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Risks related to our organization and structure.
Liquidity Risks
As described in Significant 2009 and 2010 Developments in Management’s Discussion and Analysis of Financial Condition and Results of Operations, we are currently in discussions with our lenders and venture partners to implement a restructuring of our financial obligations. However, there can be no assurances that these efforts will prove successful and we could be forced to seek reorganization under the U.S. Bankruptcy Code.
We are in default under a number of our financial obligations with respect to our lenders and our venture partners. In addition, we have significant indebtedness coming due in 2010 and 2011. We are seeking waivers with respect to all defaults and are seeking to reach negotiated settlements with our various creditors to preserve our liquidity and to enable us to continue operating. However, there can be no assurance that waivers will be received or such settlements will be reached. If the defaults are not cured within applicable cure periods, if any, and if waivers or other relief are not obtained, the defaults can cause acceleration of our financial obligations under the agreements, which we may not be in a position to satisfy. In the event of a failure to obtain necessary waivers or otherwise achieve a restructuring of our financial obligations, we could be forced to seek reorganization under the U.S. Bankruptcy Code.
Our results of operations could be adversely affected if we are required to perform under various financial guarantees or support arrangements that we have entered into as part of our operating strategy.
As part of our normal operations, we provide debt guarantees and operating deficit guarantees to some of our ventures, lenders to the ventures, or third party owners. The terms of some of these obligations do not include a limitation on the maximum potential future payments. If we are required to fund or perform under these arrangements, the amounts funded either become loans to the venture, or are recorded as a reduction in revenue or as an expense. If we are required to fund any amounts related to these arrangements, our results of operations and cash flows could be adversely affected. In addition, we may not be able to ultimately recover funded amounts.
We continue to be liable under certain operating deficit and repayment guarantees for the Klein Flottbeck and Wiesbaden communities. If we are unable to negotiate with the lenders to amend these operating deficit and repayment guarantees, we may be required to perform under these guarantees and may not have sufficient operating cash to meet these obligations at the time they become due.
Our failure to generate sufficient cash flow to cover required interest, principal and operating lease payments could result in defaults of the related debt or operating leases.
At December 31, 2009, we had total indebtedness of $440.2 million. We cannot give any assurance that we or our ventures will generate sufficient cash flow from operations to cover required interest, principal and operating lease payments. Any payment or other default could cause the lender to foreclose upon the facilities securing the indebtedness or, in the case of an operating lease, could terminate the lease, with a consequent loss of income and asset value to us. A payment or other default with respect to venture indebtedness also could trigger our obligations under support arrangements, as described in the risk factor above entitled “Our results of operations could be adversely affected if we are required to perform under various financial guarantees or support arrangements that we have entered into as part of our operating strategy”. In some cases, the indebtedness is secured by the community and a pledge of our interests in the community. In the event of a default, the lender could avoid judicial procedures required to foreclose on real property by foreclosing on the pledge instead, thus accelerating the lender’s acquisition of the community. Further, because our mortgages generally contain cross-default and cross-collateralization provisions, a nonpayment or other default by us could affect a significant number of communities.
Our failure to comply with financial obligations contained in debt instruments could result in the acceleration of the debt extended pursuant to such debt instruments, trigger other rights and restrict our operating and acquisition activity, and in the case of ventures, may cause acceleration of the venture’s debt repayment obligations and any of our correlated guarantee obligations.
There are various financial covenants and other restrictions applicable to us in our debt instruments, including provisions that:
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require us to satisfy financial statement delivery requirements;
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require us to meet certain financial tests;
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restrict our ability to pay dividends or repurchase our common stock;
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require consent for a change in control; and
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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 we are not the surviving entity without lender consent.
These covenants could reduce our flexibility in conducting our operations by limiting our ability to borrow money and may create a risk of default on our debt if we cannot continue to satisfy these covenants. If we default under our debt instruments, the debt extended pursuant to such debt instruments could become due and payable prior to its stated due date. We cannot give any assurance that we could pay this debt if it became due. Further, our Bank Credit Facility contains a cross-default provision pursuant to which a default on other indebtedness by us or by any of our consolidated subsidiaries under the Bank Credit Facility could result in the ability of the lenders to declare a default under and accelerate the indebtedness due under the Bank Credit Facility.
There are various financial covenants, financial statement delivery requirements, and other restrictions applicable to us in the debt instruments relating to certain of our ventures. Failure to comply with these covenants may trigger acceleration of the ventures’ debt repayment obligations and any of our correlated guarantee obligations or give rise to any of the other remedies provided for in such debt instruments. Additionally, certain of our venture agreements provide that an event of default under the venture’s debt instruments that is caused by us may also be considered an event of default by us under the venture agreement, giving our venture partner the right to pursue the remedies provided for in the venture agreement, potentially including a termination and winding up of the venture.
Certain of our management agreements, both with ventures and with entities owned by third parties, provide that an event of default under the debt instruments applicable to the ventures or the entities owned by third parties that is caused by us may also be considered an event of default by us under the relevant management agreement, giving the non-Sunrise party to the management agreement the right to pursue the remedies provided for in the management agreement, potentially including termination of the management agreement.
The failure of our 2009 cost reduction plan to achieve sufficient expense savings.
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) 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 184 positions will be eliminated. As of December 31, 2009, we had eliminated 154 positions and will be eliminating an additional 30 positions by mid 2010. Although we believe we will be able to reduce costs sufficiently, unforeseen events may affect our ability to fully implement the expense reduction plan or if the plan fails to achieve the anticipated results, we may not have sufficient operating cash to meet our obligations.
Our ability to execute our plan to sell certain assets.
In 2010, we intend to sell (i) our German communities, (ii) unencumbered North American properties that are held as collateral for the German electing lender (the “liquidating trust”) and, at our discretion, (iii) certain communities and land parcels, of which any net sales proceeds would be split equally between us, the mortgage holder and the lenders under the Bank Credit Facility. If we are unable to sell certain assets as planned, we may not have sufficient cash to meet our obligations.
Risks Related to Our Business Operations
The current economic environment could affect our ability to obtain financing for various purposes, including any refinancing of our Bank Credit Facility or other debt due in 2010 and 2011, on reasonable terms and could have other adverse effects on us and the market price of our common stock.
The United States stock and credit markets have continued to experience price volatility, dislocations and liquidity disruptions. These circumstances have materially impacted liquidity in the financial markets, making the terms for certain financings less attractive, and in some cases have resulted in the unavailability of financing. Continued uncertainty in the stock and credit markets may negatively impact our ability to access additional financing for the continuation of our operations and other purposes, including the refinancing of our Bank Credit Facility or other debt due in 2010 and 2011, at reasonable terms, which may negatively affect our business. We have significant current maturities of long-term debt and a significant amount is in default. The downturn in the financial markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to further adjust our business plan accordingly. These events also may make it more difficult or costly for us to raise capital, including through the issuance of common stock. The disruptions in the financial markets have had and may continue to have a material adverse effect on the market value of our common stock and other adverse effects on us and our business.
Due to the dependency of our revenues on private pay sources, events which adversely affect the ability of seniors to afford our monthly resident fees or entrance fees (including downturns in housing markets or the economy) could cause our occupancy rates, revenues and results of operations to decline.
Costs to seniors associated with independent and assisted living services are not generally reimbursable under government reimbursement programs such as Medicare and Medicaid. Only seniors with income or assets meeting or exceeding the comparable median in the regions where our communities are located typically can afford to pay our monthly resident fees. The length of the current economic downturn or future downturns or changes in demographics could adversely affect the ability of seniors to afford our resident fees. In addition, downturns in the housing markets, such as the one we are currently experiencing, could adversely affect the ability (or perceived ability) of seniors to afford our resident fees as our customers frequently use the proceeds from the sale of their homes to cover the cost of our fees. If we are unable to retain and/or attract seniors with sufficient income, assets or other resources required to pay the fees associated with independent and assisted living services and other service offerings, our occupancy rates, revenues and results of operations could decline. In addition, if the recent volatility in the housing market continues further, our results of operations and cash flows could be negatively impacted.
If our venture communities experience poor performance, we also may need to write down the value of our investment in the venture, which would adversely affect our financial results.
Termination of resident agreements and vacancies in communities could adversely affect our revenues and earnings.
State regulations governing assisted living communities generally require written resident agreements with each resident. Most of these regulations also require that each resident have the right to terminate the resident agreement for any reason on reasonable notice. Consistent with these regulations, the resident agreements signed by us generally allow residents to terminate their agreement on 30 days’ notice. Thus, we cannot contract with residents to stay for longer periods of time, unlike typical apartment leasing arrangements that involve lease agreements with specified leasing periods of up to a year or longer. If a large number of residents elected to terminate their resident agreements at or around the same time, and if our units remained unoccupied, then our revenues and earnings could be adversely affected.
Our international operations are subject to a variety of risks that could adversely affect those operations and thus our profitability and operating results.
As of December 31, 2009, we operated 15 communities in Canada, 27 communities in the United Kingdom and seven communities in Germany with a total unit capacity of approximately 4,300. Our international operations are subject to numerous risks including: exposure to local economic conditions; varying laws relating to, among other things, employment and employment termination; changes in foreign regulatory requirements; restrictions and taxes on the withdrawal of foreign investment and earnings; government policies against businesses owned by foreigners; investment restrictions or requirements; diminished ability to legally enforce our contractual rights in foreign countries; withholding and other taxes on remittances and other payments by subsidiaries; and changes in and application of foreign taxation structures including value-added taxes. In addition, we have limited experience developing and operating senior living facilities in international markets. If we are not successful in operating in international markets, our results of operations and financial condition may be materially adversely affected.
Early termination or non-renewal of our management agreements could cause a loss in revenues.
We operate senior living communities for third parties and unconsolidated ventures pursuant to management agreements. At December 31, 2009, approximately 88% of our communities were managed for third parties or unconsolidated ventures. The initial terms of our third-party management agreements generally ranges from five to 30 years. In most cases, either party to the agreements may terminate upon the occurrence of an event of default caused by the other party. In addition, in some cases, subject to our rights, if any, to cure deficiencies, community owners may terminate us as manager if any licenses or certificates necessary for operation are revoked, if there is a change in control of Sunrise or if we do not maintain a minimum stabilized occupancy level in the community or certain designated performance thresholds. In June 2009, we were terminated as manager for a portfolio of 15 communities. We managed these communities through October 1, 2009. The management fees for the years 2009, 2008 and 2007 were $2.3 million, $3.0 million and $2.9 million, respectively.
In addition, our contract with Ventas has a combined performance termination test that permits Ventas to terminate our contract for all communities failing a specified targeted termination threshold based on expected adjusted net operating income of the community if there is a failure by more than 25% of all communities we manage for Ventas. As of December 31, 2009, we may have failed the specified termination thresholds on more than 25% of these communities. The targeted termination threshold increases each year based on CPI. We are in discussions with our venture partner regarding these issues.
With respect to communities held in ventures, in some cases, the management agreement can be terminated in connection with the sale by the venture partner of its interest in the venture or the sale of properties by the venture. Also, in some instances, a community owner may terminate the management agreement relating to a particular community if we are in default under other management agreements relating to other communities owned by the same owner or its affiliates. In some of our agreements, the community owner may terminate the management agreement for any reason or no reason provided it pays the termination fee specified in the agreement. Early termination of our management agreements or non-renewal or renewal on less-favorable terms could cause a loss in revenues and could negatively impact earnings.
Our failure to attract partners for developing senior living communities in the future could adversely affect our revenues and results of operations, and harm our ability to finance the construction of new communities.
Historically, we have developed senior living communities with third-party partners and entered into long-term management contracts to manage these communities. This strategy of developing senior living communities with partners has enabled us to re-deploy our capital into new development projects, finance development and expand our portfolio of managed communities. The development of new communities with third-party partners is subject to various market conditions and the attractiveness of other investment opportunities available to our partners. Due to current market conditions, we have halted development of communities.
Ownership of the communities we manage is heavily concentrated with three of our business partners. We are in material litigation with one of the three.
As of December 31, 2009, we managed 79 communities for Ventas, 75 communities for HCP and 52 communities for a privately owned capital partner.
In June 2009, various affiliates of HCP 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 $25.9 million in 2009 and $25.4 million in 2008. We have $18.3 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 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.
The communities that we manage for these business partners are generally subject to long-term management agreements (up to 30 years) as well as other agreements related to development, support and other guarantee arrangements. This sizeable concentration could give these partners significant influence over our operating strategies and could therefore heighten the business risks disclosed above. A significant concentration might also make us more susceptible to an adverse impact from the financial distress that might be experienced by a partner. Any inability or unwillingness by any of these business partners to satisfy its obligations under their agreements with us including the obligation to make capital expenditures in the communities or to maintain Sunrise’s brand standards, could adversely affect our business, financial condition, results of operations and cash flows.
Our current and future investments in ventures could be adversely affected by our lack of sole decision-making authority, our reliance on venture partners’ financial condition, any disputes that may arise between us and our venture partners and our exposure to potential losses from the actions of our venture partners.
As of December 31, 2009, we had a minority equity interest in ventures that we do not control which owned 201 senior living communities. These ventures involve risks not present with respect to our consolidated communities or the communities that we manage only. These risks include the following:
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we share or have lesser decision-making authority with certain of our venture partners regarding major decisions affecting the ownership or operation of the venture and the community, such as the sale of the community or the making of additional capital contributions for the benefit of the community and the approval of the annual operating and capital budgets, which may prevent us from taking actions that are opposed by our venture partners;
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prior consent of our venture partners may be required for a sale or transfer to a third party of our interests in the venture, which restricts our ability to dispose of our interest in the venture;
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our venture partners might become bankrupt or fail to fund their share of required capital contributions, which may delay construction or development of a community or increase our financial commitment to the venture;
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our venture partners may have business interests or goals with respect to the community that conflict with our business interests and goals, which could increase the likelihood of disputes regarding the ownership, management or disposition of the community;
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disputes may develop with our venture partners over decisions affecting the community or the venture, which may result in litigation or arbitration that would increase our expenses and distract our officers and/or directors from focusing their time and effort on our business, and possibly disrupt the day-to-day operations of the community such as delaying the implementation of important decisions until the conflict or dispute is resolved; and
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we may suffer losses as a result of the actions of our venture partners with respect to our venture investments.
The refinancing or sale of communities held in ventures may not result in future distributions to us.
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. Distributions received by us are first recorded as a reduction of our investment. Next, we record a liability if there is a contractual obligation or implied obligation to support the venture including through our role as a general partner. Any remaining distributions are recorded as income. We refer to these transactions as “recapitalizations.” Additionally, most of our ventures are structured to provide a distribution to us upon the sale of the communities in the ventures. None of the agreements governing our venture arrangements require refinancings of debt in connection with the sale of equity interests by our venture partners. If the venture does not refinance senior debt or the property has not appreciated we would not receive any distributions in connection with the sale of equity interests by our venture partners. In addition, there can be no assurance that future “recapitalizations” or asset sales will result in distributions to us. In addition, if market conditions deteriorate or our communities experience poor performance, the amounts distributed to us upon “recapitalizations” or assets sales could be materially reduced or we may not receive distributions in some cases.
Liability claims against us in excess of insurance limits could adversely affect our financial condition and results of operations.
The senior living business entails an inherent risk of liability. In recent years, we, as well as other participants in our industry, have become subject to an increasing number of lawsuits alleging negligence or similar claims. Many of these lawsuits involve large claims and significant legal costs. We maintain liability insurance policies in amounts we believe are adequate based on the nature and risks of our business, historical experience and industry standards.
We purchase insurance for property, casualty and other risks from insurers based on published ratings by recognized rating agencies, advice from national insurance brokers and consultants and other industry-recognized insurance information sources. Moreover, certain insurance policies cover events for which payment obligations and the timing of payments are only determined in the future. Any of these insurers could become insolvent and unable to fulfill their obligation to defend, pay or reimburse us for insured claims.
Certain liability risks, including general and professional liability, workers’ compensation and automobile liability, and employment practices liability are insured in insurance policies with affiliated (i.e., wholly owned captive insurance companies) and unaffiliated insurance companies. We are responsible for the cost of claims up to a self-insured limit determined by individual policies and subject to aggregate limits in certain prior policy periods. Liabilities within these self-insured limits are estimated annually by management after considering all available information, including expected cash flows and actuarial analysis. In the event these estimates are inadequate, we may have to fund the shortfall and our operating results could be negatively impacted.
Claims may arise that are in excess of the limits of our insurance policies or that are not covered by our insurance policies. If a successful claim is made against us and it is not covered by our insurance or exceeds the policy limits, our financial condition and results of operations could be materially and adversely affected. Our obligations to pay the cost of claims within our self-insured limits include the cost of claims that arise today but are reported in the future. We estimate an amount to reserve for these future claims. In the event these estimates are inadequate, we may have to fund the shortfall and our operating results could be negatively affected. Claims against us, regardless of their merit or eventual outcome, also could have a material adverse effect on our ability to attract residents or expand our business and could require our management to devote time to matters unrelated to the operation of our business. We also have to renew our policies periodically and negotiate acceptable terms for coverage, exposing us to the volatility of the insurance markets, including the possibility of rate increases, and we cannot be sure that we will be able to obtain insurance in the future at acceptable levels. We have established a liability for outstanding losses and expenses at December 31, 2009, but the liability may ultimately be settled for a greater or lesser amount. Any subsequent changes are recorded in the period in which they are determined and will be shared with the communities participating in the insurance programs.
Interest rate increases could adversely affect our earnings because a portion of our total debt is floating rate debt.
At December 31, 2009, we had approximately $438.9 million of floating-rate debt at a weighted average interest rate of 2.85%. Debt incurred in the future also may bear interest at floating rates. Therefore, increases in prevailing interest rates could increase our interest payment obligations, which would negatively impact earnings.
We may be adversely affected by fluctuations in currency exchange rates.
We are subject to the impact of foreign exchange translation on our financial statements. To date, we have not hedged against foreign currency fluctuations; however, we may pursue hedging alternatives in the future. There can be no assurance that exchange rate fluctuations in the future will not have a material adverse effect on our business, operating results, or financial condition. At December 31, 2009, our wholly owned subsidiaries have net U.S. dollar equivalent monetary liabilities denominated in foreign currencies of $60.7 million, $2.1 million and $18.7 million in Canadian dollars, British pounds and Euros, respectively. We recorded $6.7 million, net, in exchange gains in 2009 ($8.0 million in gains related to the Canadian dollar and $(1.3) million in losses related to the Euro and British pound).
Our accounting policies and methods are fundamental to how we report our financial condition and results of operations and they may require management to make estimates about matters that are inherently uncertain.
We have identified certain accounting estimates as being “critical” to the presentation of our financial condition and results of operations because they require our management to make particularly subjective or complex judgments about matters that are inherently uncertain and because the likelihood that materially different amounts would be recorded under different conditions or using different assumptions. The risks related to our critical accounting estimates are described under “Critical Accounting Estimates” in Item 7 of this Form 10-K. Because of the inherent uncertainty of the estimates associated with these critical accounting estimates, we cannot provide any assurance that we will not change our estimates, which could cause us to make significant subsequent adjustments to the related amounts recorded. These adjustments could have a material adverse affect on our business, results of operations and financial condition.
The discovery of environmental problems at any of the communities we own or operate could result in substantial costs to us, which would have an adverse effect on our earnings and financial condition.
Under various federal, state and local environmental laws, ordinances and regulations, as a current or previous owner or operator of real property, we are subject to various federal, state and local environmental laws and regulations, including those relating to the handling, storage, transportation, treatment and disposal of medical waste generated at our facilities; identification and removal of the presence of asbestos-containing materials in buildings; the presence of other substances in the indoor environment, including mold; and protection of the environment and natural resources in connection with development or construction of our communities.
Some of our facilities generate infectious or other hazardous medical waste due to the illness or physical condition of the residents. Each of our facilities has an agreement with a waste management company for the proper disposal of all infectious medical waste, but the use of such waste management companies does not immunize us from alleged violations of such laws for operations for which we are responsible even if carried out by such waste management companies, nor does it immunize us from third-party claims for the cost to clean-up disposal sites at which such wastes have been disposed.
If we fail to comply with such laws and regulations in the future, we would face increased expenditures both in terms of fines and remediation of the underlying problem(s), potential litigation relating to exposure to such materials, and potential decrease in value to our business and in the value of our underlying assets, which would have an adverse effect on our earnings, our financial condition and our ability to pursue our growth strategy. In addition, we are unable to predict the future course of federal, state and local environmental regulation and legislation. Changes in the environmental regulatory framework could result in significant increased costs related to complying with such new regulations and result in a material adverse effect on our earnings. In addition, because environmental laws vary from state to state, expansion of our operations to states where we do not currently operate may subject us to additional restrictions on the manner in which we operate our communities, further increasing our cost of operations.
Unionization may impact wage rates and work rules.
At December 31, 2009, we had approximately 37,600 employees of which approximately 500 were employed at our corporate headquarters. In 2006, employees at one community in Canada voted to be represented by a union. There are approximately 90 employees represented by the union. We believe that a union free workplace is in the best interest of our residents, our team members and us and accordingly, we plan to expend significant organizational effort to maintain a union free workplace.
Risks Related to the Pending SEC Investigation and Pending Litigation Arising Out of the Prior Announcement of Our Restatement of Historical Financial Statements for 2005 and Prior Periods, Other Pending Government Proceedings and Other Pending Litigation
The SEC’s formal investigation has resulted in significant costs and expenses, diverted resources and could have a material adverse effect on our business, financial condition and results of operations.
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. We have commenced discussions with the SEC staff concerning potential resolution of the matter and conclusion of the investigation.
In addition, our management, Board of Directors and employees have expended a substantial amount of time on the SEC formal investigation and these other matters, diverting a significant amount of resources and attention that would otherwise be directed toward our operations and the implementation of our business strategy, all of which could materially adversely affect our business and results of operations. Further, if the SEC were to conclude that enforcement action is appropriate, we could be required to pay large civil penalties and fines. Any of these events could have a material adverse effect on our business, financial condition and results of operations.
We are involved in other litigation matters that will continue to divert our resources and attention, and could result in substantial monetary damages that could have a material adverse effect on our financial condition and results of operations if we do not prevail.
As described in Item 3, “Legal Proceedings” of this Form 10-K, we are currently involved in a significant lawsuit. If we do not prevail in this or other lawsuits, our management contracts could be terminated and/or we may be required to pay substantial monetary damages, which could have a material adverse effect on our financial condition and results of operations.
The IRS audit may result in substantial fines and penalties, which could harm our financial condition, results of operations and cash flow.
As more fully described in Item 3, “Legal Proceedings” of this Form 10-K, the United States Internal Revenue Service is auditing our 2005 through 2008 federal income tax returns. The IRS audit may result in payments of unpaid taxes, interest and penalties. Any such reimbursements and payments could have a material adverse effect on our financial condition and results of operations.
Our potential indemnification obligations and limitations of our director and officer liability insurance may have a material adverse effect on our financial condition and results of operations.
Under Delaware law, our charter and bylaws and certain indemnification agreements between us and certain of our current and former directors and officers, we have an obligation to indemnify our current and former directors and officers with respect to the pending SEC investigation, including potentially for any liability for securities violations resulting therefrom. These indemnifiable obligations may not be reimbursable under our directors’ and officers’ liability insurance. In connection with some of the matters discussed in Item 3, “Legal Proceedings” of this Form 10-K, we have advanced legal fees and related expenses to several of our current and former directors and officers and expect to continue to do so while these matters are pending.
We purchase directors and officers liability insurance from insurers based on published ratings by recognized rating agencies, advice from national insurance brokers and consultants and other industry-related insurance information sources. Our directors and officers liability insurance covers events for which payment obligations and the timing of payments are only determined in the future. The insurers could become insolvent and unable to fulfill their obligation to defend, pay or reimburse us for insured claims. In addition, the insurer’s obligation to defend, pay, or reimburse us for insured claims would cease with respect to an individual if that individual were found to have committed a deliberate criminal or fraudulent act or in the event we ultimately determine that the individual is not entitled to indemnification.
Under our directors and officers liability insurance policy, we are responsible for the cost of claims up to a self-insured limit. In addition, we cannot be sure that claims will not arise that are in excess of the limits of our insurance or that are not covered by the terms of our insurance policy. Due to these coverage limitations, we may incur significant unreimbursed costs to satisfy our indemnification obligations, which may have a material adverse effect on our financial condition and results of operations.
Risks Related to the Senior Living Industry
Competition in our industry is high and may increase, which could impede our growth and have a material adverse effect on our revenues and earnings.
The senior living industry is highly competitive. We compete with numerous other companies that provide similar senior living alternatives, such as home health care agencies, community-based service programs, retirement communities, convalescent centers and other senior living providers. In general, regulatory and other barriers to competitive entry in the independent and assisted living segments of the senior living industry are not as substantial as in the skilled nursing segment of the senior living industry. In pursuing our growth strategies, we have experienced and expect to continue to experience competition in our efforts to develop and operate senior living communities. We expect that there will be competition from existing competitors and new market entrants, some of whom may have greater financial resources and lower costs of capital than we are able to obtain. Consequently, we may encounter competition that could limit our ability to attract new residents, increase resident fee rates, attract and retain capital partners for our ventures or expand our development activities or our business in general, which could have a material adverse effect on our revenues and results of operations. Similarly, overbuilding or oversupply in any of the markets in which we operate could cause us to experience decreased occupancy, reduced operating margins and lower profitability. Increased competition for residents could also require us to undertake unbudgeted capital improvements or to lower our rates, which could adversely affect our results of operations.
Our success depends on attracting and retaining skilled personnel and increased competition for or a shortage of skilled personnel could increase our staffing and labor costs, which we may not be able to offset by increasing the rates we charge to our residents.
We compete with various health care services providers, including other senior living providers, in attracting and retaining qualified and skilled personnel. We depend on our ability to attract and retain skilled management personnel who are responsible for the day-to-day operations of each community. Turnover rates and the magnitude of the shortage of nurses, therapists or other trained personnel vary substantially from community to community. Increased competition for or a shortage of nurses, therapists or other trained personnel or general inflationary pressures may require that we enhance our pay and benefits package to compete effectively for such personnel. We may not be able to offset such added costs by increasing the rates we charge to our residents or our management fees. If there is an increase in these costs or if we fail to attract and retain qualified and skilled personnel, our business, including our ability to implement our growth strategy, and operating results could be harmed.
The need to comply with government regulation of senior living communities may increase our costs of doing business and increase our operating costs.
Senior living communities are generally subject to regulation and licensing by federal, state and local health and social service agencies and other regulatory authorities. Although requirements vary from state to state and community to community, in general, these requirements may include or address:
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personnel education, training, and records;
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administration and supervision of medication;
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the provision of limited nursing services;
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admission and discharge criteria;
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documentation, reporting and disclosure requirements;
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staffing requirements;
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monitoring of resident wellness;
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physical plant specifications;
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furnishing of resident units;
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food and housekeeping services;
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emergency evacuation plans; and
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resident rights and responsibilities.
In several of the states in which we operate or intend to operate, laws may require a certificate of need before a senior living community can be opened. In most states, senior living communities are also subject to state or local building codes, fire codes, and food service licensing or certification requirements.
Independent living communities are unregulated and not subject to state or federal inspection. However, communities that feature a combination of senior living options such as CCRCs, consisting of independent living campuses with a promise of future assisted living and/or skilled nursing services and an entrance fee requirement, are regulated by state government, usually the state’s department of insurance. CCRCs are subject to state regulation of minimum standards to ensure financial solvency and are required to give annual disclosure regarding such things as the community’s financial standing, the contractual obligations of services to the residents, residents’ rights and costs to residents to reside in the community.
Communities licensed to provide skilled nursing services generally provide significantly higher levels of resident assistance. Communities that are licensed, or will be licensed, to provide skilled nursing services may participate in federal health care programs, including the Medicare and Medicaid programs. In addition, some licensed assisted living communities may participate in state Medicaid-waiver programs. Such communities must meet certain federal and/or state requirements regarding their operations, including requirements related to physical
environment, resident rights, and the provision of health services. Communities that participate in federal health care programs are entitled to receive reimbursement from such programs for care furnished to program beneficiaries and recipients.
Senior living communities that include assisted living facilities, nursing facilities, or home health care agencies are subject to periodic surveys or inspections by governmental authorities to assess and assure compliance with regulatory requirements. Such unannounced surveys may occur annually or bi-annually, or can occur following a state’s receipt of a complaint about the community. As a result of any such inspection, authorities may allege that the senior living community has not complied with all applicable regulatory requirements. Typically, senior living communities then have the opportunity to correct alleged deficiencies by implementing a plan of correction. In other cases, the authorities may enforce compliance through imposition of fines, imposition of a provisional or conditional license, suspension or revocation of a license, suspension or denial of admissions, loss of certification as a provider under federal health care programs, or imposition of other sanctions. Failure to comply with applicable requirements could lead to enforcement action that can materially and adversely affect business and revenues. Like other senior living communities, we have received notice of deficiencies from time to time in the ordinary course of business.
Regulation of the senior living industry is evolving. Our operations could suffer if future regulatory developments, such as mandatory increases in scope of care given to residents, licensing and certification standards are revised, or a determination is made that the care provided by one or more of our communities exceeds the level of care for which the community is licensed. If regulatory requirements increase, whether through enactment of new laws or regulations or changes in the application of existing rules, our operations could be adversely affected. Furthermore, there have been numerous initiatives on the federal and state levels in recent years for reform affecting payment of health care services. Some aspects of these initiatives could adversely affect us, such as reductions in Medicare or Medicaid program funding.
We are also subject to certain federal and state laws that regulate financial arrangements by health care providers, such as the Federal Anti-Kickback Law. This law makes it unlawful for any person to offer or pay (or to solicit or receive) “any remuneration...directly or indirectly, overtly or covertly, in cash or in kind” for referring or recommending for purchase of any item or service which is eligible for payment under the Medicare or Medicaid programs. Authorities have interpreted this statute very broadly to apply to many practices and relationships between health care providers and sources of patient referral. If a health care provider were to violate the Anti-Kickback Law, it may face criminal penalties and civil sanctions, including fines and possible exclusion from government programs such as Medicare and Medicaid. Similarly, health care providers are subject to the False Claims Act with respect to their participation in federal health care reimbursement programs. Under the False Claims Act, the government or private individuals acting on behalf of the government may bring an action alleging that a health care provider has defrauded the government and seek treble damages for false claims and the payment of additional monetary civil penalties. Many states have enacted similar anti-kickback and false claims laws that may have a broad impact on health care providers and their payor sources. Recently other health care providers have faced enforcement action under the False Claims Act. It is difficult to predict how our revenue could be affected if we were subject to an action alleging violations.
We are also subject to federal and state laws designed to protect the confidentiality of patient health information. The U.S. Department of Health and Human Services has issued rules pursuant to HIPAA relating to the privacy of such information. In addition, many states have confidentiality laws, which in some cases may exceed the federal standard. We have adopted procedures for the proper use and disclosure of residents’ health information in compliance with the relevant state and federal laws, including HIPAA.
Risks Related to our Organization and Structure
Anti-takeover provisions in our governing documents and under Delaware law could make it more difficult to effect a change in control.
Our restated certificate of incorporation and amended and restated bylaws and Delaware law contain provisions that could make it more difficult for a third party to obtain control of us or discourage an attempt
to do so. In addition, these provisions could limit the price some investors are willing to pay for our common stock. These provisions include:
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Board authority to issue preferred stock without stockholder approval. Our Board of Directors is authorized to issue preferred stock having a preference as to dividends or liquidation over the common stock without stockholder approval. The issuance of preferred stock could adversely affect the voting power of the holders of our common stock and could be used to discourage, delay or prevent a change in control of Sunrise;
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Filling of Board vacancies; removal. Any vacancy occurring in the Board of Directors, including any vacancy created by an increase in the number of directors, shall be filled for the unexpired term by the vote of a majority of the directors then in office, and any director so chosen shall hold office for a term expiring at the next annual meeting of stockholders. Directors may be removed with or without cause by the affirmative vote of the holders of at least a majority of the outstanding shares of our capital stock then entitled to vote at an election of directors, provided, that no special meeting may be called at the request of the stockholders for the purpose of removing any director without cause;
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Other constituency provision. Our Board of Directors is required under our certificate of incorporation to consider other constituencies, such as employees, residents, their families and the communities in which we and our subsidiaries operate, in evaluating any proposal to acquire the Company. This provision may allow our Board of Directors to reject an acquisition proposal even though the proposal was in the best interests of our stockholders subject to any overriding applicable law;
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Call of special meetings. A special meeting of our stockholders may be called only by the chairman of the board, the president, by a majority of the directors or by stockholders possessing at least 25% of the voting power of the issued and outstanding voting stock entitled to vote generally in the election of directors, provided, that no special meeting may be called at the request of the stockholders for the purpose of removing any director without cause. This provision limits the ability of stockholders to call special meetings;
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Stockholder action instead of meeting by unanimous written consent. Any action required or permitted to be taken by the stockholders must be affected at a duly called annual or special meeting of such holders and may not be affected by any consent in writing by such holders, unless such consent is unanimous. This provision limits the ability of stockholders to take action by written consent in lieu of a meeting;
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Supermajority vote of stockholders or the directors required for bylaw amendments. A two-thirds vote of the outstanding shares of common stock is required for stockholders to amend the bylaws. Amendments to the bylaws by directors require approval by at least a two-thirds vote of the directors. These provisions may make more difficult bylaw amendments that stockholders may believe are desirable;
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Two-thirds stockholder vote required to approve some amendments to the certificate of incorporation. A two-thirds vote of the outstanding shares of common stock is required for approval of amendments to the foregoing provisions that are contained in our certificate of incorporation. All amendments to the certificate of incorporation must first be proposed by a two-thirds vote of directors. These supermajority vote requirements may make more difficult amendments to these provisions of the certificate of incorporation that stockholders may believe are desirable; and
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Advance notice bylaw. We have an advance notice bylaw provision requiring stockholders intending to present nominations for directors or other business for consideration at a meeting of stockholders to notify us by a certain date depending on whether the matters are to be considered at an annual or special meeting. Stockholders proposing matters for consideration at an annual meeting must provide notice not earlier than 120 days and not later than 90 days prior to the anniversary of the date on which we first mailed our proxy materials for the immediately preceding annual meeting. If, however, the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, stockholder notice must be delivered not earlier than 120 days and not later than 90 days prior to the date of such annual meeting, provided, however, that if the first public announcement of the date is less than 100 days prior to the date of such annual meeting, then stockholder notice must be delivered not later than the 10th day following such public announcement. Stockholders proposing matters for consideration at a special meeting must provide notice not less than 120 calendar days prior to the date of the special meeting, provided, however, that if the first public announcement
of the date of such special meeting is less than 130 days prior to the date of such special meeting, stockholder notice must be delivered not later than the 10th day following such public announcement.
In addition to the anti-takeover provisions described above, we are subject to Section 203 of the Delaware General Corporation Law. Section 203 generally prohibits a person beneficially owning, directly or indirectly, 15% or more of our outstanding common stock from engaging in a business combination with us for three years after the person acquired the stock. However, this prohibition does not apply if (A) our Board of Directors approves in advance the person’s ownership of 15% or more of the shares or the business combination or (B) the business combination is approved by our stockholders by a vote of at least two-thirds of the outstanding shares not owned by the acquiring person. When we were formed, the Klaassens and their respective affiliates and estates were exempted from this provision.
Our Board of Directors has adopted a stockholder rights agreement that could discourage a third party from making a proposal to acquire us.
We have a stockholder rights agreement that was adopted in April 2006, as amended in November 2008 and January 2010. The stockholder rights agreement may discourage a third party from making an unsolicited proposal to acquire us. Under the agreement, preferred stock purchase rights, which are attached to our common stock, generally will be triggered upon the acquisition, directly or indirectly through certain derivative positions, of 10% or more of our outstanding common stock, except that stockholders who beneficially owned more than 10% of our stock as of November 19, 2008 were permitted to maintain their existing ownership positions without triggering the preferred stock purchase rights. In addition, we amended the agreement in January 2010 to permit FMR LLC to acquire up to 14.9% of our stock under certain circumstances without triggering the preferred stock purchase rights. If triggered, these rights would entitle our stockholders, other than the person triggering the rights, to purchase our common stock, and, under certain circumstances, the common stock of an acquirer, at a price equal to one-half the market value of our common stock.
Our management has influence over matters requiring the approval of stockholders.
As of December 31, 2009, the Klaassens beneficially owned approximately 10.5% of our outstanding common stock and our executive officers and directors as a group, including the Klaassens, beneficially owned approximately 12.7% of the outstanding common stock. As a result, the Klaassens and our other executive officers and directors have influence over matters requiring the approval of our stockholders, including business combinations and the election of directors.
Item 1B.
Item 1B.
Unresolved Staff Comments
None.
Item 2.
Item 2.
Properties
We lease our corporate offices, regional operations and warehouse space under various leases. The leases have remaining terms of six months to 17 years.
Of the 384 communities we operated at December 31, 2009, 20 were wholly owned, 27 were under operating leases, one was a consolidated variable interest entity, 201 were owned in unconsolidated ventures and 135 were owned by third parties. See the “Properties” section included in Item 1, “Business” for a description of the properties. See Note 10 to the consolidated financial statements for a description of mortgages and notes payable related to certain of our properties.
Item 3.
Item 3.
Legal Proceedings
HCP
In June 2009, various affiliates of HCP 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
$25.9 million in 2009. We have $18.3 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 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.
Trinity OIG Investigation and Qui Tam Action
As previously disclosed, in 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. In 2007, Trinity and the Company were served with a complaint which amended a complaint filed under seal on November 21, 2005 by four former employees of Trinity under the qui tam provisions of the Federal False Claims Act. In 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 named 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. In 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. In April of 2009, the United States later reversed it’s decision to intervene. All parties entered into a settlement agreement which was subsequently approved by the District Court on June 3, 2009 and the lawsuit was dismissed with prejudice on November 10, 2009.
IRS Audit
The IRS 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 received reimbursement of the federal income taxes we had paid in 2005. In August 2009, the IRS concluded field work on the 2006 audit which resulted in a refund claim of $0.6 million. The IRS will not close the 2006 audit until the audits are completed for the 2007 and 2008 tax years as a net operating loss carryback from these years was applied to receive reimbursement for federal taxes we paid in 2006.
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.
SEC Investigation
In 2006 we 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. In 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 in 2007. 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.
In 2009, Sunrise and its current or former directors or officers who were named individually as defendants entered into an agreement which called 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.
Concurrently with entering into the settlement agreement, Sunrise and the individual defendants entered 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 combined to pay $13.4 million toward the settlement amount, which exhausted the coverage limits under the primary policy (after taking account of prior payments for related defense costs), but did 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 was approximately $0.1 million. No amounts were paid by the individual defendants.
In June 2009, the settlement agreement was approved and followed the settlement agreement entered into by Sunrise and the individuals named as defendants in two putative stockholder derivative actions brought by certain alleged stockholders of Sunrise for the benefit of the Company as discussed below.
Putative Shareholder Derivative Litigation
In 2007, the first of two putative shareholder derivative complaints was filed against certain of our current and former directors and officers, and naming us as a nominal defendant. 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 complaint alleged 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 sought damages and equitable relief on behalf of Sunrise.
In 2007, a putative shareholder derivative complaint was filed 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 complaint alleged breaches of fiduciary duty by the individual defendants arising out of the grant of certain stock options that were the subject of the purported class action and shareholder derivative litigation described above. The plaintiffs sought damages and equitable relief on behalf of Sunrise.
In 2009, the Company and the individual defendants entered into an agreement to settle both 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 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 provided that the Company’s insurers pay attorneys fees and expenses not to exceed $1 million. No amounts were paid by the Company or by the individual defendants. The settlement was approved and the action formally dismissed.
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.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
On November 18, 2009, we held our 2009 annual meeting of stockholders. The annual meeting was called for the following purposes: (1) to elect six directors for terms of one year each; (2) to approve and adopt the proposal to ratify the appointment of Ernst & Young as our independent registered public accounting firm for our fiscal year ending December 31, 2009; and (3) to transact any other business as may properly come before the annual meeting or any adjournments or postponements.
Each of the six director nominees (Glyn F. Aeppel, Thomas J. Donohue, David I. Fuente, Stephen D. Harlan, J. Douglas Holladay and William G. Little) were re-elected to new one year terms. The vote totals for the election of directors were as follows:
The other directors whose terms of office continue after the 2009 annual meeting are Paul J. Klaassen, Lynn Krominga and Mark S. Ordan.
The proposal to ratify the appointment of Ernst & Young as our independent registered public accounting firm for our fiscal year ending December 31, 2009 was approved at the meeting. The vote tabulation was as follows: 42,883,388 votes (98.43% of the shares present in person or represented by proxy at the meeting and entitled to vote with respect to the matter) were cast for approval of the proposal, 619,525 votes (1.42% of shares present in person or represented by proxy at the meeting and entitled to vote with respect to the matter) were cast against such proposal and 64,583 votes (0.15% of the shares present in person or represented by proxy at the meeting and entitled to vote with respect to the matter) were abstentions. Broker non-votes totaled zero. There was no other business that was considered before the 2009 annual meeting.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our common stock is traded on the New York Stock Exchange under the symbol “SRZ.”
The following table sets forth, for the quarterly periods indicated, the high and low sales prices of our common stock:
Quarterly Market Price Range of Common Stock
Holders
There were 242 stockholders of record at December 31, 2009.
Dividends
No cash dividends have been paid in the past and we have no intention to pay cash dividends in the foreseeable future.
Issuer Purchases of Equity Securities
None.
Issuance of Common Stock
In November 2009, we issued 4.2 million shares of the 5.0 million shares of common stock to three electing lenders in connection with the German debt restructuring discussed in Note 10. The common stock had a fair value at the time of issuance of $11.1 million. This amount is reflected as a deposit on our consolidated balance sheets until such time as all consideration is exchanged upon the execution of the definitive documentation.
Item 6.
Item 6.
Selected Financial Data
The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto appearing elsewhere herein.
(1)
We recorded impairment charges related to owned communities and land parcels of $31.7 million, $27.8 million, $7.6 million, $15.7 million and $2.5 million in 2009, 2008, 2007, 2006 and 2005, respectively. We recorded impairment of goodwill of $121.8 million in 2008. We recorded restructuring charges of $33.3 million
and $24.2 million in 2009 and 2008, respectively. We wrote-off capitalized project costs of $14.9 million, $95.8 million, $28.4 million, $1.3 million and $1.0 million in 2009, 2008, 2007, 2006 and 2005, respectively.
(2)
We incurred costs of $3.9 million, $30.2 million, $51.7 million and $2.6 million in 2009, 2008, 2007 and 2006, respectively, related to Accounting Restatement, Special Independent Committee inquiry, SEC investigation and stockholder litigation.
(3)
In 2006, Five Star bought out 18 management contracts and we received $134.7 million related to their buyout. We also wrote off $25.4 in unamortized management contract intangible assets. In 2005, Five Star bought out 12 management contracts and we received $83 million related to their buyout. We also wrote off $14.6 million in unamortized management contract intangible assets.
(4)
In February 2006, we completed the redemption of our remaining 5.25% convertible subordinated notes due February 1, 2009 through the issuance of common stock. Prior to the redemption date, substantially all of the approximately $120.0 million principal amount of the notes outstanding at the time the redemption was announced had been converted into approximately 6.7 million shares of common stock. The conversion price was $17.92 per share in accordance with the terms of the indenture governing the notes.
(5)
In October 2005, we completed a two-for-one stock split in the form of a 100% stock dividend. As a result of the stock split, each stockholder received one additional share of common stock for each share on that date. All per share amounts have been adjusted to reflect the stock split for all periods presented.
Item 7.
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.
Overview
We are a Delaware corporation and a provider of senior living services in the United States, Canada, the United Kingdom and Germany.
At December 31, 2009, we operated 384 communities, including 335 communities in the United States, 15 communities in Canada, 27 communities in the United Kingdom and seven communities in Germany, with a total unit capacity of approximately 40,400. Of the 384 communities we operated at December 31, 2009, 20 were wholly owned, 27 were under operating leases, one was consolidated as a variable interest entity, 201 were owned in unconsolidated ventures and 135 were owned by third parties. During 2009, we opened 23 new communities, with a combined unit capacity of approximately 2,100, which were developed by us.
We have six operating segments for which operating results are separately and regularly reviewed by key decision makers: North American Management, North American Development, Equity Method Investments, Consolidated (Wholly Owned/Leased), United Kingdom and Germany (part of which is included in discontinued operations).
North American Management includes the results from the management of third party, venture and wholly owned/leased Sunrise senior living communities in the United States and Canada.
North American Development includes the results from the development of Sunrise senior living communities in the United States and Canada.
Equity Method Investments includes the results from our investment in domestic and international ventures.
Consolidated (Wholly Owned/Leased) includes 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 $21.9 million, $22.2 million and $22.2 million for 2009, 2008 and 2007, respectively.
United Kingdom includes the results from the development and management of Sunrise senior living communities in the United Kingdom.
Germany includes the results from the management of nine (two of which have been 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 stock markets and credit markets in the United States and the rest of the world have been experiencing significant price volatility, dislocations and liquidity disruptions. As a result the market prices of many stocks, including ours, have fluctuated substantially and these circumstances have materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in some cases have resulted in the unavailability of financing. Continued uncertainty in the credit markets has caused us to discontinue our development business and may negatively impact our ability to refinance our Bank Credit Facility and our maturities of long-term debt due 2010 and 2011, of approximately $0.4 billion, at reasonable terms. There are also current maturities of venture debt due in 2010 of approximately $0.3 billion. A prolonged downturn in the financial markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to further adjust our business plan accordingly. These events also may make it more difficult or costly for us to raise capital, including through the issuance of common stock. The disruptions in the financial markets have had and may have a material adverse effect on the market value of our common stock and other adverse effects on us and our business.
Significant 2009 and 2010 Developments
Overview
During 2009, we continued to reduce overhead costs; restructure, repay and extend maturities of some of our debt; and sell assets to generate liquidity. Our focus in 2010 will be on: (1) operating high-quality assisted living and memory care communities in North America, Germany and the United Kingdom; (2) increasing occupancy and improving the operating efficiency of our communities; (3) improving the operating efficiency of our corporate operations; (4) generating liquidity; (5) divesting of non-core assets; and (6) reducing our operational and financial risk.
We continue to reduce our financial obligations and reach negotiated settlements with various creditors. We are unable to borrow additional funds under our Bank Credit Facility. We are seeking waivers with respect to existing defaults under many of our debt obligations to avoid acceleration of these obligations. We have been successful in reducing our exposure related to our German communities, our Fountains portfolio and our Aston Gardens venture, each discussed in more detail below. However, we continue to have significant debt maturing in 2010 and 2011 and there can be no assurance that we will be able to extend this debt or obtain additional financing. The existence of these factors raise substantial doubt about our ability to continue as a going concern and our auditors have modified their report with respect to the 2009 consolidated financial statements to include a going concern reference.
Asset Sales
In 2009, we sold 21 non-core assisted living communities, located in 11 states, to Brookdale Senior Living, Inc. (“Brookdale”) for an aggregate purchase price of $204 million. At closing, we received approximately $59.6 million in net proceeds after we paid or the purchaser assumed approximately $134.1 million of mortgage loans, the posting of required escrows, various prorations and adjustments, and payments of expenses by us, generating a gain of $48.9 million.
In 2010, we intend to sell (i) our German communities, (ii) the liquidating trust assets and, at our discretion, (iii) certain communities and land parcels, of which any net sales proceeds on the disposition of these assets would be split equally between us, the mortgage holder and the lenders under the Bank Credit Facility.
Fountains Venture
In 2009, we entered into agreements with our venture partner and the lender to the venture 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 in exchange for which we have, among other things:
•
Transferred our 20-percent ownership interest in the Fountains venture to our venture partner;
•
Contributed vacant land parcels adjacent to six of the Fountains communities and owned by us to the Fountains venture;
•
Agreed to transfer management of the 16 Fountains communities as soon as the transition closing conditions are met and the new manager has obtained the regulatory approvals necessary to assume control of the facilities; and
•
Repaid the venture the management fee we had earned to date in 2009 of $1.8 million.
We transferred management of eight of the 16 communities to the new manager on February 1, 2010, and expect to transfer management of the remaining eight communities by mid-2010.
Greystone
In 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) $2.0 million in cash at closing; (ii) $5.7 million in short-term notes which have subsequently been repaid, (iii) a $6.0 million 7-year note (iv) a $2.5 million note payable, and (v) 35% of the future net proceeds received by the seed capital investors for each of the seed capital interests purchased from us. In 2009, we received $1.0 million in net proceeds for one of our seed capital interests.
Aston Gardens
In April 2009, we sold the equity interest in our Aston Gardens venture and were released from all guarantee obligations. Our management contracts for the six communities in the venture were 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.
Restructuring Plan
In 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 others, 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) 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 184 positions will be eliminated. As of December 31, 2009, we had eliminated 154 positions and will be eliminating an additional 30 positions by mid 2010. We have recorded severance expense of $8.3 million as a result of the plan through December 31, 2009 and expect to record an additional $1.6 million through mid 2010. The costs from the 2009 restructuring plan are in addition to the costs incurred in 2009 related to the 2008 restructuring plan, which provided for the elimination of 182 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. Upon his termination, 70,859 shares of restricted stock and 750,000 options vested. 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.
In January 2010, we terminated the employment of Daniel J. Schwartz, our Senior Vice President, North American Operations, in connection with this plan, effective as of May 31, 2010. Mr. Schwartz will receive the severance payments and benefits payable to him pursuant to his employment agreement upon a termination of his employment, except that in lieu of a lump sum cash severance payment equal to two years’ base salary and 75% of his target bonus amount (based on his base salary of $0.4 million and target bonus of 100% of base salary), Mr. Schwartz will receive such cash severance payment in the form of equal monthly installments of 1/24th of the total cash severance amount commencing July 2010 and continuing until December 2010, and the remaining balance to be paid in a lump sum on December 31, 2010.
In September 2009, we terminated our lease on a portion of our corporate headquarters in McLean, Virginia. We recorded a charge of $2.7 million which is reflected in restructuring expense on our consolidated statement of operations. We expect to save $5.6 million in cash over four years as a result of terminating this portion of the lease.
Results of Operations
Our results of operations for each of the three years in the period ended December 31 were as follows:
Segment results are as follows (in thousands):
The following table summarizes our portfolio of operating communities at December 31, 2009, 2008 and 2007:
Adjusted Income (Loss) from Ongoing Operations
Adjusted income (loss) from ongoing operations is a measure of operating performance that is not calculated in accordance with U.S. generally accepted accounting principles and should not be considered as a substitute for income/loss from operations or net income/loss. Adjusted income from ongoing operations is used by management to focus on cash generated from our ongoing operations and to help management assess if adjustments to current spending decisions are needed.
The following table reconciles adjusted income (loss) from ongoing operations to loss from operations (in thousands):
Operating Revenue
Management fees and buyout fees
2009 Compared to 2008
Management fees were $112.5 million in 2009 compared to $131.6 million in 2008, a decrease of $19.1 million, or 14.5%. This decrease was primarily comprised of:
•
$7.7 million decrease related to management fees from the Fountains venture;
•
$6.0 million decrease primarily due to lower occupancy;
•
$5.3 million decrease as a result of terminated management contracts;
•
$2.0 million decrease in incentive management fees; partially offset by
•
$1.0 million increase related to international communities;
•
$2.6 million increase from communities in the lease-up phase; and
•
$3.2 million increase from an increase in average daily rates.
2008 Compared to 2007
Management fees were $131.6 million in 2008 compared to $122.3 million in 2007, an increase of $9.3 million, or 7.6%. This increase was primarily comprised of:
•
$6.8 million increase from fees associated with existing communities of which $4.8 million is attributable to an increase in average daily rates in North America, $2.2 million is attributable to international communities and a decrease of $0.2 million due to lower occupancy;
•
$2.6 million increase in management fees from 17 communities accounted for under the deposit method through July 2007 with no management fee recognition;
•
$4.0 million of expense in 2007 related to a one time refund pursuant to an agreement with a venture partner;
•
$1.4 million increase of fees from communities in the lease-up phase; partially offset by
•
$2.4 million decrease from terminated management contracts; and
•
$1.9 million decrease in incentive management fees.
Resident fees for consolidated communities
2009 Compared to 2008
Resident fees for consolidated communities were $350.3 million in 2009 compared to $341.0 million in 2008, an increase of $9.3 million, or 2.7%. This increase was primarily comprised of:
•
$7.8 million from the addition of three consolidated Canadian communities and one domestic community;
•
$5.1 million from increases in average daily rates; partially offset by a
•
$3.6 million decrease due to lower occupancy.
2008 Compared to 2007
Resident fees for consolidated communities were $341.0 million in 2008 compared to $323.0 million in 2007, an increase of $18.0 million, or 5.6%. This increase was primarily comprised of:
•
$21.4 million from existing consolidated communities primarily resulting from increases in average daily rates;
•
$1.8 million from the addition of three consolidated Canadian communities that were opened during 2008; partially offset by a
•
$5.2 million decrease from two communities previously accounted for under the financing method of accounting in 2007.
Ancillary fees
Professional fees from development, marketing and other
Professional fees from development, marketing and other were as follows:
2009 Compared to 2008
The $31.2 million decrease in professional fees in 2009 compared to 2008 was comprised primarily of a $16.3 million decrease in North American development fees due to final completion stages of projects for whom the majority of the revenue had been recognized previously and $2.6 million in design fees. Internationally, development fees decreased $12.3 million due to two less projects in 2009 compared to 2008 and $1.1 million decrease in guarantee fees due to no projects in 2009 earning guarantee fees.
2008 Compared to 2007
The $14.9 million increase in professional fees in 2008 compared to 2007 was comprised primarily of a $17.9 million increase in North American development fees due to the net increase of nine communities under development in North America for which we were earning professional fees, from five communities in 2007 to 14 communities in 2008. For International, development fees decreased $1.8 million due to four less projects in 2008 compared to 2007 and a $1.2 million decrease in guarantee fees due to earning fees on two less projects in 2007 compared to 2008.
Reimbursed costs incurred on behalf of managed communities
2009 Compared to 2008
Reimbursed costs incurred on behalf of managed communities were $942.8 million in 2009 compared to $1,011.4 million in 2008. The decrease of 6.8% was due primarily to 47 fewer communities in 2009 than 2008.
2008 Compared to 2007
Reimbursed costs incurred on behalf of managed communities were $1,011.4 million in 2008 compared to $956.0 million in 2007. The change of 5.8% was due primarily to more communities managed in 2008 than 2007 (before the consolidation of Germany and the termination of 11 communities at the end of November 2008).
Operating Expenses
Community expense for consolidated communities
2009 Compared to 2008
Community expense for consolidated communities was $268.3 million in 2009 compared to $257.6 million in 2008, an increase of $10.7 million, or 4.2%. This increase was primarily comprised of:
•
$7.2 million from the addition of three Canadian communities and one domestic community;
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$2.1 million from existing communities due to increased labor costs partially offset by reductions in food and repairs and maintenance; and
•
$2.6 million from an insurance credit in 2008.
2008 Compared to 2007
Community expense for consolidated communities was $257.6 million in 2008 compared to $231.8 million in 2007, an increase of $25.8 million, or 11.1%. This increase was primarily comprised of:
•
$19.6 million from existing communities resulting primarily from increased labor, utility, and repairs and maintenance costs; and
•
$4.0 million from the addition of three Canadian communities that were opened during 2008.
Community lease expense
2009 Compared to 2008
Community lease expense decreased $0.5 million primarily related to a decrease in contingent rent for two communities.
2008 Compared to 2007
Community lease expense decreased $2.5 million or 4.0% primarily due to a decrease in contingent rent of $2.9 million partially offset by a $0.6 million increase in base rent in one community. In 2008, contingent rent was $5.3 million compared to $8.2 million in 2007.
Depreciation and amortization
Depreciation and amortization expense by segment was as follows:
2009 Compared to 2008
The increase in depreciation and amortization expense of $7.1 million was primarily comprised of $5.2 million additional amortization expense related to the change in the estimated lives of management contracts and $1.2 million of incremental depreciation related to four new communities.
2008 Compared to 2007
The decrease in depreciation and amortization expense of $3.1 million was primarily comprised of decreases related to $6.1 million of depreciation recorded in 2007 relating to assets accounted for under the deposit method and $1.2 million related to the termination and write-off of certain development and management contracts in 2007 partially offset by an increase in depreciation expense of $3.7 million for assets placed in service and consolidated in 2008.
Ancillary expenses
General and administrative
2009 Compared to 2008
General and administrative expense was $119.9 million in 2009 compared to $157.5 million in 2008, a decrease of $37.6 million, or 23.9%. This decrease is primarily due to:
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$11.6 million decrease in salaries and bonus as a result of our cost reduction program;
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$17.0 million decrease in general corporate expenses including information technology costs, training and education and temporary help;
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$4.4 million decrease in travel;
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$7.2 million decrease in bonus expense related to one of our ventures;
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$1.5 million decrease related to an employee litigation settlement in 2008;
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$1.2 million decrease due to a 2008 penalty related to one of our communities; partially offset by
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$5.1 million increase in executive deferred compensation costs.
2008 Compared to 2007
General and administrative expense was $157.5 million in 2008 compared to $183.5 million in 2007, a decrease of $26.0 million, or 14.2%. This decrease was primarily the result of a $19.2 million decrease in bonus expense related to our first U.K. venture.
Development expense
2009 Compared to 2008
Development expense was $12.5 million in 2009 compared to $34.1 million in 2008, a decrease of $21.6 million, or 63.4%. This decrease, related to the reduction of development activity, was primarily comprised of:
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$11.2 million decrease in development labor costs; and
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$10.5 million decrease in development related expenses including travel, insurance, professional fees, legal, telecommunication, and other costs.
2008 Compared to 2007
Development expense was $34.1 million in 2008 compared to $35.1 million in 2007, a decrease of $1.0 million, or 2.7%. This decrease was primarily comprised of:
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$7.1 million increase in development labor costs and other expenses; offset by
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$8.1 million decrease in project costs that were not capitalized as the projects were not considered probable.
Write-off of capitalized project costs
The write-off of capitalized project costs was $14.9 million in 2009, $95.8 million in 2008 and $28.4 million in 2007. In 2009, we had one significant project write-off of $11.0 million. In 2008, we suspended the development of three condominium projects and we wrote off $27.7 million of development costs. Also, based on our decision to decrease our development pipeline, we wrote off approximately $68.1 million of costs related to 215 development projects we discontinued during 2008. The development project write-offs in 2007 primarily relate to the $21.0 million write-off of capitalized development costs for four senior living condominium projects we discontinued due to adverse economic conditions.
Accounting Restatement, Special Independent Committee Inquiry, SEC investigation and pending stockholder litigation
We incurred legal and accounting fees of approximately $3.9 million in 2009, $30.2 million in 2008 and $51.7 million in 2007 related to the accounting review, the Special Independent Committee Inquiry, the SEC investigation and responding to various shareholder actions. The Special Independent Committee activities and the accounting restatement were completed during the first quarter of 2008; however, we continue to incur legal fees and related expenses in connection with the SEC investigation and stockholder litigation.
Restructuring cost
Costs associated with our 2009 and 2008 restructuring plans were $33.3 million in 2009 and $24.2 million in 2008. During 2009 and 2008, we initiated a plan to reduce our general and administrative expense, development and venture support head count and certain non-payroll costs. We have eliminated 336 positions in overhead and development, primarily in our McLean, Virginia headquarters. It is our intention to continue to reduce costs in 2010.
Provision for doubtful accounts
2009 Compared to 2008
The provision for doubtful accounts decreased $6.5 million during 2009 compared to 2008 primarily due to a reserve of $6.4 million for advances to a venture and a $1.6 million reserve write-off of the remaining Aston Gardens operating deficit guarantee in 2009 compared to a reserve of $14.2 million for the Fountains operating deficit guarantee loan in 2008.
2008 Compared to 2007
The provision for doubtful accounts was $20.1 million in 2008 compared to $7.7 million in 2007, an increase of $12.4 million. The increase is due primarily to reserving $14.2 million for the Fountains operating deficit guarantee loan and $0.5 million for the Aston Gardens operating deficit loan.
Loss on financial guarantees and other contracts
We recorded a loss on our financial guarantees of $2.1 million during 2009 related to construction cost overrun guarantees on a condominium project, a completion guarantee on an operating property and a settlement of operating deficit guarantees on a venture.
Loss on financial guarantees and other contracts was $5.0 million in 2008 which was comprised of approximately $2.6 million in construction cost overrun guarantees on the condominium project discussed below and $2.4 million for income support.
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 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.
Impairment of owned communities, land parcels, goodwill and intangible assets
During 2009, we recorded impairment charges of $31.7 million related to 11 land parcels, two ceased developments, one community and one condominium project.
During 2008, we recorded an impairment charge of $121.8 million related to all the goodwill for our North American business segment which resulted from our acquisition of Marriott Senior Living, Inc. in 2003 and Karrington Health, Inc. in 1999. In addition, we recorded impairment charges of $15.8 million related to two communities in the U.S. and $12.0 million related to land parcels that are no longer expected to be developed.
During 2007, we recorded an impairment charges of $7.6 million related to two communities in the U.S.
Costs incurred on behalf of managed communities
Costs incurred on behalf of managed communities were $947.6 million in 2009 compared to $1,005.0 million in 2008. Costs incurred on behalf of managed communities were $956.0 million in 2007. The decrease in 2009 from 2008 of 5.7% was due primarily to 47 fewer managed communities in 2009 than 2008 and higher insurance charges in 2008. The increase in 2008 compared to 2007 was due to an increase in the number of communities managed during 2008 (before the consolidation of Germany and the termination of 11 communities at the end of November 2008) and higher costs primarily due to inflation for items such as labor, food and utilities.
Other Non-operating Income (Expense)
2009 Compared to 2008
Total other non-operating income (expense) was $0.4 million and $(28.3) million for 2009 and 2008, respectively. The decrease of $28.7 million in other non-operating expense was primarily due to:
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$4.9 million decrease in interest income;
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$3.6 million increase in interest expense due to a decrease in interest capitalized as a result of communities under construction being put into operation;
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$11.3 million decrease in net losses on our investments in auction rate securities which are classified as trading securities and carried at fair value; and
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$6.7 million for net foreign exchange gains in 2009 comprised of the $8.0 million of gain related to the Canadian dollar, $(0.6) million and $(0.7) million of loss related to the British pound and Euro, respectively, compared to $(14.6) million of net foreign exchange losses in 2008 comprised of $(14.2) million and $(3.1) million of loss related to the Canadian dollar and British pound, respectively, and $2.7 million of gain related to the Euro.
2008 Compared to 2007
Total other non-operating expense was $(28.3) million and $(1.5) million for 2008 and 2007, respectively. The increase in other non-operating expense of $26.8 million was primarily due to:
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$1.5 million increase in interest expense due to increased borrowings;
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$7.8 million unrealized loss on our investments in auction rate securities which are classified as trading securities and carried at fair value. The unrealized loss on our investments was based on an analysis of sales discounts achieved in the secondary market and management’s judgment and resulted in an estimated discount of 20% from the face amount of the securities. Due to the uncertainty in the market for auction rate securities, it is reasonably likely that this assumption could change in the future. If the discount used was 10%, the unrealized loss would have been $3.9 million. If the discount used was 30%, the unrealized loss would have been $11.7 million; and
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$(14.6) million of foreign exchange losses in 2008 compared to $(2.3) million of foreign exchange losses in 2007. In 2008, the exchange loss was comprised of $(14.2) million and $(3.1) million in losses related to the Canadian dollar and to the British pound, respectively, and $2.7 million in gain related to the Euro. In 2007,
exchange gains of $7.2 million related to the Canadian dollar and losses of $(3.2) million and $(6.3) million related to the British pound and Euro, respectively.
Gain on the Sale and Development of Real Estate and Equity Interests
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 2009, 2008 and 2007 are as follows (in millions):
During 2009, 2008 and 2007, we recognized pre-tax gains of approximately $12.3 million, $8.1 million and $85.2 million, respectively, related to previous sales of real estate 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. At December 31, 2009, there was no remaining deferred gain from previous sales of real estate where sale accounting was not achieved.
Sunrise’s Share of Earnings (Losses) and Return on Investment in Unconsolidated Communities
The increase in our share of income (losses) in unconsolidated communities of $34.7 million was primarily due to our UK venture, in which we have a 20% interest, selling four communities to a venture in which we have a 10% interest. As a result of sales, the venture recorded a gain of which we recognized $19.5 million for our equity interest in the earnings. In addition, there were non-recurring losses in 2008 of $6.2 million and $4.7 million from our Fountains and Aston Gardens ventures, respectively, and operating losses from joint ventures were smaller in 2009 compared to 2008.
Our share of equity in (losses) earnings in unconsolidated communities decreased $91.7 million in 2008 from 2007 primarily due to one venture in the U.K. which had a significant transaction in 2007 whereby a venture in which we have a 20% interest sold six 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 ventures, we recorded earnings in unconsolidated communities of approximately $75.5 million during the third quarter of 2007. The remaining difference in our share of equity in earnings is primarily the result of an increase between 2008 and 2007 of pre-opening expenses and operating losses during initial lease-up periods.
In 2009, our return on investment in unconsolidated communities was the result of operating distributions of $10.6 million from investments where the book value was zero and we had no contractual obligation or implied obligations to support the venture.
In 2008, our return on investment in unconsolidated communities was the result of the following: (1) the expiration of three contractual obligations which resulted in the recognition of $9.2 million of income from the recapitalization of three ventures; (2) receipt of $8.3 million of proceeds resulting from the refinancing of the debt of one of our ventures with eight communities; (3) the recapitalization and refinancing of debt of one venture with two communities which resulted in a return on investment of $3.3 million; and (4) distributions of $12.7 million from operations from investments where the book value is zero and we have no contractual or implied obligations to support the venture.
In 2007, our return on investment in unconsolidated communities was primarily the result of three venture recapitalizations. In one transaction, the majority owner of a venture sold their majority interest to a new third party, the debt was refinanced, and the total cash we received and the gain recognized was $53.0 million. In another transaction, in conjunction with a sale by us of a 15% equity interest which gain is recorded in “Gain on the sale and development of real estate and equity interests” and the sale of the majority equity owner’s interest to a new third party, the debt was refinanced, and we received total proceeds of $4.1 million relating to our retained 20% equity interest in two ventures, which we recorded as a return on investment in unconsolidated communities.
In 2009, based on the receipt of a notice of default from the lender to a venture in which we own a 20% interest and the poor rental experience in the venture, we considered our investment to be other than temporarily impaired and wrote off the remaining equity balance of $1.1 million. We also determined the fair value of our investment in a venture in which we had a 1% interest had decreased to zero and was other than temporarily impaired, resulting in an impairment charge of $0.1 million. In addition, we wrote-down our equity investments in two of our development ventures by $7.4 million based on poor performance and defaults under the ventures’ construction loan agreements.
In 2008, we wrote-down our equity investments in our Fountains and Aston Gardens ventures by $10.7 million and $4.8 million, respectively.
In 2007, we wrote-down 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 were 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 was non-recourse to us, except for monthly principal payments during the term of the debt. Based on our assessment, we determined that our investment was impaired and as a result, we recorded a pre-tax impairment charge of approximately $21.6 million in the fourth quarter of 2007.
(Loss) Income from Investments Accounted for Under the Profit Sharing Method
(Loss) income from investments accounted for under the profit sharing method was as follows:
We currently apply the profit-sharing method to two transactions that occurred in 2006 where we sold a majority interest in two separate entities related to a partially developed condominium project as we provided guarantees to support the operations of the entities for an extended period of time.
Benefit from (Provision for) Income Taxes
The benefit from (provision for) income taxes was $3.9 million, $47.1 million and $(13.3) million in 2009, 2008 and 2007, respectively. Our effective tax benefit (provision) rate was 3.3%, 12.6% and (122.8)% in 2009, 2008 and 2007, respectively. At December 31, 2009 and 2008, our net deferred tax liabilities were zero and $2.8 million, respectively, and at December 31, 2009 and 2008, we had a total valuation allowance against deferred tax assets of $167.2 million and $138.8 million, respectively. The effective tax rate in 2008 is significantly impacted by the increase in the valuation allowance as of December 31, 2008 as we determined that as of the end of 2008, we are no longer able to conclude that it is more likely than not that net deferred tax assets will be realized. In 2009 and 2008, the effective tax rate was significantly impacted by the write-off of goodwill that was partially non-deductible for tax purposes.
Discontinued Operations
Discontinued operations consists of our German communities which we are marketing for sale, our Greystone subsidiary sold in 2009, 22 communities sold in 2009, one community closed in 2009, our Trinity subsidiary which ceased operations in 2008 and two communities which were sold in 2008, and for which we have no continuing involvement.
The following amounts related to those communities and businesses have been segregated from continuing operations and reported as discontinued operations.
Due to the valuation allowance on net deferred tax assets, no benefit for income taxes was allocated to discontinued operations for 2009.
Germany’s loss, included in discontinued operations, was $81.1 million for 2009 which included an impairment charge of $49.9 million. Greystone’s income includes $23.7 million of gain related to its sale.
In addition, in 2009, we sold 21 non-core assisted living communities, located in 11 states, to Brookdale Senior Living, Inc. for an aggregate purchase price of $204 million. At closing, we received approximately $59.6 million in net proceeds after we paid or the purchaser assumed approximately $134.1 million of mortgage loans, the posting of required escrows, various prorations and adjustments, and payments of expenses by us, generating a gain of $48.9 million. This gain was after a reduction of $5.0 million related to potential future indemnification obligations which expire in November 2010.
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. In exchange for the consideration, we and the former majority stockholders of Trinity have reciprocally released each other from any and all claims that each such parties had against other such parties relating to any matters through the date of the settlement agreement.
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.
Segment Analysis - 2009 Compared to 2008
Overview
Effective in 2009, we changed our operating segments. In 2008, we reported four operating segments: domestic operations, international operations (Canada and the United Kingdom), Germany and Greystone. We now have six operating segments for which operating results are regularly reviewed by our chief operating decision makers. We continue to evaluate our business and our presentation of the various segments that comprise our business. Accordingly, in the future we may change and/or refine our operating segments to present meaningful information to our chief operating decision makers.
The following analysis compares the 2009 operating results of our segments to the 2008 operating results. Due to the changes to our segments in 2009, a comparison to 2007 results by segment was not practical. Refer to Note 18 for additional information on our segments.
North American Management
Revenue within the North American Management segment is comprised of management fees, resident fees from our New York Dignity and Fountains Home Health operations and reimbursed costs incurred on behalf of managed communities. Revenue was $1,106.0 million in 2009 compared to $1,190.0 million in 2008, a decrease of $84.0 million or 7.1%. Management fees decreased $22.0 million due to the termination of management contracts, lower occupancy and management fees related to the Fountains venture. Reimbursed costs incurred on behalf of the managed communities decreased $64.5 million due to significantly fewer communities in 2009 than 2008.
Operating expense within the North American Management segment is comprised of costs to operate the management company, community expense to operate the New York Dignity and Fountains Home Health operations and costs incurred on behalf of managed communities. Operating expense was $1,072.9 million in 2009 compared to $1,263.2 million in 2008, a decrease of $190.3 million or 15.1%. The decrease was primarily due to the impairment charge of $121.6 million related to all the goodwill from the acquisition of Marriott Senior Living, Inc. in 2003 and Karrington Health, Inc. in 1999. In addition, general and administrative costs decreased
$20.9 million and costs incurred on behalf of managed communities decreased $57.2 million from 2008 due to significantly fewer communities in 2009 than 2008.
Overall, income before benefit from income taxes and discontinued operations in 2009 was $37.1 million, an increase of $109.4 million from the prior year. However, although favorable, the 2009 income from operations does not reflect unallocated expenses that reside in our unallocated corporate and eliminations segment, which reported a loss from operations of $79.8 million in 2009.
North American Development
Revenue within the North American Development segment is comprised of professional fees from development, marketing and other. Revenue was $6.6 million in 2009 compared to $27.4 million in 2008, a decrease of $20.8 million or 75.9%. The decrease was due to the wind down of development activity in North America during 2009.
Operating expense within the North American Development segment is comprised of costs to develop Sunrise communities. Operating expense was $65.7 million in 2009 compared to $142.9 million in 2008, a decrease of $77.2 million or 54.0%. The decrease was primarily due to write-off of capitalized projects costs. The write-off of North American capitalized projects was $15.4 million in 2009 compared to $97.6 million in 2008 resulting in an $82.2 million decrease. Our development expense decreased $12.1 million in 2009 due to decreased development activity. These decreases were offset by an increase of $23.0 million in impairment of land parcels.
Loss before benefit from income taxes and discontinued operations in 2009 was $53.7 million, a decrease of $58.4 million from the prior year for reasons described above.
Equity Method Investments
Equity Method Investments revenue consists primarily of transaction fees earned in the United Kingdom related to joint venture capital transactions. Revenue was $2.2 million in 2009 compared to $2.3 million in 2008, a decrease of $0.1 million or 4.3%. Revenue remained relatively unchanged.
Equity Method Investments expenses consists primarily of operating expenses associated with our ventures. Operating expense was $7.0 million in 2009 compared to $29.2 million in 2008, a decrease of $22.2 million or 76.0%. Other operating expenses were $6.3 million in 2009 compared to $19.6 million in 2008. The primary reasons for the decrease of $13.3 million were a decrease of $7.2 million in bonus expense related to our UK venture and a $3.3 million decrease in salaries and restructuring costs related to our cost reduction program. Impairment expense decreased $6.4 million due the impairment of land in 2008.
Sunrise’s share of earnings (losses) and return on investment in unconsolidated communities was ($13.8) million in 2008 and $5.7 million in 2009, an increase of $19.5 million. Refer to Sunrise’s Share of Earnings (Losses) and Return on Investment in Unconsolidated Communities for a detailed discussion of this increase.
Income before benefit from income taxes and discontinued operations in 2009 was $1.1 million, an increase of $41.1 million for reasons discussed above.
Consolidated (Wholly Owned/Leased)
Revenue within the Consolidated (Wholly Owned/Leased) segment is comprised of resident fees. Revenue was $350.1 million in 2009 compared to $340.8 million in 2008, an increase of $9.3 million or 2.7%. The increase was due to the addition of three Canadian communities and one domestic community during 2008 and an increase in the average daily rate. The increase was partially offset by a decrease due to lower occupancy.
Operating expense within the Consolidated (Wholly Owned/Leased) segment is comprised of costs to operate our communities. Operating expense was $369.7 million in 2009 compared to $373.9 million in 2008, a decrease of $4.2 million or 1.1%. Community expense increased $5.7 million in 2009 due to the opening of four additional communities during 2008 and increased labor costs partially offset by reductions in food and repairs and maintenance. The increase was offset by a decrease in impairment expense of $12.9 million.
Loss before benefit from income taxes and discontinued operations in 2009 was ($16.7) million, a decrease of $24.0 million from the prior year. The change was primarily due to a decrease of $13.5 million in the income from operations discussed above and a decrease of $12.4 million in foreign exchange gains related to our Canadian communities.
United Kingdom
United Kingdom operating revenue consists of management fees, professional fees from development, marketing and other and reimbursed costs incurred on behalf of managed communities. Operating revenue was $27.6 million in 2009 compared to $32.8 million in 2008. The decrease of $5.2 million was primarily due to a $12.1 million decrease in professional fees from development, marketing and other as we wound down development in the United Kingdom during 2009. This decrease was offset by an increase in management fees and reimbursed costs incurred on behalf of managed communities of $6.8 million due to the opening of seven communities in 2009 and the continued lease up of communities that opened in 2008.
United Kingdom operating expenses consist primarily of development expense and other operating expenses. Development expense was $1.7 million in 2009 compared to $4.3 million in 2008. This decrease of $2.6 million was due to the winding down of development activity during 2009. Other operating expenses increased $2.3 million to $25.0 million in 2009 from $22.7 million in 2008 primarily due to an increase in costs incurred on behalf of managed communities due to the opening of seven communities in 2009 and the continued lease up of communities that opened in 2008.
Overall, loss before benefit from income taxes and discontinued operations in 2009 was ($0.9) million, a decrease of $3.8 million from the prior year for reasons discussed above.
German Management Company
German Management Company operating revenue consists of management fees in 2009 and management fees and reimbursed costs incurred on behalf of managed communities in 2008. Operating revenue was $1.7 million in 2009 compared to $11.1 million in 2008. The decrease in revenues of $9.4 million was primarily the result of consolidating the German communities in 2009 and no longer recognizing reimbursed costs incurred on behalf of managed communities in this line item.
German Management Company operating expenses consist primarily of other operating expenses. Operating expenses were $5.1 million in 2009 compared to $15.5 million in 2008. The decrease of $10.4 million was primarily the result of consolidating the German communities in 2009 and no longer recognizing costs incurred on behalf of managed communities and downsizing the German Management Company due to the decision to discontinue operations in Germany.
Loss before benefit from income taxes and discontinued operations in 2009 was ($4.1) million, an increase of $1.9 million from the prior year. The change was primarily due to an increase of $1.0 million in the income from operations discussed above and a decrease of $3.2 million in foreign exchange gains.
Unallocated Corporate and Eliminations
Revenue within the Unallocated Corporate and Eliminations segment is comprised of the elimination of the Wholly Owned/Leased management and design fees. Revenue was ($30.1) million in 2009 compared to ($33.5) million in 2008, a decrease of $3.4 million or 10.1%. The decrease is due to lower occupancy and minimal design fees in 2009.
Operating expense within the Unallocated Corporate and Eliminations segment is comprised of overhead costs not directly attributable to an operating segment, elimination of the Wholly Owned/Leased management fee expense and the costs from our insurance entities. Operating expense was $48.7 million in 2009 compared to $66.5 million in 2008, a decrease of $17.8 million or 26.8%. General and administrative decreased $32.1 million in 2009 primarily due to a reduction in salaries, professional and legal fees. The decrease was partially offset by an increase of $19.0 million in restructuring costs associated with our plan to reduce overhead costs.
Overall, the loss before benefit from income taxes and discontinued operations in 2009 was ($79.8) million, a decrease of $29.6 million from the prior year due to the changes in income from operations discussed above.
Liquidity and Capital Resources
Overview
We had $39.3 million and $29.5 million of unrestricted cash and cash equivalents at December 31, 2009 and December 31, 2008, respectively. Since January 1, 2009, we have had no borrowing availability under the Bank Credit Facility. As a result, during 2009, we have financed our operations primarily with cash generated from operations and sales of assets, including the sale of our Greystone subsidiary, the sale of our Aston Gardens equity interest and the sale of 21 communities.
In 2010, we intend to sell (i) our German communities, (ii) the liquidating trust assets and, at our discretion, (iii) certain communities and land parcels, of which any net sales proceeds on the disposition of these assets would be split equally between us, the mortgage holder and the lenders under the Bank Credit Facility.
Additional financing resources will be required to refinance existing indebtedness that comes due within the next 12 months. We have undertaken efforts to reduce expenses and preserve liquidity including; (i) significantly reducing operating costs; (ii) seeking to restructure the terms of our indebtedness including extension of scheduled maturity dates; and (iii) pursuing sales of selected assets. No assurance can be given that we will be successful in achieving any of these efforts.
As of December 31, 2009, we have no projects under development and we do not currently have plans to commence any new projects. We will reconsider future development when market conditions stabilize and the cost of capital for development projects is in line with projected returns.
Debt and Bank Credit Facility
Debt
At December 31, 2009, we had $440.2 million of outstanding debt as follows (in thousands):
(1)
The face amount of the debt related to the German communities was $215.2 million at December 31, 2009. Excludes $10.5 million of accrued interest on the German debt as of December 31, 2009 which is reflected in Liabilities associated with German assets held for sale on our consolidated balance sheet.
Principal maturities of debt at December 31, 2009 are as follows (in thousands):
Along with contractual maturities due in 2010, debt that is in default is also reflected in current portion of long term debt.
Debt that is in default at December 31, 2009 consists of the following (in thousands):
The German debt is in default as we stopped making principal and interest payments in 2009. The remaining debt is in default as we have failed to comply with various financial covenants. On February 12, 2010, we extended $56.9 million of debt that was either past due or in default at December 31, 2009. The debt is associated with an operating community and two land parcels. In connection with the extension we (i) made a $5.0 million principal payment at closing; (ii) extended the terms of the debt to no earlier than December 2, 2010; (iii) provided for an additional $5.0 million principal payment on or before July 31, 2010; and, among other items, (iv) defaults under the loan agreements were waived by the lenders. 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 of December 31, 2009 as follows (in thousands):
Germany Venture
We own nine communities (two of which have been 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 ($72.0 million at December 31, 2009), has a stipulated release price for each community. With respect to the remaining five communities, we have provided guarantees to the lenders for the payment 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. However, in connection with the German debt restructuring, we have settled with this lender. The face amount of the total debt related to the German communities, excluding accrued but unpaid interest, at December 31, 2009 is $215.2 million. We also had accrued interest of $10.5 million and $0.6 million at December 31, 2009 and 2008, respectively, related to this debt.
At the beginning of 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. We 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. The standstill agreements stipulate that neither party will 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 late 2009, we entered into a restructuring agreement, in the form of a binding term sheet, with three of our lenders (“electing 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 three lenders contended that these claims had an aggregate value of approximately $131.1 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 three lenders represent approximately 83.5 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 have issued to the electing lenders 4.2 million shares of our common stock, their pro rata share of up to 5 million shares of our common stock. The fair value of the 4.2 million shares at the time of issuance was $11.1 million. This amount is reflected as a deposit on our consolidated balance sheets until such time as all consideration is exchanged upon the execution of the definitive documentation. In addition, we will grant mortgages for the benefit of all electing lenders on the liquidating trust. Following the first execution of the definitive documentation for the restructuring, we will continue to pursue the sale of the 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 the sale of the liquidating trust, 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 satisfaction of our remaining obligation to the minimum payments.
In addition, we have been marketing 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. In 2009, we engaged a broker to assist in the sale of the nine German communities and at that time, classified the German assets as held for sale. As the book value of the majority of the assets was in excess of their fair value less estimated costs to sell, we recorded a charge of $49.9 million in 2009 which is included in discontinued operations.
The closing of the transaction, including the execution of the definitive documentation, the release of claims and the issuance of Sunrise common stock, was conditioned upon receipt of consent for the transaction from Bank of America, N.A., as the administrative agent under our Bank Credit Facility, which consent was received. In accordance with the binding term sheet, definitive documentation was to be executed as soon as reasonably possible (but no later than 40 days) after the receipt of such required consent. In December 2009, we extended the execution of the definitive documentation to allow the parties additional time to complete the definitive documentation. We expect to complete this process by the end of February 2010.
At December 31, 2009, we continue to be liable under operating deficit and repayment guarantees for two communities which are not part of the restructuring. In addition, we were liable for a principal repayment guarantee for the Hoesel land parcel which was not part of the restructuring agreement. The Hoesel land parcel was sold and the liability was released in early 2010. We expect to recognize a gain of $0.7 million on the sale in 2010.
Mortgage Financing
In 2008, 16 of our wholly owned subsidiaries incurred mortgage indebtedness in the aggregate principal amount of approximately $106.7 million from Capmark Bank (“Capmark”) as lender and servicer pursuant to 16 separate cross-collateralized, cross-defaulted mortgage loans. Shortly after the closing, Capmark assigned the mortgage loans to Fannie Mae. Variable monthly interest payments were in an amount equal to (i) one third (1/3) of the “Discount” (which was the difference between the loan amount and the price at which Fannie Mae was able to sell its three-month, rolling discount mortgage backed securities) plus (ii) 227 basis points (2.27%) times the outstanding loan amount divided by twelve (12).
In connection with the mortgage loans, we entered into interest rate protection agreements that provided for payments to us in the event the LIBOR rate exceeded 5.6145%. These loans and interest rate protection agreements were either assigned to the buyer of 15 of the 16 communities in 2009 or paid off in connection with that closing.
Also in 2009, mortgage loans of $32.2 million were either assigned to the purchaser or repaid in conjunction with the sale of the underlying assets.
Bank Credit Facility
In 2009, we entered into various amendments to our Bank Credit Facility. These amendments, among other things:
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extended the maturity date to December 2, 2010;
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removed all existing financial covenants other than the minimum liquidity covenant;
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renewed existing letters of credit;
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modified the minimum liquidity covenant to not less than $10.0 million of unrestricted cash on hand the last day of the month;
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modified the restriction on the disposal of assets to include disposition of certain assets as long as 50% of the net sale proceeds are allocated to the lenders; and
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permanently reduced the commitment after future principal repayments or cancellation of letters of credit.
Total amendment fees paid were $1.4 million. Principal payments of $61.3 million were made during 2009 in accordance with these amendments. In addition, $20.0 million was placed into a collateral account for the benefit of other creditors from the proceeds of the sale of 21 communities. $6.2 million of cash was used to satisfy the obligations of other creditors and $13.8 million remains in the collateral account at December 31, 2009. This amount is included in restricted cash in the consolidated balance sheets.
We have no borrowing availability under the Bank Credit Facility. We have $19.4 million of letters of credit outstanding under the Bank Credit Facility at December 31, 2009.
Other Debt
Sunrise ventures have total debt of $3.7 billion with near-term scheduled debt maturities of $0.3 billion in 2010. Of this $3.7 billion of debt, there is long-term debt that is in default of $0.7 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 and to extend the maturity dates. In certain cases, we have provided operating deficit and completion guarantees to the lenders or ventures. We have operating deficit or completion guarantee agreements with respect to ventures in which we are obligated for total debt of $1.1 billion or 30% of the total venture debt. Under the operating deficit agreements, we are obligated to pay operating shortfalls, if any, with
respect to these ventures. Any such payments could include amounts arising in part from the venture’s obligations for monthly principal and interest on the venture debt. We do not believe that these operating deficit agreements would obligate us to make payments of principal and interest on such venture debt that might become due as a result of acceleration of such indebtedness. We have minority non-controlling interests in these ventures.
Certain of these ventures have financial covenants that are based on the consolidated results of Sunrise. 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. These events of default could allow the financial institutions who have extended credit to seek acceleration of the loans.
Guarantees
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 ventures to fund operating shortfalls. The terms of the guarantees match the term of the underlying venture debt and generally range from three to five years, to the extent we are able to refinance the venture debt. Fundings under the operating deficit guarantees and debt repayment guarantees are generally recoverable either out of future cash flows of the venture or from proceeds of the sale of communities. We have no projects under construction at December 31, 2009.
The maximum potential amount of future fundings for outstanding guarantees, the carrying amount of the liability for expected future fundings at December 31, 2009 and fundings during 2009 are as follows (in thousands):
Senior Living Condominium Project
In conjunction with the sale of a majority interest in one condominium venture and one assisted living venture discussed in Note 6, we are obligated to fund operating shortfalls. The weak economy in the Washington, D.C. area has resulted in lower condominium sales than forecasted and we have funded $3.5 million under the guarantees through December 31, 2009. In addition, we are required to fund marketing costs associated with the sale of the condominiums which we estimate will total approximately $7.5 million by the time the remaining inventory of condominiums are sold.
In July 2009, the lender alleged 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.
Agreements with Marriott International, Inc.
Our agreements with Marriott International, Inc. (“Marriott”), which 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 $8.1 million at December 31, 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 $2.2 billion at December 31, 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 December 31, 2009, the remaining liability under this obligation is $44.3 million. We have not funded under these guarantees, and do not expect to fund under such guarantees in the future.
Contractual Obligations
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 14 to our Consolidated Financial Statements for a discussion of our commitments.
Principal maturities of debt, equity investments in unconsolidated entities and future minimum lease payments at December 31, 2009 are as follows (in thousands):
(1)
We have various standing or renewable contracts with vendors. These contracts are all cancellable with minimal or no cancellation penalties. Contract terms are generally one year or less.
(2)
In addition to the obligations in the table above, approximately $19 million of unrecognized tax benefits have been recorded as liabilities and we are uncertain as to if or when such amounts may be settled.
Cash Flows
Our primary sources of cash from operating activities are from management 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, general and
administrative expenses and restructuring expenses. 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 of 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.
Net cash provided by (used in) operating activities was $33.4 million and $(123.9) million in 2009 and 2008, respectively. During 2009, net working capital provided cash of $32.5 million as opposed to using cash of $63.2 million in 2008. Discontinued operations provided cash of $2.1 million in 2009 as compared to using cash of $39.9 million in 2008.
Net cash (used in) provided by operating activities was $(123.9) million and $128.5 million in 2008 and 2007, respectively. During 2008, net working capital used cash of $63.2 million as opposed to providing cash of $5.0 million in 2007. In 2008, the use of cash primarily relates to the payment of accounts payable and other accrued expenses. In addition, distributions of earnings from unconsolidated subsidiaries were $134.0 million less in 2008 as compared to 2007. Discontinued operations used cash of $39.9 million in 2008 as compared to providing cash of $64.1 million in 2007.
Net cash provided by (used in) investing activities was $84.4 million and $(172.5) million in 2009 and 2008, respectively, an increase of $256.9 million. The increase in cash provided by investing activities was primarily due to a decrease of $206.6 million in capital expenditures and condominium fundings, an increase in cash provided by discontinued operations of $140.9 million as the result of asset sale proceeds and a decrease in investments in unconsolidated communities of $16.0 million. These increases in cash were partially offset by a decrease of $52.1 million of proceeds from the disposition of assets and increase in restricted cash of $71.2 million.
Net cash used in investing activities was $172.5 million and $248.5 million in 2008 and 2007, respectively, a decrease of $76.0 million. In 2008, we slowed our development pace resulting in a decrease in capital expenditures from $237.6 million in 2007 to $173.5 million in 2008. During 2008, we funded $57.9 million for our senior living condominium project, with no corresponding outflow in 2007. In 2008, we had no asset acquisitions, compared to $49.9 million in 2007. Restricted cash decreased by approximately $41.0 million in 2008 compared to 2007 due in part to the net purchase of $38.9 million of auction rate securities using restricted cash in our insurance captive and due to refunds made to our venture partners from changes to our self insurance liabilities from reassessment of the actuarial liabilities.
Net cash (used in) provided by financing activities was $(108.0) million and $187.7 million for 2009 and 2008, respectively, a decrease of $295.7 million. This decrease was primarily due to a decrease in net borrowings of long-term debt of $93.4 million, a decrease in net borrowings of debt related to discontinued operation of $144.8 million and repayments of $61.3 million under our Bank Credit Facility as compared to repayments of $5.0 million in 2008.
Net cash provided by financing activities was $187.7 million and $176.3 million in 2008 and 2007, respectively, resulting primarily from $9.9 million in net increased borrowings. The significant sources of new financing in 2008 were new mortgage debt related to 16 of our wholly-owned subsidiaries ($106.7 million), 15 of which were sold in 2009 and the mortgage proceeds from 2008 are included in discontinued operations, construction debt for one community under development ($31.2 million), and a margin loan collateralized by auction rate securities ($21.4 million).
Market Risk
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):
At December 31, 2009, we had approximately $438.9 million of floating-rate debt at a weighted average interest rate of 2.85%. Debt incurred in the future also may bear interest at floating rates. Therefore, increases in prevailing interest rates could increase our interest payment obligations, which would negatively impact earnings. A one-percent change in interest rates would increase or decrease annual interest expense by approximately $4.4 million based on the amount of floating-rate debt at December 31, 2009. A five-percent change in interest rates would increase or decrease annual interest expense by approximately $21.9 million based on the amount of floating-rate debt at December 31, 2009.
We are subject to the impact of foreign exchange translation on our financial statements. To date, we have not hedged against foreign currency fluctuation; however, we may pursue hedging alternatives in the future. At December 31, 2009, our wholly owned subsidiaries have net U.S. dollar equivalent monetary liabilities denominated in foreign currency of $60.7 million, $2.1 million and $18.7 million in Canadian dollars, British pounds and Euros, respectively. We recorded $6.7 million, net, in exchange gains in 2009 ($8.0 million in gains related to the Canadian dollar and $(0.6) million and $(0.7) million in losses related to the Euro and British pound, respectively).
Critical Accounting Estimates
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 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.
Impairment of Intangible Assets, Long-Lived Assets and Investments in Ventures
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 at the lowest level of cash flows which is typically at the community or land parcel level, 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.
Assumptions and Approach Used. We estimate the fair value of an intangible asset, or asset group based on market prices (i.e., the amount for which the 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:
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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;
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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
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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.
In 2009, we recorded certain 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 $4.5 million which is included in operating expenses under impairment of long-lived assets.
In 2009, we recorded impairment charges of $24.9 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 $24.9 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, recent sale and a cost of capital rate to the communities’ average net income to estimate fair value of all of these assets. The charges are included in operating expenses under impairment of long-lived assets.
In 2009, upon designation of the German assets as 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 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 2009 we recorded a charge of $49.9 million which is included in discontinued operations.
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 defaults, 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 related risks are identical to those used for goodwill, intangible assets and long-lived assets described above.
In 2009, based on the receipt of a notice of default from the lender to a venture in which we own a 20% interest and the poor rental experience in the venture, we considered our equity to be other than temporarily impaired and wrote off the remaining equity balance of $1.1 million. We determined the fair value of our investment in a venture in which we had a 1% interest had decreased to zero and was other than temporarily impaired, resulting in an impairment charge of $0.1 million. In addition, we wrote-down our equity investments in two of our development ventures by $7.4 million based on poor performance and defaults under the ventures’ construction loan agreements.
In 2008, we wrote-down our equity investments in our Fountains and Aston Gardens ventures by $10.7 million and $4.8 million, respectively.
In 2007, we wrote-down 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 were 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, except for monthly principal payments during the term of the debt. Based on our assessment, we determined that our investment was impaired and as a result, we recorded a pre-tax impairment charge of approximately $21.6 million in the fourth quarter of 2007.
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. (“Sunrise Captive”). Sunrise Captive issues policies of insurance to and receives premiums from Sunrise that are reimbursed through expense allocation to each operated community and us. 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 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 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. 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, 2009, 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 $100 million at December 31, 2009. The expected liability is based on a 50% confidence level. If we had used a 75% confidence level, the recorded liability would be approximately $17 million higher. If we had used a 90% confidence level, the recorded liability would be approximately $35 million higher.
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 $13.0 million and $12.9 million at December 31, 2009 and 2008, respectively. We believe that the liability for outstanding losses and expenses is appropriate to cover the ultimate cost of losses incurred at December 31, 2009, but actual claims may differ. 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.
Variable Interest Entities
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.
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.
Effective January 1, 2010, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) issued Accounting Standards Update (“ASU”) 2009-17 (ASU 2009-17) Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 establishes a qualitative approach to the determination of the primary beneficiary of a VIE based on controlling financial interest in a variable interest entity that replaces the previous quantitative approach. However, ASU 2009-17 does not eliminate the need to perform a quantitative analysis in applying other provisions of the ASC Consolidations topic, including the determination of VIE status. Upon adoption of ASU 2009-17, we must reconsider our consolidation conclusions for all entities with which we are involved. Additionally, ASU 2009-17 eliminates the primary beneficiary reconsideration concept and effectively requires continuous evaluation as to the determination of the primary beneficiary as facts and circumstances change. We do not believe ASU 2009-17 will have a material impact on our consolidated financial position, results of operations or cash flows. Considering that we will need to perform quantitative analysis for VIE determination under ASU 2009-17, we will continue to make estimates and assumptions referred to above.
Valuation of Deferred Tax Assets
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.
ASC Income Tax Topic 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 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 would be required to establish 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. ASC Income Tax Topic 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:
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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;
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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 but such projections are more subjective and when such projections are combined with a history of recent losses it is difficult to reach verifiable conclusions and, accordingly, we give little or no weight to such projections when combined recent financial reporting losses; and
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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.
We have experienced significant losses in the last three years. As indicated above, in making our assessment of the realizability of tax assets we assess reversing temporary differences, available tax planning strategies and estimates of future taxable income. We more heavily weight recent financial reporting losses and, accordingly, as of December 31, 2009 have given little or no weight to subjectively determined projections of future taxable income exclusive of reversing temporary differences. Tax planning strategies have been considered historically but due to the significant net operating loss carryforwards as of December 31, 2009 we have not considered such strategies to be reasonably viable. As a result of changes in judgment on the realizability of future tax benefits, a valuation allowance was established on all deferred tax assets net of reversing deferred tax liabilities.
At December 31, 2009 and 2008, our deferred tax assets, net of the valuation allowances of $167.2 million and $138.8 million, respectively, were $117.2 million and $112.9 million, respectively. At December 31, 2009 and 2008, our deferred tax liabilities were $117.2 million and $115.7 million, respectively, and therefore the net deferred tax liabilities recorded were zero and $2.8 million as of December 31, 2009 and 2008, respectively.
A return to profitability by us in future periods may result in a reversal of the valuation allowance relating to certain recorded deferred tax assets.
Liability for Possible Tax Contingencies
Liabilities for tax contingencies are recognized based on the requirements of ASC Income Tax Topic. This topic 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 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” 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. We are also required to accrue interest and penalties that, under relevant tax law, we would incur if the uncertain tax positions ultimately were not sustained. Accordingly, 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 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, 2009 and 2008, we had recorded liabilities for possible losses on uncertain tax positions including related interest and penalties of $6.4 million and $4.6 million, respectively.
Accounting for Financial Guarantees
When we historically entered into guarantees in connection with the sale of real estate, we were 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. Fundings that are recoverable as a loan from a venture are considered in the determination of the loss recorded. Loan amounts are evaluated for impairment at inception and then quarterly.
Assumptions and Approach Used. We calculate 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:
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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;
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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 is 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
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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.
Litigation
Litigation is subject to uncertainties and the outcome of individual litigated matters is not fully predictable. Various legal actions, claims and proceedings are pending against us, some for specific matters described in Note 14 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.
New Accounting Standards
We adopted the following provisions of the ASC at the beginning of 2009:
We adopted new provisions of ASC Fair Value Measurements Topic for non-financial assets and liabilities. We had previously adopted the other provisions of fair value measurement for financial assets and liabilities beginning in 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 new provisions of the ASC Business Combination Topic beginning in 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 to be included in the measurement of the business acquired and instead should be expensed as incurred. These provisions apply prospectively to business combinations occurring in or after January 2009.
We adopted new provisions of the ASC Consolidation Topic. 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 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.
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. 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.
In the second quarter of 2009, we adopted the following provisions of the ASC, none of which had a material impact on our reported consolidated financial position, results of operations or cash flows:
ASC Investments - Debt and Equity Securities Topic 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.
ASC Financial Instruments Topic 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.
ASC Fair Value Measurements Topic 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.
ASC Subsequent Events Topic establishes 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.
In the third quarter of 2009, the FASB issued 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. ASU 2009-05 did not have a material impact on our consolidated financial position, results of operations or cash flows.
Future Adoption of Accounting Standards
In the second quarter 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 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, ASU 2009-17 requires ongoing assessments as to whether an enterprise is the primary beneficiary and eliminates the quantitative approach in determining the primary beneficiary. ASU 2009-17 is effective for us January 1, 2010. We do not believe that ASU 2009-17 will have a material impact on our consolidated financial position, results of operations or cash flows.
In the fourth quarter of 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. It no longer requires third party evidence. 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.
Impact of Inflation
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.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosure About Market Risk
Quantitative and qualitative disclosure about market risk appears in the “Market Risk” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Item 8.
Item 8.
Financial Statements and Supplementary Data
The following information is included on the pages indicated:
*
To be filed by amendment as soon as these financial statements become available.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. 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, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 and Note 10 to the accompanying consolidated financial statements, the Company’s Bank Credit Facility expires on December 2, 2010, unless further extended. The Company cannot borrow under the Bank Credit Facility and the Company has significant debt maturing in 2010 which it does not have the ability to repay. These conditions raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1 and Note 10. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
We have also 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, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 24, 2010 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
McLean, Virginia
February 24, 2010
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 CHANGES IN STOCKHOLDERS’ EQUITY
See accompanying notes.
SUNRISE SENIOR LIVING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements
1.
Organization and Presentation
Organization
We are a provider of senior living services in the United States, Canada, the United Kingdom and Germany. Founded in 1981 and incorporated in Delaware in 1994, we began with a simple but innovative vision - to create an alternative senior living option that would emphasize quality of life and quality of care. We offer a full range of personalized senior living services, including independent living, assisted living, care for individuals with Alzheimer’s and other forms of memory loss, nursing and rehabilitative care. In the past, we also developed senior living communities for ourselves, for ventures in which we retained an ownership interest and for third parties. Due to current economic conditions, we have suspended all new development.
At December 31, 2009, we operated 384 communities, including 335 communities in the United States, 15 communities in Canada, 27 communities in the United Kingdom and seven communities in Germany, with a total unit capacity of approximately 40,400. Of the 384 communities that we operated at December 31, 2009, 20 were wholly owned, 27 were under operating leases, one was consolidated as a variable interest entity, 201 were owned in unconsolidated ventures and 135 were owned by third parties. During 2009, we opened 23 new communities, with a combined unit capacity of approximately 2,100.
Basis of Presentation
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. 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. 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.
Discontinued operations consists of our German communities which we are marketing for sale, 22 communities which were sold in 2009 and for which we have no continuing involvement, one community which was closed in 2009, our Greystone subsidiary which was sold in 2009, our Trinity subsidiary which ceased operations in 2008, and two communities which were sold in 2008 and for which we have no continuing involvement.
The accompanying consolidated financial statements have been prepared on the basis of us continuing as a going concern. As discussed in more detail in Note 10, our Bank Credit Facility expires on December 2, 2010. At this time, we cannot borrow under the Bank Credit Facility and we have significant debt maturing in 2010. We are seeking waivers with respect to all defaults and are seeking to reach negotiated settlements with our various creditors to preserve our liquidity and to enable us to continue operating. However, these conditions raise substantial doubt about our ability to continue as a going concern.
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.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Cash and Cash Equivalents
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.
Restricted Cash
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 the Sunrise Captive of $93.5 million and $94.4 million at December 31, 2009 and 2008, respectively, is available to pay claims. The earnings from the investment of the cash of Sunrise Captive are used to reduce future costs of and pay the liabilities of the Sunrise Captive. Interest income in the Sunrise Captive was $0.7 million, $3.4 million and $3.5 million for 2009, 2008 and 2007, respectively.
Allowance for Doubtful Accounts
We provide an allowance for doubtful accounts on our outstanding receivables based on an analysis of collectability, including our collection history and generally do not require collateral to support outstanding balances.
Due from Unconsolidated Communities
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
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 our historical acquisition of land and the development and construction of communities, pre-acquisition costs were expensed as incurred until we determined that the costs were directly identifiable with a specific property. The costs were then capitalized if the property was already acquired or the acquisition of the property was probable. Upon acquisition of the land, we commenced capitalization of all direct and indirect project costs clearly associated with the development and construction of the community. We expensed indirect costs as incurred that were not clearly related to projects. We charged direct costs to the projects to which they related. If a project was abandoned, we expensed any costs previously capitalized. We capitalized the cost of the corporate development department based on the time employees devoted to each project. We capitalized interest as described in “Capitalization of Interest Related to Development Projects” and other carrying costs to the project and the capitalization period continued until the asset was ready for its intended use or was abandoned.
We capitalized the cost of tangible assets used throughout the selling process and other direct costs, provided that their recovery was reasonably expected from future sales.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
We ceased all development activities for owned assets at the end of 2008. Therefore, no development costs were capitalized for owned assets in 2009.
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).
Assets Held for Sale
At December 31, 2009 and 2008, approximately $40.7 million and $49.1 million of assets, respectively, were held for sale. The majority of these assets are undeveloped land parcels and certain condominium units that were acquired through an acquisition. We classify an asset as held for sale when all of the following criteria are met:
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executive management has committed to a plan to sell the asset;
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the asset is available for immediate sale in its present condition;
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an active program to locate a buyer and other actions required to complete the sale have been initiated;
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the asset is actively being marketed; and
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the sale of the asset is probable and it is unlikely that significant changes to the sale plan will be made.
We classify land as held for sale when it is being actively marketed. For wholly owned operating communities, binding purchase and sale agreements are generally subject to substantial due diligence and historically these sales have not always been consummated. As a result, we generally do not believe that the “probable” criteria is met until the community is sold. Upon designation as an asset held for sale, we record the asset at the lower of its carrying value or its estimated fair value, less estimated costs to sell, and we cease depreciation.
Real Estate Sales
We account for sales of real estate in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Property, Plant and Equipment Topic. For sales transactions meeting the requirements of the Topic 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 the ASC Property, Plant and Equipment Topic. 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 the Property, Plant and Equipment Topic.
For sales transactions that do not meet the full accrual sale criteria, 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.
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 exceeds costs related to the entire property.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
We also may provide guarantees 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) income from investments accounted for under the profit-sharing method” in the consolidated statements of operations. 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. At December 31, 2009, we have two transactions accounted for under the profit-sharing method.
Capitalization of Interest Related to Development Projects
Interest is capitalized on real estate under development, including investments in ventures in accordance with ASC Interest Topic. The capitalization period commences when development begins and continues until the asset is ready for its intended use or the enterprise substantially suspends all activities related to the acquisition of the asset. 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 had no real estate under development at the end of 2009. Interest capitalized in 2009 was $0.5 million.
Intangible Assets
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.
Investments in Unconsolidated Communities
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 ASC Consolidation Topic, we review all of our ventures to determine if they are variable interest entities (“VIEs”) and require consolidation. 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
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
a majority of the venture’s expected residual returns, or both. At December 31, 2009, we consolidated one VIE where we are the primary beneficiary.
In accordance with ASC Consolidation Topic, 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.
For ventures not consolidated, we apply the equity method of accounting in accordance with ASC Investments - Equity Method and Joint Ventures Topic. 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 this Topic, 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 therefore, 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 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 operations.
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.
Deferred Financing Costs
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.
Loss Reserves For Certain Self-Insured Programs
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,
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Notes to Consolidated Financial Statements - (Continued)
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, 2009, 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.
Employee Health and Dental Benefits
We offer employees an option to participate in our self-insured health and dental plans. 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. 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, 2009, 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.
Continuing Care Agreements
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 re-occupancy or termination of the care agreement.
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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, 2009 or December 31, 2008.
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 $33.2 million and $35.3 million at December 31, 2009 and 2008, 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.
Accounting for Guarantees
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.
Asset Retirement Obligations
In accordance with ASC Asset Retirement and Environmental Obligations Topic 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.
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.
Income Taxes
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.
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Notes to Consolidated Financial Statements - (Continued)
Revenue Recognition
“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.
“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 30 days notice.
“Ancillary services” is comprised of fees for providing care services to residents of certain communities owned by ventures and fees for providing home health assisted living services.
“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.
“Reimbursed costs incurred on behalf of managed communities” 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 “Costs incurred on behalf of managed communities”.
We considered the indicators in ASC Revenue Recognition Topic, 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.
Stock-Based Compensation
We record compensation expense for our employee stock options, restricted stock awards, and employee stock purchase plan in accordance with ASC Equity Topic. This Topic requires that all share-based payments to employees be recognized in the consolidated statements of operations 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.
Foreign Currency Translation
Our reporting currency is the U.S. dollar. Certain of our subsidiaries’ functional currencies are the local currency of their respective country. In accordance with ASC Foreign Currency Matters Topic, 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
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Notes to Consolidated Financial Statements - (Continued)
income” in the consolidated balance sheets. Monetary assets and liabilities denominated in foreign currencies are retranslated at the functional currency rate of exchange at the balance sheet date. All differences are recorded to the statement of operations.
Advertising Costs
We expense advertising as incurred. Total advertising expense for the years ended December 31, 2009, 2008 and 2007 was $4.1 million, $4.3 million and $4.2 million, respectively.
Legal Contingencies
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 reasonably estimated. We review these accruals quarterly and make revisions based on changes in facts and circumstances.
Reclassifications
Certain amounts have been reclassified to conform to the current year presentation. The majority of the reclassification are to discontinued operations which includes our German communities which we began marketing for sale in 2009, our Greystone subsidiary sold in 2009, 24 sold communities of which 22 were sold in 2009 and two in 2008, one community closed in 2009 and our Trinity subsidiary which ceased operations in 2008 and for which we have no continuing involvement.
New Accounting Standards
We adopted the following provisions of the ASC at the beginning of 2009:
We adopted new provisions of ASC Fair Value Measurements Topic for non-financial assets and liabilities. We had previously adopted the other provisions of fair value measurement for financial assets and liabilities beginning in 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 new provisions of the ASC Business Combination Topic beginning in 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 to 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 January 2009.
We adopted new provisions of the ASC Consolidation Topic. 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 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.
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Notes to Consolidated Financial Statements - (Continued)
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. 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.
In the second quarter of 2009, we adopted the following provisions of the ASC, none of which had a material impact on our reported consolidated financial position, results of operations or cash flows:
ASC Investments - Debt and Equity Securities Topic 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.
ASC Financial Instruments Topic 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.
ASC Fair Value Measurements Topic 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.
ASC Subsequent Events Topic establishes 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.
In the third quarter of 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. ASU 2009-05 did not have a material impact on our consolidated financial position, results of operations or cash flows.
Future Adoption of Accounting Standards
In the second quarter 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. ASU 2009-17 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, ASU 2009-17 requires ongoing assessments as to whether an enterprise is the primary beneficiary and eliminates the quantitative approach in determining the primary beneficiary. ASU 2009-17 is effective for us January 1, 2010. We do not believe that ASU 2009-17 will have a material impact on our consolidated financial position, results of operations or cash flows.
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Notes to Consolidated Financial Statements - (Continued)
In the fourth quarter of 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. It no longer requires third party evidence. 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.
3.
Fair Value Measurements
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. The ASC Fair Value Measurements Topic established 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 that 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 and marketable securities measured at fair value as of December 31, 2009 (in thousands):
At December 31, 2009, we held investments in three Student Loan Auction-Rate Securities (“SLARS”), two with a face amount of $8.0 million each and one with a face amount of $6.1 million, for a total of $22.1 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 rates for these SLARS are reset every 7 to 35 days. The interest rates at December 31, 2009 ranged from 0.26% to 0.50%. Uncertainties in the credit markets have prevented us and other investors from liquidating auction rate securities. We classify our investments in auction rate securities as trading securities and carry them at fair value. The fair value of the securities at December 31, 2009 was determined to be $18.7 million and we recorded unrealized and realized gains (losses) of $3.6 million and $(7.8) million in 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
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of SLARS in the secondary market ranged from 16% to 43% at December 31, 2009 with an average SLARS discount on closed deals of 20% at December 31, 2009.
During 2009, $8.8 million of our auction rate securities were called and redeemed at par and $8.0 million were sold at a discount of 10% of par. As a result, we recognized a gain on the redemption and sale of those securities of $2.6 million. Approximately $8.4 million of the proceeds were used to repay the margin loan related to the SLARS, refer to Note 10.
The following table reconciles the beginning and ending balances for the auction rates securities using fair value measurements based on significant unobservable inputs for 2009 (in thousands):
At December 31, 2009, we had 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 was approximately $2.3 million at December 31, 2009. The valuation was based on Level 1 inputs.
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 December 31, 2009 consists of the following (in thousands):
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):
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Notes to Consolidated Financial Statements - (Continued)
In 2009, we recorded certain land parcels (including two closed construction sites), a condominium project and a closed property as held for sale at the lower of their carrying value or fair value less estimated costs to sell. We used appraisals, bona fide offers, 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 $4.5 million which is included in operating expenses under impairment of long-lived assets. At the end of 2009, seven land parcels classified as assets held for sale had been held for sale for over a year. Therefore, the requirements to be classified as held for sale are not being met and the assets have been re-classified to held and used as of December 31, 2009. However, we continue to market these land parcels for sale.
Assets Held and Used
In 2009, we recorded impairment charges of $24.9 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 appraisals, recent sale and a cost of capital rate to the communities’ average net income to estimate fair value of all of these assets. We subsequently sold 21 operating communities that were classified as assets held and used and the $22.6 million impairment charge related to certain of these communities is included in discontinued operations. The remaining $2.3 million impairment charges are included in operating expenses under impairment of owned communities and land parcels.
In 2009, we also recorded impairment charges of $24.9 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, bona fide offers, market knowledge and brokers’ opinions of value to determine fair value. The charges are included in operating expenses under impairment of owned communities and land parcels.
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 December 31, 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
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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 December 31, 2009.
4.
Allowance for Doubtful Accounts
Allowance for doubtful accounts consists of the following (in thousands):
(1)
Includes provision associated with discontinued operations.
5.
Property and Equipment
Property and equipment consists of the following (in thousands):
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Notes to Consolidated Financial Statements - (Continued)
Depreciation expense was $31.8 million, $30.5 million and $27.2 million in 2009, 2008 and 2007, respectively.
In 2009, we sold 21 non-core communities with a net book value of $142.5 million for an aggregate purchase price of $204 million. We recorded a gain of approximately $48.9 million after a deduction of $5.0 million related to potential future indemnification obligations which expire in November 2010. We reclassed $100.9 million of property and equipment, net to German Assets Held for Sale. We recorded impairment charges of $49.9 million related to the German assets, another $49.9 million related to assets held and used and $4.5 million related to assets held for sale. Refer to Note 3.
During 2008, we recorded impairment charges of $19.3 million related to five communities in the U.S., $5.2 million related to two communities in Germany and $12.0 million related to land parcels that were no longer expected to be developed. During 2007, we recorded an impairment charge of $7.6 million related to two communities in the U.S.
6.
Sales of Real Estate
Total gains (losses) on sale recognized are as follows (in millions):
Basis of Performance of Services
During the years ended December 31, 2009, 2008 and 2007, we sold majority membership interests in entities owning partially developed land or sold partially developed land to ventures with none, four and three underlying communities, respectively, for zero, $78.7 million and $13.9 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 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. As the result of the deferral of gains on sale and fees received after the sale, additional deferred gains of $2.3 million, $8.5 million and $5.3 million were recorded in 2009, 2008 and 2007, respectively. Gains of $7.6 million, $4.9 million and $3.6 million were recognized in 2009, 2008 and 2007, respectively.
In 2008, in connection with the sale of a majority membership interest in an entity which owned an operating community, we 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 totaling approximately $8.7 million was initially deferred and is being recognized using the basis of performance of services method. We recorded gains of $2.9 million and $4.7 million in 2009 and 2008, respectively.
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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 was applied. In 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. Also, as part of the 2007 transaction, we indemnified the buyer for a period of 12 months against any losses up to $1 million. An additional gain of $0.5 million was recognized in 2008 when the indemnification period expired.
Deposit Method
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 in 2007. In 2009 and 2008, the buyer reimbursed us for some of the income support payments previously made. We recorded additional gains of $3.4 million and $0.9 million in 2009 and 2008, respectively, relating to these reimbursements.
Relevant details are as follows (in thousands):
Installment Method
In 2009, we sold a wholly owned community to an unrelated third party for approximately $2.0 million. We received $0.3 million in cash and a note receivable for $1.7 million when the transaction closed. The cash received did not meet the minimum initial investment required to adequately demonstrate the buyer’s commitment to purchase this type of asset. Therefore, we have applied the installment method of accounting to this transaction. Under the installment method, the seller recognizes a sale of real estate. However, profit is recognized on a reduced basis. As of December 31, 2009, we have received $0.2 million of the amount outstanding on the note receivable, recognizing a total gain of $0.5 million in 2009. This community sale is included in discontinued operations as we have no continuing involvement.
Investments Accounted for Under the Profit-Sharing Method, net
During 2009, a guarantee we provided in conjunction with the sale of three communities in 2004 expired. The guarantee stated that we would 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 until a certain coverage ratio was reached.
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Notes to Consolidated Financial Statements - (Continued)
In 2004, we had concluded that the guarantee would be for an extended period of time and applied the profit-sharing method of accounting. Upon the expiration of the guarantee, we recorded a gain of approximately $8.9 million.
During 2008, we completed the recapitalization of a venture with two underlying properties that was initially sold in 2004. As a result of this recapitalization, the guarantees that required us to use the profit-sharing method of accounting for our previous sale of real estate in 2004 were released and we recorded a gain on sale of approximately $6.7 million.
We currently apply the profit-sharing method to two transactions that occurred in 2006 where we sold a majority interest in two separate entities related to a partially developed condominium project as we provided guarantees to support the operations of the entities for an extended period of time. 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 ventures. Through December 31, 2009, we have paid $51.2 million in cost overruns. Construction of this project is now complete. Our investment carrying value at December 31, 2009 is $11.0 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 $13.6 million from the two ventures in 2009. 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.
Relevant details are as follows (in thousands):
Land and Community Sales
During 2009, 2008 and 2007, we sold one, four and three pieces of undeveloped land, respectively. We recognized (losses) gains of $(0.4) million, $(0.9) million and $5.7 million, in 2009, 2008 and 2007, respectively, related to these land sales.
In addition, in 2009, we sold 21 non-core assisted living communities, located in 11 states, to Brookdale Senior Living, Inc. for an aggregate purchase price of $204 million. At closing, we received approximately $59.6 million in net proceeds after we paid or the purchaser assumed approximately $134.1 million of mortgage loans, the posting of required escrows, various prorations and adjustments, and payments of expenses by us, recognizing a gain of
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
$48.9 million. This gain was after a reduction of $5.0 million related to potential future indemnification obligations which expire in November 2010. In 2008, we sold two communities for approximately $3.3 million in cash after transaction costs. There were no forms of continuing involvement that precluded sale accounting or gain recognition for all these sales. These community sales are included in discontinued operations as we have no continuing involvement.
Condominium Sales
In 2006, we acquired the long-term management contracts of two San Francisco Bay area continuing care retirement communities (“CCRC”) and the ownership of one community. As part of the acquisition, we also received ten vacant condominium units from the seller that we could renovate and sell. In 2007, we purchased an additional 37 units. Of the 47 units acquired, three were converted into a fitness center for the community, 14 were converted into seven double units and three were converted into a triple unit. In 2009 and 2008, we sold nine and nine, respectively, of the 35 renovated units and recognized (losses) gains on those sales totaling $(1.0) million and $1.0 million, respectively.
Sales of Equity Interests
During 2009, 2008 and 2007, we sold our equity interest in one, one and four ventures, respectively, whose underlying asset is real estate. In accordance with ASC Property, Plant and Equipment Topic, 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 this Topic. For all of the transactions, we did not provide any forms of continuing involvement that would preclude sale accounting or gain recognition. We recognized losses or gains on sale of zero, $(0.4) million and $10.6 million, respectively, related to these sales.
7.
Variable Interest Entities
Generally accepted accounting principles requires that a VIE, defined as an entity subject to consolidation according to the provisions of the ASC Consolidation Topic, must be consolidated by the primary beneficiary. The primary beneficiary is the party that absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns or both. We perform a qualitative and quantitative analysis using the methodology as described under the ASC Consolidation Topic to calculate expected losses to determine if the entity is a VIE. If the entity is a VIE, we determine which party has the greater variability and is the primary beneficiary. At December 31, 2009, we are the primary beneficiary of one VIE and therefore consolidate that entity.
VIEs where Sunrise is the Primary Beneficiary
We have a management agreement with a not-for-profit corporation established to own and operate a continuing care retirement community (“CCRC”) in New Jersey. This entity is a VIE. The CCRC contains a 60-bed skilled nursing unit, a 32-bed assisted living unit, a 27-bed Alzheimer’s care unit and 252 independent living apartments. We have included $18.1 million and $19.2 million, respectively, of net property and equipment and debt of $23.2 million and $23.9 million, respectively, in our 2009 and 2008 consolidated balance sheets for this entity. The majority of the debt is bonds that are secured by a pledge of and lien on revenues, a letter of credit with Bank of New York and by a leasehold mortgage and security agreement. We guarantee the letter of credit. Proceeds from the bonds’ issuance were used to acquire and renovate the CCRC. In 2009 and 2008, we guaranteed $21.9 million and $22.5 million, respectively, of the bonds. The entity has incurred losses and has experienced negative working capital for several years and has failed the debt service coverage ratio related to the bonds. Management fees earned by us were $0.6 million, $0.5 million and $0.5 million in 2009, 2008 and 2007, respectively. The management agreement also provides for reimbursement to us for all direct cost of operations. Payments to us for direct operating expenses and management fees were $11.1 million, $7.5 million and $4.2 million in 2009, 2008 and 2007, respectively. The entity obtains professional and general liability coverage through our affiliate, Sunrise Senior
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Living Insurance, Inc. The entity incurred $0.2 million per year for 2009, 2008 and 2007, related to the professional and general liability coverage. The entity also has a ground lease with us. Rent expense is recognized on a straight-line basis at $0.7 million per year. Deferred rent relating to this agreement is $6.1 million and $5.6 million at December 31, 2009 and 2008, respectively. These amounts are eliminated in our consolidated financial statements.
Beginning in September 2008, we consolidated the German communities as the venture was a VIE. In January 2009, we exercised our option and acquired a controlling interest of 94.9% in the German communities. In June 2009, we exercised our option and acquired the remaining 5.1% interest in our German communities therefore wholly owning those communities.
We previously consolidated six VIEs that were investment partnerships formed with third-party partners to invest capital in the pre-financing stage of Greystone projects. Five of these investment partnerships were sold as part of the Greystone transaction in March 2009 and we retained ownership in one which we deconsolidated as we are no longer affiliated with the general partner and do not control the entity. This entity was dissolved as of January 22, 2010. We owned 49.5% of the investment partnership with 50.5% owned by third parties. The purpose of the venture had been to develop a senior living community owned by a nonprofit entity.
VIEs Where We Are Not the Primary Beneficiary but Hold a Significant Variable Interest in the VIEs
In July 2007, we formed a venture with a third party to purchase six communities from our first U.K. development venture. The entity was financed with £187.6 million of debt. The venture also entered into a firm commitment to purchase 11 additional communities from our first U.K. development venture. As of December 31, 2009, the venture has 15 operating communities in the U.K. Our equity investment in the venture is zero at December 31, 2009. The line item “Due from unconsolidated communities” on our consolidated balance sheet contains $1.1 million due from the venture. Our maximum exposure to loss is our equity investment of zero. We calculated the maximum exposure to loss as the maximum loss (regardless of probability of being incurred) that we could be required to record in our statement of operations as a result of our involvement with the VIE.
In September 2006, a venture was formed to acquire and operate six senior living facilities located in Florida. We owned a 25% interest in the venture as managing member and our venture partner owned the remaining 75% interest. The venture was financed with $156 million of equity and $304 million of debt. 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. On April 30, 2009, we sold our 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.
8.
Intangible Assets and Goodwill
Intangible assets consist of the following (in thousands):
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Amortization was $13.1 million, $11.3 million and $14.4 million in 2009, 2008 and 2007, respectively. Amortization is expected to be approximately $2.9 million, $2.9 million, $2.9 million, $2.8 million and $2.8 million in 2010, 2011, 2012, 2013 and 2014, respectively.
Goodwill was $39.0 million at December 31, 2008 and related to the acquisition of Greystone. Greystone was sold in 2009. Refer to Note 7.
In 2008 and 2007, we recorded an impairment charge of $9.8 million and $56.7 million related to our Trinity goodwill and related intangible assets. Trinity ceased operations in December 2008. This impairment charge is recorded in discontinued operations. In 2008, we also recorded an impairment charge of $121.8 million related to all the goodwill for our North American business segment which resulted from our acquisitions of Marriott Senior Living, Inc. in 2003 and Karrington Health, Inc. in 1999. The impairment was recorded as the fair value of the North American business and was determined to be less than the fair value of the net tangible assets and identifiable intangible assets.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
9.
Investments in Unconsolidated Communities
The following are our investments in unconsolidated communities as of December 31, 2009:
(1)
Investments are accounted for under the profit-sharing method of accounting. See Note 6.
Included in “Due from unconsolidated communities” are net receivables and advances from unconsolidated ventures of $34.0 million and $76.9 million at December 31, 2009 and 2008, respectively. Net receivables from these ventures relate primarily to development and management activities.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Summary financial information for unconsolidated ventures accounted for by the equity method is as follows (in thousands):
Accounting policies used by the unconsolidated ventures are the same as those used by us.
Total management fees and reimbursed contract services from related unconsolidated ventures was $521.8 million, $534.2 million and $489.1 million in 2009, 2008 and 2007, respectively.
Our share of earnings and return on investment in unconsolidated communities consists of the following (in thousands):
Our investment in unconsolidated communities was greater than our portion of the underlying equity in the venture by $47.8 million and $3.9 million as of December 31, 2009 and 2008, respectively.
Return on Investment in Unconsolidated Communities
Sunrise’s return on investment in unconsolidated communities includes cash distributions from ventures arising from a refinancing of debt within ventures. We first record all equity distributions as a reduction of our investment. Next, we record a liability if there is a contractual obligation or implied obligation to support the venture including in our role as general partner. Any remaining distribution is recorded in income.
In 2009, our return on investment in unconsolidated communities was primarily the result of distributions of $10.6 million from operations from investments where the book value is zero and we have no contractual or implied obligation to support the venture.
In 2008, our return on investment in unconsolidated communities was the result of the following: (1) the expiration of three contractual obligations which resulted in the recognition of $9.2 million of income from the recapitalization of three ventures; (2) receipt of $8.3 million of proceeds resulting from the refinancing of the debt of one of our ventures with eight communities; (3) the recapitalization and refinancing of debt of one venture with two communities which resulted in a return on investment of $3.3 million; and (4) distributions of $12.7 million from operations from investments where the book value is zero and we have no contractual or implied obligations to support the venture.
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,
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
the debt was refinanced, and the total cash we received and the gain recognized was $53.0 million. In another transaction, in conjunction with a sale by us of a 15% equity interest which gain is recorded in “Gain on the sale and development of real estate and equity interests” and the sale of the majority equity owner’s interest to a new third party, the debt was refinanced, and we received total proceeds of $4.1 million relating to our retained 20% equity interest in two ventures, which we recorded as a return on investment in unconsolidated communities.
Transactions
In 2007, we entered into a venture to develop 18 assisted living communities in the U.K. over the next four years with us serving as the developer and then as the manager of the communities. This is our second venture in the U.K. We own 20% of the venture. Property development will be funded through contributions of up to approximately $200.0 million by the partners, based upon their pro rata percentage, with the balance funded by loans provided by third-party lenders, giving the venture a total potential investment capacity of approximately $1.0 billion.
In 2009, 2008 and 2007, our first U.K. development venture in which we have a 20% equity interest sold four, four and seven communities, respectively, 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 (loss) earnings in 2009, 2008 and 2007 of approximately $19.5 million, $(3.6) million and $75.5 million, respectively. When our U.K. 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 this bonus pool. During 2009, 2008 and 2007, we recorded bonus expense of $0.7 million, $7.9 million and $27.8 million, respectively, in respect of the bonus pool relating to the U.K. venture. These bonus amounts are funded from capital events and the cash is retained by us in restricted cash accounts until payment of bonuses. As of December 31, 2009, approximately $0.2 million of this amount was included in restricted cash. Under this bonus arrangement, no bonuses were payable until we receive distributions at least equal to certain capital contributions and loans made by us to the U.K. and Germany ventures. This bonus distribution limitation was satisfied in 2008.
In 2007, we contributed $4.4 million for a 20% interest in an unconsolidated venture which purchased an existing building for approximately $22.0 million and renovated the building into a senior independent living facility. During 2008 and 2009, we also made advances to the venture aggregating $6.4 million while it was under construction. In 2009, the venture received a notice of default from its lender for alleged violation of financial covenants and other matters and the lender stopped funding under the loan. In the third quarter of 2009, the residents were relocated to other senior living facilities and the facility was shut down due to poor rental experience in the venture. The lender is in the process of foreclosing on the asset. Based on this, we determined our equity to be other than temporarily impaired and wrote off the balance of $1.1 million. In addition, we do not believe that collectability of our receivable is reasonably assured and we wrote-down the carrying value of our receivable to zero.
In 2008, the lease between a venture in which we hold a 25% ownership interest and the landlord was terminated. The venture received a $4.0 million termination fee of which we are entitled to our proportionate share of $1.0 million. As a result of this transaction, the venture was liquidated. As of December 31, 2008, our carrying value for our investment in the venture was $1.7 million. Thus, under the ASC Property, Plant and Equipment Topic, we recorded a $0.7 million impairment charge in 2008.
In 2007, we entered into two development ventures to develop and build 28 senior living communities in the United States during 2007 and 2008, with us serving as the developer and then as the manager of the communities. We own 20% of the ventures. Property development was funded through contributions of up to approximately $208.0 million by the partners, based upon their pro rata percentage, with the balance funded by loans provided by third party lenders, giving the ventures a total potential investment capacity of approximately $788.0 million.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
In 2000, we formed Sunrise At Home, a venture offering home health assisted living services in several East Coast markets and Chicago. In June 2007, Sunrise At Home was merged into AllianceCare. AllianceCare provides services to seniors, including physician house calls and mobile diagnostics, home care and private duty services through 24 local offices located in seven states. Additionally, AllianceCare operates more than 125 Healthy Lifestyle Centers providing therapeutic rehabilitation and wellness programs in senior living facilities. In the merger, Sunrise received approximately an 8% preferred ownership interest in AllianceCare and Tiffany Tomasso, our executive vice president of European operations, was appointed to the Board of Directors. Our investment in AllianceCare is accounted for under the cost method.
In 2007, we decided to withdraw from ventures that owned two pieces of undeveloped land in Florida. We wrote off our remaining investment balance of approximately $1.1 million in the two projects.
Aston Gardens
In 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 sell our 25% equity interest and to resign as managing member of the venture and manager of the communities when we were released from various guarantees provided to the venture’s lender.
In 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 had previously written down our equity interest and our receivable to these expected amounts in 2008 so there was no gain or loss on the transaction in 2009.
Fountains Venture
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 had been charging a default rate of interest 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 were recoverable in the form of a loan to the venture, which were to be repaid prior to the repayment of equity capital to the partners, but were subordinate to the repayment of other venture debt. We funded $14.2 million under this operating deficit guarantee which had been written-down to zero as of December 31, 2008. These advances under the operating deficit guarantee were in addition to the $12.8 million we funded under our income support guarantee to our venture partner, which was written-down to zero as of December 31, 2008.
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 these agreements, 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 venture, loan and management agreements, including obligations under operating deficit and income support obligations. We retain certain management and operating obligations going forward during a temporary transition period.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
In exchange for these releases, we have, among other things:
•
Transferred our 20-percent ownership interest in the Fountains joint venture to our joint venture partner;
•
Contributed vacant land parcels adjacent to six of the Fountains communities and owned by us to the Fountains venture;
•
Agreed to transfer management of the 16 Fountains communities as soon as the transition closing conditions are met and the new manager has obtained the regulatory approvals necessary to assume control of the facilities; and
•
Repaid the venture the management fee we had earned to date in 2009 of $1.8 million.
The contributed vacant land parcels were carried on our consolidated balance sheet at a book value of $12.9 million, in addition to a guarantee liability of $12.9 million both of which was written off upon closing of the transaction resulting in no gain or loss.
We transferred management of eight of the 16 communities to the new manager on February 1, 2010, and expect to transfer management for the remaining eight communities by mid-2010.
10.
Debt and Bank Credit Facility
Debt
At December 31, 2009, we had $440.2 million of outstanding debt with a weighted average interest rate of 2.87% as follows (in thousands):
(1)
The face amount of the debt related to the German communities was $215.2 million at December 31, 2009. Excludes $10.5 million of accrued interest on the German debt as of December 31, 2009 which is reflected in Liabilities associated with German assets held for sale on our consolidated balance sheet.
Of the outstanding debt we had $1.4 million of fixed-rate debt with a weighted average interest rate of 6.7% and $438.9 million of variable rate debt with a weighted average interest rate of 2.85%.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Principal maturities of debt at December 31, 2009 are as follows (in thousands):
Along with contractual maturities due in 2010, debt that is in default is also reflected in current portion of long term debt. Debt that is in default at December 31, 2009 consists of the following (in thousands):
The German debt is in default as we stopped paying monthly principal and interest payments in 2009. The remaining debt is in default as we have failed to comply with various financial covenants. On February 12, 2010, we extended $56.9 million of debt that was either past due or in default at December 31, 2009. The debt is associated with an operating community and two land parcels. In connection with the extension we (i) made a $5.0 million principal payment at closing; (ii) extended the terms of the debt to no earlier than December 2, 2010; (iii) provided for an additional $5.0 million principal payment on or before July 31, 2010; and, among other items, (iv) defaults under the loan agreements were waived by the lenders. 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 of December 31, 2009 as follows (in thousands):
Germany Venture
We own nine communities (two of which have been 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 ($72.0 million at December 31,
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
2009), has a stipulated release price for each community. With respect to the remaining five communities, we have provided guarantees to the lenders for the payment 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. However, in connection with the German debt restructuring, we have settled with this lender. The face amount of the total debt related to the German communities, excluding accrued but unpaid interest, at December 31, 2009 is $215.2 million. We also had accrued interest of $10.5 million and $0.6 million at December 31, 2009 and 2008, respectively, related to this debt.
At the beginning of 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. We 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. The standstill agreements stipulate that neither party will 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 late 2009, we entered into a restructuring agreement, in the form of a binding term sheet, with three of our lenders (“electing 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 three lenders contended that these claims had an aggregate value of approximately $131.1 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 three lenders represent approximately 83.5 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 have issued to the electing lenders 4.2 million shares of our common stock, their pro rata share of up to 5 million shares of our common stock. The fair value of the 4.2 million shares at the time of issuance was $11.1 million. This amount is reflected as a deposit on our consolidated balance sheets until such time as all consideration is exchanged upon the execution of the definitive documentation. In addition, we will grant mortgages for the benefit of all electing lenders on certain of our unencumbered North American properties (the “liquidating trust”). Following the first execution of the definitive documentation for the restructuring, we will continue to pursue the sale of the 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 the sale of the liquidating trust, 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 satisfaction of our remaining obligation to the minimum payments.
In addition, we have been marketing 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. In 2009, we engaged a broker to assist in the sale of the nine German communities and at that time, classified the German assets as held for sale. As the book value of the majority of the assets was in excess of their fair value less estimated costs to sell, we recorded a charge of $49.9 million in 2009 which is included in discontinued operations.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
The closing of the transaction, including the execution of the definitive documentation, the release of claims and the issuance of Sunrise common stock, was conditioned upon receipt of consent for the transaction from Bank of America, N.A., as the administrative agent under our Bank Credit Facility, which consent was received. In accordance with the binding term sheet, definitive documentation was to be executed as soon as reasonably possible (but no later than 40 days) after the receipt of such required consent. In December 2009, we extended the execution of the definitive documentation to allow the parties additional time to complete the definitive documentation. We expect to complete this process by the end of February 2010.
At December 31, 2009, we continue to be liable under operating deficit and repayment guarantees for two communities which are not part of the restructuring. In addition, we were liable for a principal repayment guarantee for the Hoesel land parcel which was not part of the restructuring agreement. The Hoesel land parcel was sold and the liability was released in early 2010. We expect to recognize a gain of $0.7 million on the sale in 2010.
Mortgage Financing
In 2008, 16 of our wholly owned subsidiaries incurred mortgage indebtedness in the aggregate principal amount of approximately $106.7 million from Capmark Bank (“Capmark”) as lender and servicer pursuant to 16 separate cross-collateralized, cross-defaulted mortgage loans. Shortly after the closing, Capmark assigned the mortgage loans to Fannie Mae. Variable monthly interest payments were in an amount equal to (i) one third (1/3) of the “Discount” (which was the difference between the loan amount and the price at which Fannie Mae was able to sell its three-month, rolling discount mortgage backed securities) plus (ii) 227 basis points (2.27%) times the outstanding loan amount divided by twelve (12).
In connection with the mortgage loans, we entered into interest rate protection agreements that provided for payments to us in the event the LIBOR rate exceeded 5.6145%. These loans and interest rate protection agreements were assigned to the buyer of 15 of the 16 communities in 2009.
Also in 2009, mortgage loans of $32.2 million were either assigned to the purchaser or repaid in conjunction with the sale of the underlying assets.
Bank Credit Facility
In 2009, we entered into various amendments to our Bank Credit Facility. These amendments, among other things:
•
extended the maturity date to December 2, 2010;
•
removed all existing financial covenants other than the minimum liquidity covenant;
•
renewed existing letters of credit;
•
modified the minimum liquidity covenant to not less than $10.0 million of unrestricted cash on hand the last day of the month;
•
modified the restriction on the disposal of assets to include disposition of certain assets as long as 50% of the net sale proceeds are allocated to the lenders; and
•
permanently reduced the commitment after future principal repayments or cancellation of letters of credit.
Total amendment fees paid were $1.4 million. Principal payments of $61.3 million were made during 2009 in accordance with these amendments. In addition, $20.0 million was placed into a collateral account for the benefit of other creditors from the proceeds of the sale of 21 communities. $6.2 million of cash was used to satisfy the obligations of other creditors and $13.8 million remains in the collateral account at December 31, 2009. This amount is included in restricted cash in the consolidated balance sheets.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
We have no borrowing availability under the Bank Credit Facility. We have $19.4 million of letters of credit outstanding under the Bank Credit Facility at December 31, 2009.
Other
Sunrise ventures have total debt of $3.7 billion with near-term scheduled debt maturities of $0.3 billion in 2010. Of this $3.7 billion of debt, there is long-term debt that is in default of $0.7 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 and to extend the maturity dates. In certain cases, we have provided operating deficit and completion guarantees to the lenders or ventures. We have operating deficit or completion guarantee agreements with respect to ventures in which we are obligated for total debt of $1.1 billion or 30% of the total venture debt. Under the operating deficit agreements, we are obligated to pay operating shortfalls, if any, with respect to these ventures. Any such payments could include amounts arising in part from the venture’s obligations for monthly principal and interest on the venture debt. We do not believe that these operating deficit agreements would obligate us to make payments of principal and interest on such venture debt that might become due as a result of acceleration of such indebtedness. We have minority non-controlling interests in these ventures.
Certain of these ventures have financial covenants that are based on the consolidated results of Sunrise. 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. These events of default could allow the financial institutions who have extended credit to seek acceleration of the loans.
Value of Collateral and Interest Paid
At December 31, 2009 and 2008, the net book value of properties pledged as collateral for mortgages payable was $291.2 million and $530.7 million, respectively.
Interest paid totaled $12.6 million, $27.1 million and $14.1 million in 2009, 2008 and 2007, respectively. Interest capitalized was $0.5 million, $6.4 million and $9.3 million in 2009, 2008 and 2007, respectively.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
11.
Income Taxes
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount recognized for income tax purposes. The significant components of our deferred tax assets and liabilities are as follows (in thousands):
Our worldwide taxable loss for 2009 and 2008 was estimated to be $176.1 million and $243.1 million. We have recognized significant losses for 2009, 2008 and 2007. As a result, all available sources of positive and negative evidence were evaluated. In 2008, a determination was made that deferred tax assets in excess of reversing deferred tax liabilities were not likely to be realized. Therefore, a valuation allowance on net deferred tax assets was established as of December 31, 2008. At December 31, 2009 and 2008, our total valuation allowance on deferred tax assets were $167.2 million and $138.8 million, respectively.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
At December 31, 2009, we have estimated U.S. federal net operating loss carryforwards of $253.4 million which are carried forward to offset future taxable income in the U.S. for up to 20 years. At December 31, 2009 and 2008, we had state net operating loss carryforwards, after prior year provision to return adjustments, valued at $23.5 million and $25.8 million, respectively, which are expected to expire from 2011 through 2025. At December 31, 2009 and 2008, we had German net operating loss carryforwards to offset future foreign taxable income of $93.0 million and $43.3 million, respectively, which have an unlimited carryforward period to offset future taxable income in Germany. At December 31, 2009 and 2008, we had Canadian net operating loss carryforwards of $35.8 million and $18.0 million, respectively, to offset future foreign taxable income, which are carried forward to offset future taxable income in Canada for up to 20 years. At December 31, 2009 and 2008, we had U.K. net operating loss carryforwards to offset future foreign taxable income of $3.3 million and $3.0 million, respectively, which have an unlimited carryforward period to offset future taxable income in the U.K. As of December 31, 2009 and 2008, we have fully reserved deferred tax assets with respect to all foreign subsidiaries. During 2009 and 2008, we provided income taxes for unremitted earnings of our foreign subsidiaries that are not considered permanently reinvested.
In 2009, we recognized for tax purposes a worthless stock deduction related to our Trinity investment of which $28.4 million was permanent goodwill. In 2008, we recorded an impairment charge in continuing operations of $121.8 million related to goodwill for our North American business segment. Of the total, $39.2 million was permanent goodwill and therefore impacted the effective tax rate.
At December 31, 2008, we had Alternative Minimum Tax credits of $4.7 million. During 2009, we elected to carryback the 2008 Alternative Minimum Tax losses and received a refund related to the credits. Thus at December 31, 2009, we have no remaining Alternative Minimum Tax credits. At December 31, 2009 and 2008, we had $1.3 million and $1.3 million of foreign tax credit carryforwards as of each reporting date which expire in 2013. In addition we have general business credits carryforwards of $1.5 million and $1.5 million at December 31, 2009 and 2008, respectively. The major components of the provision for income taxes attributable to continuing operations are as follows (in thousands):
Current taxes payable for 2007 has been reduced by approximately $2.2 million, reflecting the tax benefit to us of stock-based compensation during the year. The tax impact of stock-based compensation has been recognized as an increase or decrease to additional paid-in capital.
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Notes to Consolidated Financial Statements - (Continued)
The differences between the amount that would have resulted from applying the domestic federal statutory tax rate (35%) to pre-tax income from continuing operations and the reported income tax expense from continuing operations recorded for each year are as follows:
Included in the balances of unrecognized tax benefits at December 31, 2009 and 2008 were approximately $13.9 million and $17.8 million, respectively, of tax positions that, if recognized, would decrease our effective tax rate.
We reflect interest and penalties, if any, on unrecognized tax benefits in the consolidated statements of operations as income tax expense. The amount of interest recognized in the consolidated statements of operations for 2009 and 2008 related to unrecognized tax benefits was a pre-tax expense of $1.2 million and $0.4 million,
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Notes to Consolidated Financial Statements - (Continued)
respectively. The amount of penalties recognized in the consolidated statements of operations for 2009 and 2008 related to unrecognized tax benefits was a pre-tax expense of $0.1 million and $0.5 million, respectively.
The total amount of accrued liabilities for interest recognized in the consolidated balance sheets related to unrecognized tax benefits as of December 31, 2009 and 2008 was $4.6 million and $3.4 million, respectively. The total amount of accrued liabilities for penalties recognized in the consolidated balance sheets related to unrecognized tax benefits as of December 31, 2009 and 2008 was $1.8 million and $1.9 million, respectively. To the extent that uncertain matters are settled favorably, this amount could reverse and decrease our effective tax.
The Internal Revenue Service (“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 2005 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. We do not believe that it is reasonably possible that the amount for unrecognized tax benefits will significantly change during the next twelve months.
12.
Stockholders’ Equity
Issuance of Common Stock
In November 2009, we issued 4.2 million shares of the 5.0 million shares of common stock to three electing lenders in connection with the German debt restructuring discussed in Note 10. The common stock had a fair value at the time of issuance of $11.1 million. This amount is reflected as a deposit on our consolidated balance sheets until such time as all consideration is exchanged upon the execution of the definitive documentation.
Stock Options
We have equity award plans providing for the grant of incentive and nonqualified stock options to employees, directors, consultants and advisors. At December 31, 2009, these plans provided for the grant of options to purchase up to 24,596,189 shares of common stock. Under the terms of the plans, the option exercise price and vesting provisions are fixed when the option is granted. The options typically expire ten years from the date of grant and vest over a three to four-year period. The option exercise price is not less than the fair market value of a share of common stock on the date the option is granted.
In 1996, our Board of Directors approved a plan which provided for the potential grant of options to any director who is not an officer or employee of us or any of our subsidiaries (the “Directors’ Plan”). Under the terms of the Directors’ Plan, the option exercise price was not less than the fair market value of a share of common stock on the date the option was granted. The period for exercising an option began upon grant and generally ended ten years from the date the option was granted. All options granted under the Directors’ Plan were non-incentive stock options. There were no options outstanding under the plan at December 31, 2009. The Director’s Plan has now expired and no new options can be granted under it. Our directors are considered employees under the provisions of ASC Equity Topic.
The fair value of stock options is estimated as of the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term (estimated period of time outstanding) is estimated using the historical exercise behavior of employees and directors. Expected volatility is based on historical volatility for a period equal
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Notes to Consolidated Financial Statements - (Continued)
to the stock option’s expected term, ending on the day of grant, and calculated on a monthly basis. Compensation expense is recognized ratably using the straight-line method for options with graded vesting.
A summary of our stock option activity and related information for the year ended December 31, 2009 is presented below (share amounts are shown in thousands):
The weighted average grant date fair value of options granted was $1.94 and $1.47 per share in 2009 and 2008, respectively. No options were granted or exercised in 2007. The total intrinsic value of options exercised was $1.7 million and $4.6 million, respectively, for 2009 and 2008, respectively. The fair value of shares vested was $2.3 million, $1.0 million, and $1.3 million for 2009, 2008 and 2007, respectively. Unrecognized compensation expense related to the unvested portion of our stock options was approximately $5.4 million as of December 31, 2009, and is expected to be recognized over a weighted-average remaining term of approximately 1.8 years.
In 2007, the Compensation Committee of our Board of Directors extended the exercise period of stock options that were set to expire unexercised due to the inability of the optionees to exercise the options due to our not being current in our SEC filings. The Compensation Committee set the new expiration date as 30 days after we became a current filer with the SEC. As a result of this modification, we recognized $2.4 million of stock-based compensation expense in 2007 and $0.4 million in 2008.
The amount of cash received from the exercise of stock options was approximately $1.0 million and there was no related tax benefit as we have net operating loss carryforwards as of December 31, 2009.
We generally issue shares for the exercise of stock options from authorized but unissued shares.
On November 13, 2008, Mr. Ordan, CEO, was granted an award of 1,500,000 promotion stock options under our 2008 Omnibus Incentive Plan. The promotion options have a term of 10 years and an exercise price per share equal to the closing price per share of our common stock on the grant date. One-third of the promotion options will vest on the first three anniversaries of the date of grant, subject to Mr. Ordan’s continued employment on the applicable vesting date.
On December 23, 2008, Mr. Nadeau, CFO, Ms. Pangelinan, CAO, Mr. Schwartz, Senior Vice President, North American Operations, and Mr. Neeb, Chief Investment Officer, were granted awards of 750,000, 500,000, 200,000, and 500,000 retention stock options, respectively, under our 2008 Omnibus Incentive Plan. These retention options
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Notes to Consolidated Financial Statements - (Continued)
have a term of 10 years and an exercise price per share equal to the closing price per share of our common stock on the grant date. One-third of the retention options vest on each of the first three anniversaries of the date of grant, subject to the executive’s continued employment on the applicable vesting date.
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. Upon his termination, 70,859 shares of restricted stock and 750,000 options vested. 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. We recorded non-cash compensation expense of $0.8 million as a result of the vesting acceleration.
Restricted Stock
We have equity award plans providing for the grant of restricted stock to employees, directors, consultants and advisors. These grants vest over one to five years and some vesting may be accelerated if certain performance criteria are met. Compensation expense is recognized ratably using the straight-line method for restricted stock with graded vesting.
A summary of our restricted stock activity and related information for the years ended December 31, 2009, 2008 and 2007 is presented below (share amounts are shown in thousands):
The total fair value of restricted shares vested was $28.77 per share and $20.55 per share for 2009 and 2008, respectively. Unrecognized compensation expense related to the unvested portion of our restricted stock was approximately $2.1 million as of December 31, 2009, and is expected to be recognized over a weighted-average remaining term of approximately 2.1 years.
Restricted stock shares are generally issued from existing shares.
Stockholder Rights Agreement
We have a Stockholders Rights Agreement (“Rights Agreement”) that was adopted effective as of April 24, 2006, as amended in November 2008 and January 2010. All shares of common stock issued by us between the effective date of the Rights Agreement and the Distribution Date (as defined below) have rights attached to them. The rights expire on April 24, 2016. The Rights Agreement replaced our prior rights plan, dated as of April 25,
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Notes to Consolidated Financial Statements - (Continued)
1996, which expired by its terms on April 24, 2006. Each right, when exercisable, entitles the holder to purchase one one-thousandth of a share of Series D Junior Participating Preferred Stock at a price of $170.00 per one one-thousand of a share (the “Purchase Price”). Until a right is exercised, the holder thereof will have no rights as a stockholder of us.
The rights initially attach to the common stock. The rights will separate from the common stock and a distribution of rights certificates will occur (a “Distribution Date”) upon the earlier of (1) ten days following a public announcement that a person or group (an “Acquiring Person”) has acquired, or obtained the right to acquire, directly or through certain derivative positions, 10% or more of the outstanding shares of common stock (the “Stock Acquisition Date”) or (2) ten business days (or such later date as the Board of Directors may determine) following the commencement of, or the first public announcement of the intention to commence, a tender offer or exchange offer, the consummation of which would result in the beneficial ownership by a person of 10% or more of the outstanding shares of common stock.
In general, if a person acquires, directly or through certain derivative positions, 10% or more of the then outstanding shares of common stock, each holder of a right will, after the end of the redemption period referred to below, be entitled to exercise the right by purchasing for an amount equal to the Purchase Price common stock (or in certain circumstances, cash, property or other securities of us) having a value equal to two times the Purchase Price. All rights that are or were beneficially owned by the Acquiring Person will be null and void. If at any time following the Stock Acquisition Date (1) we are acquired in a merger or other business combination transaction, or (2) 50% or more of our assets or earning power is sold or transferred, each holder of a right shall have the right to receive, upon exercise, common stock of the acquiring company having a value equal to two times the Purchase Price. Our Board of Directors generally may redeem the rights in whole but not in part at a price of $.005 per right (payable in cash, common stock or other consideration deemed appropriate by our Board of Directors) at any time until ten days after a Stock Acquisition Date. In general, at any time after a person becomes an Acquiring Person, the Board of Directors may exchange the rights, in whole or in part, at an exchange ratio of one share of common stock for each outstanding right.
The Rights Agreement was amended in November 2008 to: (1) modify the definition of beneficial ownership so that it covers, with certain exceptions (including relating to swaps dealers), interests in shares of common stock created by derivative positions in which a person is a receiving party to the extent that actual shares of common stock are directly or indirectly held by the counterparties to such derivative positions; and (2) decrease from 20% to 10% the threshold of beneficial ownership of common stock above which investors become “Acquiring Persons” under the Rights Agreement and thereby trigger the issuance of the rights. Pursuant to the amendment, stockholders who beneficially owned more than 10% of our common stock as of November 19, 2008 were permitted to maintain their existing ownership positions without triggering the preferred stock purchase rights.
The Rights Agreement was further amended in January 2010 to exclude FMR LLC (and its affiliates and associates) from the definition of “Acquiring Person” so long as (1) FMR is the beneficial owner of 14.9% or less of our outstanding common stock, (2) FMR acquired, and continues to beneficially own, such shares of common stock in the ordinary course of business with no purpose of changing or influencing the control, management or policies of the Company, and not in connection with or as a participant to any transaction having such purpose, and (3) FMR is not required to report its beneficial ownership on Schedule 13D under the Securities Exchange Act, and, if FMR is the beneficial owner of shares representing 10% or more of the shares of common stock then outstanding, is eligible to file a Schedule 13G to report its beneficial ownership of such shares.
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Notes to Consolidated Financial Statements - (Continued)
13.
Net Loss Per Common Share
The following table summarizes the computation of basic and diluted net loss per common share amounts presented in the accompanying consolidated statements of operations (in thousands, except per share amounts):
Options are included under the treasury stock method to the extent they are dilutive. Shares issuable upon exercise of stock options after applying the treasury stock method of 513,025, 661,423 and 1,367,157 for 2009, 2008 and 2007, respectively, have been excluded from the computation because the effect of their inclusion would be anti-dilutive.
14.
Commitments and Contingencies
Leases for Office Space
Rent expense for office space, excluding Trinity, for 2009, 2008 and 2007 was $7.7 million, $9.7 million and $7.1 million, respectively. We lease our corporate and regional offices under various leases which expire through September 2013. In 2008, we ceased using approximately 40,276 square feet of office space at our corporate headquarters and recorded a charge of $2.0 million. In 2009, we terminated a portion of our lease at our corporate headquarters and recorded an additional charge of $2.7 million related to the termination.
Trinity Leases
Trinity filed a plan of liquidation and dissolution before the Delaware Chancery Court in January 2009. The Chancery Court will supervise the disposition of the assets of Trinity for the benefit of its creditors. Obligations under long-term leases for office space used in Trinity’s operations were eliminated by the legal requirement for the landlord to mitigate damages by re-leasing the vacated space and any amounts not relieved will be resolved pursuant to the plan of dissolution.
When Trinity ceased operations in December 2008, all leased premises were vacated and leasehold improvements and furniture, fixtures and equipment were abandoned. As a result, we recorded a charge of $1.2 million and $2.7 million in 2009 and 2008, respectively, related to the lease abandonment which are included in loss from discontinued operations.
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Notes to Consolidated Financial Statements - (Continued)
Leases for Operating Communities
We have operating leases for ten communities (excluding the Marriott leases discussed below) with terms ranging from 15 to 20 years, with two ten-year extension options. We have two other ground leases related to four operating communities with lease terms ranging from 15 to 99 years. These leases are subject to annual increases based on the consumer price index and/or stated increases in the lease. In addition, we have one ground lease related to an abandoned project.
In connection with the acquisition of Marriott Senior Living Services, Inc. (“MSLS”) in March 2003, we assumed 14 operating leases and renegotiated an existing operating lease agreement for another MSLS community in June 2003. We also entered into two new leases with a landlord who acquired two continuing care retirement communities from MSLS at the same date. Fifteen of the leases expire in 2013, while the remaining two leases expire in 2018. The leases had initial terms of 20 years, and contain one or more renewal options, generally for five to 15 years. The leases provide for minimum rentals and additional rentals based on the operations of the leased community. Rent expense for operating communities subject to operating leases was $59.3 million, $59.8 million and $62.3 million for 2009, 2008 and 2007, respectively, including contingent rent expense of $4.4 million, $5.3 million and $8.2 million for 2009, 2008 and 2007, respectively.
Future minimum lease payments under office, ground and other operating leases at December 31, 2009 are as follows (in thousands):
Letters of Credit
At December 31, 2009, in addition to $19.4 million in letters of credit related to our Bank Credit Facility, we have letters of credit outstanding of $85.4 million relating primarily to our insurance programs.
Guarantees
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 ventures to fund operating shortfalls. The terms of the guarantees match the term of the underlying venture debt and generally range from three to five years, to the extent we are able to refinance the venture debt. Fundings under the operating deficit guarantees and debt repayment guarantees are generally recoverable either out of future cash flows of the venture or from proceeds of the sale of communities. We have no projects under construction at December 31, 2009.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
The maximum potential amount of future fundings for outstanding guarantees, the carrying amount of the liability for expected future fundings at December 31, 2009 and fundings during 2009 are as follows (in thousands):
Senior Living Condominium Project
In conjunction with the sale of a majority interest in one condominium venture and one assisted living venture discussed in Note 6, we are obligated to fund operating shortfalls. The weak economy in the Washington, D.C. area has resulted in lower condominium sales than forecasted and we have funded $3.5 million under the guarantees through December 31, 2009. In addition, we are required to fund marketing costs associated with the sale of the condominiums which we estimate will total approximately $7.5 million by the time the remaining inventory of condominiums are sold.
In July 2009, the lender alleged 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.
Agreements with Marriott International, Inc.
Our agreements with Marriott International, Inc. (“Marriott”), which 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 $8.1 million at December 31, 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 $2.2 billion at December 31, 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
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Notes to Consolidated Financial Statements - (Continued)
December 31, 2009, the remaining liability under this obligation is $44.3 million. We have not funded under these guarantees, and do not expect to fund under such guarantees in the future.
Employment Agreements
We have employment agreements with Mark S. Ordan, Chief Executive Officer, Julie A. Pangelinan, Chief Financial Officer, Daniel J. Schwartz, Senior Vice President - North American Operations and Greg Neeb, Chief Investment Officer.
Each of the employment agreements provides for a three-year employment term with automatic one-year renewals at the end of that term and each year thereafter unless either party provides notice to the other, at least 120 days prior to the next renewal date, that the term will not be extended. Under the employment agreements, Mr. Ordan, Ms. Pangelinan, Mr. Schwartz and Mr. Neeb will receive an annual base salary of $650,000, $400,000, $350,000, and $400,000 per year, respectively, and each of such executives will be eligible for an annual bonus under our annual incentive plan.
Pursuant to each of the employment agreements, in the event that the executive’s employment is terminated by us, the executive will be entitled to severance benefits specified in the contracts. In the event that the executive becomes subject to any golden parachute excise taxes under Section 4999 of the Internal Revenue Code, the executive will be entitled to an additional payment such that the executive is placed in the same after-tax position as if no excise tax had been imposed. However, if the aggregate payments that the executive is entitled to receive exceeds by 10 percent or less the maximum amount that the executive could receive without being subject to the excise tax, then the executive will not receive such gross-up payment, and payments otherwise subject to the excise tax will be reduced to the maximum amount that the executive could receive without being subject to the excise tax.
On January 22, 2010, we announced the termination of employment of Daniel J. Schwartz for other than for “cause” effective May 31, 2010.
Legal Proceedings
HCP
In June 2009, various affiliates of HCP 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 $25.9 million in 2009. We have $18.3 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 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.
Trinity OIG Investigation and Qui Tam Action
As previously disclosed, in 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. In 2007, Trinity
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
and the Company were served with a complaint which amended a complaint filed under seal on November 21, 2005 by four former employees of Trinity under the qui tam provisions of the Federal False Claims Act. In 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 named 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. In 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. In April of 2009, the United States later reversed it’s decision to intervene. All parties entered into a settlement agreement which was subsequently approved by the District Court on June 3, 2009 and the lawsuit was dismissed with prejudice on November 10, 2009.
IRS Audit
The IRS 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 received reimbursement of the federal income taxes we had paid in 2005. In August 2009, the IRS concluded field work on the 2006 audit which resulted in a refund claim of $0.6 million. The IRS will not close the 2006 audit until the audits are completed for the 2007 and 2008 tax years as a net operating loss carryback from these years was applied to receive reimbursement for federal taxes we paid in 2006.
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.
SEC Investigation
In 2006 we 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. In 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 in 2007. 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.
In 2009, Sunrise and its current or former directors or officers who were named individually as defendants entered into an agreement which called for the certification by the court of a class consisting of persons (with certain
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Notes to Consolidated Financial Statements - (Continued)
exceptions) who purchased Sunrise common stock between February 26, 2004 and July 28, 2006, and payment of $13.5 million in cash.
Concurrently with entering into the settlement agreement, Sunrise and the individual defendants entered 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 combined to pay $13.4 million toward the settlement amount, which exhausted the coverage limits under the primary policy (after taking account of prior payments for related defense costs), but did 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 was approximately $0.1 million. No amounts were paid by the individual defendants.
In June 2009, the settlement agreement was approved and followed the settlement agreement entered into by Sunrise and the individuals named as defendants in two putative stockholder derivative actions brought by certain alleged stockholders of Sunrise for the benefit of the Company as discussed below.
Putative Shareholder Derivative Litigation
In 2007, the first of two putative shareholder derivative complaints was filed against certain of our current and former directors and officers, and naming us as a nominal defendant. 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 complaint alleged 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 sought damages and equitable relief on behalf of Sunrise.
In 2007, a putative shareholder derivative complaint was filed 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 complaint alleged breaches of fiduciary duty by the individual defendants arising out of the grant of certain stock options that were the subject of the purported class action and shareholder derivative litigation described above. The plaintiffs sought damages and equitable relief on behalf of Sunrise.
In 2009, the Company and the individual defendants entered into an agreement to settle both 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 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 provided that the Company’s insurers pay attorneys fees and expenses not to exceed $1 million. No
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
amounts were paid by the Company or by the individual defendants. The settlement was approved and the action formally dismissed.
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.
15.
Related-Party Transactions
Sunrise Senior Living Real Estate Investment Trust
In December 2004, we closed the initial public offering of Sunrise REIT, an independent entity we established in Canada. Sunrise REIT was formed to acquire, own and invest in income producing senior living communities in Canada and the United States.
Concurrent with the closing of its initial public offering, Sunrise REIT issued C$25.0 million (U.S. $20.8 million at December 31, 2004) principal amount of subordinated convertible debentures to us, convertible at the rate of C$11.00 per unit. We held a minority interest in one of Sunrise REIT’s subsidiaries and held the convertible debentures until November 2005, but did not own any common shares of Sunrise REIT. We entered into a 30-year strategic alliance agreement that gave us the right of first opportunity to manage all Sunrise REIT communities and Sunrise REIT had a right of first offer to consider all development and acquisition opportunities sourced by us in Canada. Pursuant to this right of first offer, we and Sunrise REIT entered into fixed price acquisition agreements with respect to seven development communities at December 31, 2005. In addition, we had the right to appoint two of the eight trustees that oversaw the governance, investment guidelines, and operating policies of Sunrise REIT.
The proceeds from the offering and placement of the debentures were used by Sunrise REIT to acquire interests in 23 senior living communities from us and our ventures, eight of which are in Canada and 15 of which are in the United States. Three of these communities were acquired directly from us for an aggregate purchase price of approximately $40.0 million and 20 were acquired from ventures in which we participated for an aggregate purchase price of approximately $373.0 million. With respect to the three Sunrise consolidated communities, we realized “Gain on sale and development of real estate and equity interests” of $2.2 million in 2004, and deferred gain of $4.1 million, which was recognized in the fourth quarter of 2006. We contributed our interest in the 15 U.S. communities to an affiliate of Sunrise REIT in exchange for a 15% ownership interest in that entity. Sunrise REIT also acquired an 80% interest in one of our communities that was in lease-up in Canada for a purchase price of approximately $12.0 million, with us retaining a 20% interest. We also recognized $2.1 million of “Professional fees from development, marketing and other” revenue in 2004 for securing debt on behalf of Sunrise REIT. We had seven wholly owned communities under construction at December 31, 2005 of which two were sold to Sunrise REIT in 2006 and five wholly owned communities under construction at December 31, 2006, which were to be sold to Sunrise REIT in 2007.
In April 2007, Ventas, Inc., a large healthcare REIT acquired Sunrise REIT, the owner of 77 Sunrise communities. We have an ownership interest in 56 of these communities. The management contracts for these communities did not change.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
We recognized the following in our consolidated statements of operations related to Sunrise REIT (in thousands):
Sunrise Senior Living Foundation
Sunrise Senior Living Foundation (“SSLF”) is an independent, not-for-profit organization whose purpose is to operate schools and day care facilities, provide low and moderate income assisted living housing and own and operate a corporate conference center. Paul Klaassen, our Chairman of the Board of Directors and his wife are the primary contributors to, and serve on the board of directors and serve as officers of, SSLF. One or both of them also serve as directors and as officers of various SSLF subsidiaries. Certain other of our employees also serve as directors and/or officers of SSLF and its subsidiaries. Since November 2006, the Klaassens’ daughter has been the Director of SSLF. She was previously employed by SSLF from June 2005 to July 2006. Since October 2007, the Klaassens’ son-in-law has also been employed by SSLF. Beginning January 2007, one of our employees became the full-time director of the schools operated by a subsidiary of SSLF, while continuing to provide certain services to us. Through October 2007, we continued to pay the salary and benefits of this former employee. In March 2008, SSLF reimbursed us approximately $68,000, representing the portion of the individual’s salary and benefits attributable to serving as the director of the schools.
Prior to April 2005, we managed the corporate conference center owned by SSLF (the “Conference Facility”) and leased the employees who worked at the Conference Facility under an informal arrangement. Effective April 2005, we entered into a contract with the SSLF subsidiary that currently owns the property to manage the Conference Facility. The contract was terminated December 31, 2008. Under the contract, we received a discount when renting the Conference Facility for management, staff or corporate events, at an amount to be agreed upon, and priority scheduling for use of the Conference Facility. We were paid monthly a property management fee of 1% of gross revenues for the immediately preceding month, which we estimated to be our cost of managing this property. The costs of any of our employees working on the property were also to be paid in addition to the 1% property management fee. In addition, we agreed, if Conference Facility expenses exceed gross receipts, determined monthly, to make non-interest bearing loans in an amount needed to pay Conference Facility expenses, up to a total amount of $75,000 per 12-month period. Any such loan was required to be repaid to the extent gross receipts exceed Conference Facility expenses in any subsequent months. There were no loans made by us under this contract provision in 2007, 2008 or 2009. Either party could terminate the management agreement upon 60 days’ notice. Salary and benefits for our employees who manage the Conference Facility, which were reimbursed by SSLF, totaled approximately $0.3 million in 2008 and $0.3 million in 2007. In 2008 and 2007, we earned $3,000 and $6,000 in management fees. We rented the conference center for management, staff and corporate events and paid approximately $0.02 million in 2008 and $0.1 million in 2007 to SSLF. The Trinity Forum, a faith-based leadership forum of which Mr. Klaassen is the past chairman and is currently a trustee, operates a leadership academy on a portion of the site on which the Conference Facility is located. The Trinity Forum does not pay rent for this space, but leadership academy fellows who reside on the property provide volunteer services at the Conference Facility.
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Notes to Consolidated Financial Statements - (Continued)
SSLF’s stand-alone day care center, which provides day care services for our employees and non-Sunrise employees, is located in the same building complex as our corporate headquarters. The day care center subleases space from us under a sublease that commenced in April 2004, expires September 30, 2013, and was amended in January 2007 to include additional space. The sublease payments, which equal the payments we are required to make under our lease with our landlord for this space, are required to be paid monthly and are subject to increase as provided in the sublease. SSLF paid Sunrise approximately $0.2 million, $0.1 million and $0.1 million in sublease payments in 2009, 2008 and 2007, respectively.
Fairfax Community Ground Lease
We lease the real property on which our Fairfax, Virginia community is located from Paul and Teresa Klaassen pursuant to a 99-year ground lease entered into in June 1986, as amended in August 2003. Rent expense under this lease is approximately $0.2 million annually.
Consulting Agreement
In November 2008, we entered into an oral consulting arrangement with Mr. Klaassen. Under the consulting arrangement, we agreed to pay Mr. Klaassen a fee of $25,000 per month for consulting with us and Mr. Ordan, our new chief executive officer, on senior living matters. This was in addition to any benefits Mr. Klaassen was entitled to under his employment agreement. Fees totaling $87,500 were paid to Mr. Klaassen for three and a half months commencing in November 2008.
Corporate Use of Residence
In June 1994, the Klaassens transferred to us property which included a residence and a Sunrise community in connection with a financing transaction. In connection with the transfer of the property, we agreed to lease back the residence to the Klaassens under a 99-year ground lease. The rent was $1.00 per month. Under the lease, the Klaassens were responsible for repairs, real estate taxes, utilities and property insurance for the residence. For approximately the past 12 years, the Klaassens have permitted the residence to be used by us for business purposes, including holding meetings and housing out of town employees. In connection with its use of the residence, we have paid the real estate taxes, utilities and insurance for the property and other expenses associated with the business use of the property, including property maintenance and management services. We paid expenses totaling approximately $0.1 million annually. For several years ending August/September 2006, the Klaassens’ son lived at the guest house on the property. In December 2007, the Klaassens terminated their 99-year ground lease for no consideration.
Purchase of Condominium Unit
In January 2006, Mr. Klaassen entered into a purchase agreement with a joint venture in which we own a 30% equity interest and with which we have entered into a management services agreement. Pursuant to the purchase agreement, Mr. Klaassen has agreed to purchase for his parents a residential condominium unit at the Fox Hill condominium project. The purchase price of the condominium is approximately $1.4 million. In June 2007, the purchase agreement was modified to reflect certain custom amenities upgrades to the unit for an aggregate price of approximately $0.1 million.
Service Evaluators Incorporated
Service Evaluators Incorporated (“SEI”) is a for-profit company which provided independent sales and marketing analysis, commonly called “mystery shopping” services, for the restaurant, real estate and senior living industries in the United States, Canada and United Kingdom. Janine I. K. Connell and her husband, Duncan S. D. Connell, are the owners and President and Executive Vice President of SEI, respectively. Ms. Connell and Mr. Connell are the sister and brother-in-law of Mr. Klaassen and Ms. Connell is the sister-in-law of Ms. Klaassen.
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Notes to Consolidated Financial Statements - (Continued)
For approximately 13 years, we contracted with SEI to provide mystery shopping services for us. These services included on-site visits at Sunrise communities, on-site visits to direct area competitors of Sunrise communities, telephonic inquiries, and narrative reports of the on-site visits, direct comparison analysis and telephone calls. In 2005, we paid SEI approximately $0.7 million for approximately 380 communities. We paid approximately $0.7 million to SEI in 2006 for approximately 415 communities and approximately $0.5 million in 2007 for approximately 435 communities. The SEI contract was terminable upon 12 months’ notice. In August 2007, we gave SEI written notice of the termination of SEI’s contract, effective August 2008. We paid SEI approximately $0.5 million under SEI’s contract in 2008.
Greystone Earnout Payments
In May 2005, we acquired Greystone. Greystone’s founder, Michael B. Lanahan, was appointed chairman of our Greystone subsidiary in connection with the acquisition and he currently serves as one of our executive officers. Pursuant to the terms of the Purchase Agreement, we paid $45.0 million in cash, plus approximately $1.0 million in transaction costs, to acquire all of the outstanding securities of Greystone. We also agreed to pay up to an additional $7.5 million in purchase price if Greystone met certain performance milestones in 2005, 2006 and 2007. The first earnout payment was $5.0 million based on 2005 and 2006 results and was paid in April 2007. Mr. Lanahan’s share of such earnout payment as a former owner of Greystone was approximately $1.5 million. The remaining $2.5 million earnout is based on Greystone’s 2007 results, and was paid in April 2008. Mr. Lanahan’s share of that payment was approximately $0.3 million. Greystone was sold to Mr. Lanahan in March 2009.
Purchase of Aircraft Interest by Mr. Klaassen
In July 2008, Mr. Klaassen purchased from us one of the four fractional interests in private aircrafts owned by us. The purchase price for such interest was approximately $0.3 million, which represented the fair market value of the interest at the time of purchase as furnished to us by independent appraisers. The purchase of the fractional interest was approved by the Audit Committee of our Board of Directors.
SecureNet Payment Systems LLC
In October 2008, we entered into a contract with SecureNet Payment Systems LLC (“SecureNet”) to provide consulting services in connection with the processing of direct deposit and credit card payments by community residents of their monthly fees. The sales agent representing SecureNet, whose compensation will be based on SecureNet’s revenue from the contract, is the wife of a Sunrise employee. In November 2008, after the award of the contract, that employee became Senior Vice President, North American Operations and an officer of the Company. The Governance Committee reviewed this transaction at its meeting on July 20, 2009 and concluded that the bidding process was done with integrity, that the award to SecureNet appeared to have been in our best interest and that our employee’s relationship to the SecureNet sales representative did not have any influence over the decision to select SecureNet. In 2009, $0.2 million of fees were paid to SecureNet.
16.
Employee Benefit Plans
401k Plan
We have a 401(k) Plan (“the Plan”) covering all eligible employees. Under the Plan, eligible employees may make pretax contributions up to 100% of the IRS limits. The Plan provides an employer match dependent upon compensation levels and years of service. The Plan does not provide for discretionary matching contributions. Matching contributions were $1.6 million, $1.7 million and $1.6 million in 2009, 2008 and 2007, respectively.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Sunrise Executive Deferred Compensation Plans
We have an executive deferred compensation plan (the “Executive Plan”) for employees who meet certain eligibility criteria. Under the Plan, eligible employees may make pre-tax contributions in amounts up to 25% of base compensation and 100% of bonuses. We may make discretionary matching contributions to the Executive Plan. Employees vest in the matching employer contributions, and interest earned on such contributions, at a date determined by the Benefit Plan Committee. Matching contributions were zero in both 2009 and 2008 and $0.4 million in 2007. We terminated the Executive Plan in January 2010 and distributions will be paid in 2011.
Chief Executive Officer Deferred Compensation Plan
Pursuant to an employment agreement with Mr. Klaassen, we are required to make contributions of $150,000 per year for 12 years, beginning on September 12, 2000 into a non-qualified deferred compensation account, notwithstanding any termination of Mr. Klaassen’s employment (such as his retirement in November 2008). At the end of the 12-year period, any net gains accrued or realized from the investment of the amounts contributed by us are payable to Mr. Klaassen and we will receive any remaining amounts. At December 31, 2007, we had contributed an aggregate of $0.9 million into this plan, leaving an aggregate amount of $0.9 million to be contributed. We made contributions for 2006 and 2007 in the second quarter of 2008 to bring the plan up to date and contributed the current year funding in the third quarter of 2008. At December 31, 2009, we had contributed an aggregate of $1.5 million into this plan, leaving approximately $0.3 million to be contributed.
17.
Discontinued Operations
Discontinued operations consists of our German communities which we are marketing for sale, our Greystone subsidiary which was sold in 2009, 22 communities which were sold in 2009, one community which was closed in 2009, our Trinity subsidiary which ceased operations in 2008, and two communities which were sold in 2008. We have no continuing involvement with these sold communities or sold businesses.
The following amounts related to those communities and businesses have been segregated from continuing operations and reported as discontinued operations.
Due to the valuation allowance on net deferred tax assets in 2008, no benefit for income taxes was allocated to discontinued operations for 2009.
18.
Information about Sunrise’s Segments
Effective in 2009, we changed our operating segments. In 2008, we reported four operating segments: domestic operations, international operations (Canada and the United Kingdom), Germany and Greystone. We now
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
have six operating segments for which operating results are regularly reviewed by our chief operating decision makers:
North American Management includes the results from the management of third party, venture and wholly owned/leased Sunrise senior living communities in the United States and Canada.
North American Development includes the results from the development of Sunrise senior living communities in the United States and Canada.
Equity Method Investments includes the results from our investment in domestic and international ventures.
Consolidated (Wholly Owned/Leased) includes 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 $21.9 million, $22.2 million and $22.2 million for 2009, 2008 and 2007, respectively.
United Kingdom includes the results from the development and management of Sunrise senior living communities in the United Kingdom.
Germany includes the results from the management of nine (two of which have been 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 2009, and Trinity, which ceased operations in 2008, are now reported as discontinued operations. Restatement of 2007 to the current segments was not practical.
Our historical segment reporting has been restated to reflect the changes made in 2009.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
Segment results are as follows (in thousands):
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
In 2009, 2008 and 2007, our first U.K. development venture in which we have a 20% equity interest sold four, four and seven communities, respectively, 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 (loss) earnings in 2009, 2008 and 2007 of
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
approximately $19.5 million, $(3.6) million and $75.5 million, respectively. When our U.K. 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 this bonus pool. During 2009, 2008 and 2007, we recorded bonus expense of $0.7 million, $7.9 million and $27.8 million, respectively, in respect of the bonus pool relating to the U.K. venture. These bonus amounts are funded from capital events and the cash is retained by us in restricted cash accounts until payment of bonuses. As of December 31, 2009, approximately $0.2 million of this amount was included in restricted cash. Under this bonus arrangement, no bonuses were payable until we receive distributions at least equal to certain capital contributions and loans made by us to the U.K. and Germany ventures. This bonus distribution limitation was satisfied in 2008.
We recorded $6.7 million, net, in foreign exchange gains in 2009 ($8.0 million in gains related to the Canadian dollar and $(1.3) million in losses related to the Euro and British pound); in 2008, net losses of $14.6 million ($14.2 million and $3.1 million in losses related to the Canadian dollar and British pound, respectively, and $2.7 million in gains related to the Euro); in 2007, net losses of $2.3 million ($7.2 million in gains related to the Canadian dollar and $9.5 million in losses related to the Euro and British pound).
Upon designation as assets held for sale, we recorded the German assets at the lower of their carrying value or their fair value less estimated costs to sell. We used 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 2009 we recorded a charge of $49.9 million which is included in discontinued operations.
Also in 2009, we recorded land parcels, operating communities, closed construction sites, a condominium project and closed communities which were either held and used or 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 was in excess of the fair value, we recorded impairment charges of $31.7 million.
In 2008, we recorded an impairment charge of $121.8 million related to all the goodwill for our North American business segment which resulted from our acquisition of Marriott Senior Living, Inc. in 2003 and Karrington Health, Inc. in 1999. The impairment was recorded as the fair value of the North American business was less than the fair value of the net tangible assets and identifiable intangible assets.
In 2008, we recorded impairment charges of $19.3 million related to five communities in the U.S., $5.2 million related to two communities in Germany and $12.0 million related to land parcels that are no longer expected to be developed. In 2007, we recorded an impairment charge of $7.6 million related to two communities in the U.S.
We generated 14.2%, 12.0% and 11.8% of revenue from Ventas in 2009, 2008 and 2007, respectively; 23.2%, 18.8% and 18.9% from HCP in 2009, 2008 and 2007, respectively; and 11.4% in 2009 from a private capital partner for senior living communities which we manage.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
19.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist of the following (in thousands):
20.
Severance and Restructuring Plan
In 2008, we implemented a program to reduce corporate expenses, including a voluntary separation program for certain team members, as well as a reduction of spending related to administrative processes, vendors, consultants and other costs. As a result of this program and other staffing reductions, we eliminated 182 positions in overhead and development, primarily in our McLean, Virginia headquarters, associated with this program. We have recorded severance charges related to this program of $3.0 million and $15.0 million for 2009 and 2008, respectively. Primarily all of the restructuring charges are reflected in our domestic segment.
With the elimination of these positions, we reconfigured our office space and two floors of leased space in our headquarters were vacated. We ceased using the space on December 31, 2008. The fair value of the lease obligation of the vacated space was approximately $2.4 million. A charge of $2.0 million (net of an existing straight-line lease liability of approximately $0.4 million) was recorded in 2008 for this obligation. In addition, we recorded an impairment charge of $0.9 million related to the leasehold improvements in the vacated space.
In 2009, we announced a plan to continue to reduce corporate expenses through a further reorganization of our corporate cost structure, including a reduction in spending related to, among others, 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) to approximately $100 million, and to reduce our centrally administered services which are charged to the communities by approximately $1.5 million. Under this plan, approximately 184 positions will be eliminated. As of December 31, 2009, we had eliminated 154 positions and will be eliminating an additional 30 positions by mid 2010. We have recorded severance expense of $8.3 million as a result of the plan through December 31, 2009 and expect to record an additional $1.6 million through mid 2010.
In May 2009, we entered into a separation agreement with our then 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.
In January 2010, we terminated the employment of Daniel J. Schwartz, our Senior Vice President, North American Operations, in connection with this plan, effective as of May 31, 2010. Mr. Schwartz will receive the severance payments and benefits payable to him pursuant to his employment agreement upon a termination of his employment, except that in lieu of a lump sum cash severance payment equal to two years’ base salary and 75% of
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
his target bonus amount (based on his base salary of $0.4 million and target bonus of 100% of base salary), Mr. Schwartz will receive such cash severance payment in the form of equal monthly installments of 1/24th of the total cash severance amount commencing July 2010 and continuing until December 2010, and the remaining balance to be paid in a lump sum on December 31, 2010.
Mr. Paul Klaassen resigned as our chief executive officer effective November 1, 2008 and became our non-executive Chair of the Board. Upon his resignation as our chief executive officer, under his employment agreement, he became entitled to receive:
•
annual payments for three years, beginning on the first anniversary of the date of termination, equal to Mr. Klaassen’s annual salary ($0.5 million) and bonus ($0) for the year of termination;
•
continuation of the medical insurance and supplemental coverage provided to Mr. Klaassen and his family until Mr. Klaassen attains or, in the case of his death, would have attained, age of 65 (but to his children only through their attainment of age 22); and
•
continued participation in his deferred compensation plan in accordance with the terms of his employment agreement.
The fair value of the continued participation of Mr. Klaassen in the deferred compensation plan cannot be reasonably estimated, as it is dependent upon Mr. Klaassen’s selection of available investment options and the future performance of those selections. Accordingly, no additional accrual was recorded with respect to the continued participation by Mr. Klaassen in his deferred compensation plan. At December 31, 2009, we had a deferred compensation liability of $0.1 million. See Note 15 of the Notes to the Consolidated Financial Statements for more information regarding Mr. Klaassen’s deferred compensation account.
The following table reflects the activity related to our severance and restructuring plans during 2009:
Included in the above table is legal and professional fees of $18.7 million relating to corporate restructuring.
Sunrise Senior Living, Inc.
Notes to Consolidated Financial Statements - (Continued)
21.
Comprehensive Loss
Comprehensive loss for the twelve months ended December 31, 2009, 2008 and 2007 was as follows (in thousands):
22.
Quarterly Results of Operations (Unaudited)
The following is a summary of quarterly results of operations for the fiscal quarter (in thousands, except per share amounts):
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Notes to Consolidated Financial Statements - (Continued)
(1)
The sum of per share amounts for the quarters may not equal the per share amount for the year due to a variance in shares used in the calculations or rounding.
(2)
During the fourth quarter of 2009, we sold 21 properties and recognized a gain of $48.9 million which is included in discontinued operations. During the fourth quarter of 2008, we recorded an impairment charge of $121.8 million related to all of the goodwill for our North American business segment. Also, we determined that a valuation allowance on the net deferred tax assets was required. Because of this, we reversed the tax benefit associated with our extraordinary loss recorded in the third quarter.
23.
Subsequent Events
On January 31, 2010, our first U.K. development venture in which we have a 20% equity interest sold two 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 estimate that we will record equity in earnings related to this venture of approximately $4.6 million in the first quarter of 2010.
On February 12, 2010, we extended $56.9 million of debt that was either past due or in default at December 31, 2009. The debt is associated with an operating community and two land parcels. In connection with the extension we (i) made a $5.0 million principal payment at closing; (ii) extended the terms of the debt to no earlier than December 2, 2010; (iii) provided for an additional $5.0 principal payment on or before July 31, 2010; and, among other items, (iv) defaults under the loan agreements were waived by the lenders.
On February 15, 2010, we sold two operating properties for approximately $10.8 million which will result in an expected gain of approximately $4.1 million. This expected gain is after a reduction of $0.7 million related to potential future indemnification obligations which expire in February 2011. The properties are part of the liquidating trust held as collateral for the electing lenders and all proceeds from the sale are to be distributed to the electing lenders upon execution of the definitive documentation for the restructuring.
We have evaluated all other events occurring after December 31, 2009 through February 24, 2010, the date our financial statements are issued.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A.
Controls and Procedures
Evaluation of Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, our Chief Executive Officer and the Chief Financial Officer concluded that, as of December 31, 2009, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the SEC.
Management’s Report on Internal Control Over Financial Reporting
Management of Sunrise is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of internal control over financial reporting. As defined by rules of the SEC, internal control over financial reporting is a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements in accordance with U.S. generally accepted accounting principles.
A system of internal control over financial reporting (1) pertains to the maintenance of records that, in reasonable detail, should accurately and fairly reflect the Company’s transactions and dispositions of the Company’s assets; (2) provides reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of the Company’s management and directors; and (3) provides reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In connection with the preparation of the Company’s annual consolidated financial statements, management undertook an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). Management’s assessment included an evaluation of the design of the Company’s internal control over financial reporting and testing of the operational effectiveness of key financial reporting controls. Management has concluded that, as of December 31, 2009, our internal control over financial reporting was effective based on these criteria.
Our independent registered public accounting firm, Ernst & Young LLP, that audited the financial statements in this report has issued an attestation report expressing an opinion on the effectiveness of internal control over financial reporting at December 31, 2009, which appears at the end of this Item 9A.
Changes in Internal Control over Financial Reporting
None.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Stockholders and Board of Directors
Sunrise Senior Living, Inc.
We have audited Sunrise Senior Living, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Sunrise Senior Living, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Sunrise Senior Living, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Sunrise Senior Living, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 of Sunrise Senior Living, Inc. and our report dated February 24, 2010 expressed an unqualified opinion thereon that included an explanatory paragraph regarding Sunrise Senior Living, Inc.’s ability to continue as a going concern.
/s/ Ernst & Young LLP
McLean, Virginia
February 24, 2010
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance
The information required by this item is included under the captions “Election of Directors - Biographical and Other Information,” “Executive Officers,” “Corporate Governance - Overview,” “- Revised Code of Conduct and Integrity” and “- Audit Committee,” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our 2010 Annual Meeting Proxy Statement, which we intend to file within 120 days after our fiscal year end, and is incorporated by reference herein.
Item 11.
Item 11.
Executive Compensation
The information required by this item is included under the captions “Corporate Governance - 2009 Director Compensation,” “Compensation Discussion and Analysis,” “Report of Compensation Committee,” “Summary Compensation Table,” “Grants of Plan-Based Awards in Fiscal Year 2009,” “Narrative to Summary Compensation Table and Grants of Plan-Based Awards Table,” “Outstanding Equity Awards at Fiscal Year-End 2009,” “Option Exercises and Stock Vested in Fiscal Year 2009,” Nonqualified Deferred Compensation for Fiscal Year 2009,” “Potential Payments Upon Termination and Change of Control to Messrs. Ordan and Neeb and Ms. Pangelinan,” “Payments Made to Mr. Nadeau Upon Termination of Employment,” “Payments to be Made to Mr. Schwartz Upon Termination of Employment,” “Payments Made to Mr. Gaul Upon Termination of Employment,” “Narrative Disclosure of the Company’s Compensation Policies and Practices as They Relate to the Company’s Risk Management,” and “Compensation Committee Interlocks and Insider Participation” in our 2010 Annual Meeting Proxy Statement, which we intend to file within 120 days after our fiscal year end, and is incorporated by reference herein.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
The information required by this item is included under the captions “Stock Owned by Management,” “Principal Holders of Voting Securities” and “Equity Compensation Plan Information” in our 2010 Annual Meeting Proxy Statement, which we intend to file within 120 days after our fiscal year end, and is incorporated by reference herein.
Item 13.
Item 13.
Certain Relationships and Related Transactions and Director Independence
The information required by this item is included under the captions “Certain Transactions” and “Corporate Governance - Director Independence” in our 2010 Annual Meeting Proxy Statement, which we intend to file within 120 days after our fiscal year end, and is incorporated by reference herein.
Item 14.
Item 14.
Principal Accounting Fees and Services
The information required by this item is included under the captions “Ratification of Appointment of Independent Registered Public Accounting Firm - Independent Registered Public Accountant’s Fees” and “- Pre-Approval of Audit and Non-Audit Fees” in our 2010 Annual Meeting Proxy Statement, which we intend to file within 120 days after our fiscal year end, and is incorporated by reference herein.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules
a.
(1) All financial statements
Consolidated financial statements filed as part of this report are listed under Part II, Item 8 of this Form 10-K.
(2)
Financial statement schedules
No schedules are required because either the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information is included in the consolidated financial statements or the notes thereto.
b. Exhibits
The exhibits listed in the accompanying index are filed as part of this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 25th
day of February 2010.
SUNRISE SENIOR LIVING, INC.
By:
/s/ Mark S. Ordan
Mark S. Ordan, Director and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the date indicated above.
EXHIBIT INDEX
+
Represents management contract or compensatory plan or arrangement.
*
Filed herewith.