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Mark Ordan – Chief Executive Officer

Richard Nadeau – Chief Financial Officer

Tiffany Tomasso – Chief Operating Officer


Ryan Daniels – William Blair

Jerry Doctrow – Stifel Nicolaus

Derrick Dagnan – Avondale Partners

Rosemary Pugh – Green Street Advisors

Sunrise Senior Living (SRZ) Q3 2008 Earnings Call November 7, 2008 9:00 AM ET


Welcome to Sunrise Senior Living's investor conference call. This is Mark Ordan, Sunrise's Chief Executive Officer. As you know, Paul Klaassen has transitioned to his new role as Non-Executive Chair, so I'll be leading today's call. Joining me today are Tiffany Tomasso, our Chief Operating Officer and Rick Nadeau, our Chief Financial Officer.

Before we being, let me remind you that this call is being recorded and the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 apply to this conference call. During the course of this call, the company will make various remarks concerning management's expectations, predictions, plans and prospects that constitute forward-looking statements. Actual results may differ materially from those anticipated by these forward-looking statements as a result of a variety of factors including those identified in our 2007 Form 10-K and our 2008 Form 10-Q.

Any forward-looking statements reflect management's current view only and the company undertakes no obligation to revise or update such statements in the future. For a further discussion on the company's forward-looking statements, we refer you to our 2007 Form 10-K and our 2008 Form 10-Q.

As you saw earlier today we issued a press release that includes our third quarter results and operating metrics. Rick Nadeau will describe in detail another very core bottom line quarter, but first I want to address what we have been doing to improve our operations and our balance sheet.

Clearly, the second half of 2008 is dominated by one, our work to repair the negatives from decisions and hindsight have hurt Sunrise and today's economic environment are particularly challenging. And two, to support and build our core portfolio which represents the number one brand and team in senior living.

These two areas of focus are fully compatible. The major threat to our balance sheet are the results of non core areas of spending, overhead which is outsize for our company and the funding of development leading up to the recent fall out. We recently announced a voluntary separation program which successfully reduced our overhead run rate.

Today, we are announcing major spending reductions and our development pipeline, our development staffing and design group staffing, the ceasing of funding the ongoing operations of our Trinity subsidiary now, a wait and see capital funding for our Greystone subsidiary during this current capital market debt freeze, and, further overhead reductions around the company.

We are working closely with our banks so that they feel assured that the combination of our collateral base, our cash flow projections and our conservative going forward plans provide comfort that we can support an appropriately sized credit facility. We are working with other banks and other non-bank capital sources to explore various sources of liquidity so that our line maturity can come and go uneventfully.

We believe that we have good relationships with our capital partners, and in difficult times as partners, our interest broadly overlap. We are grateful for their support and we are committed to them and our banks to keep their Sunrise investments secure and growing.

I have been asked more about the few portfolio's that we've lost than I have about the many that thrive. We've lost two portfolio's where our results have been uneven, where the price of retention would have provided good initial optics but bad economic returns. We won't do that.

Over 400 of our 450 communities are very, very successful and are the foundation of our 90% plus occupancy levels. In recent weeks when newspapers only describe varying levels of disaster and analysts have assumed the end of senior living, our occupancy has held. In a little while, Tiffany will talk more about this.

From looking for a pin to burst the bubble, we'll ask pointedly have we ever used economics to boost our occupancy. Where some can, I see an inflation needle and over 90% occupied communities with fairly full cost loads; increased occupancy is an immediate boost to the bottom line. A decrease is the same, but opposite effect.

We have for Sunrise, that's 27 years and for me 6 months, actively managed the economic occupancy of Sunrise. I believe by the way that every smart company in any similar business does the same thing. You focus on how you can increase your NOI.

Before I turn the call over to Rick, let me give you a few thoughts on our German venture and on development pipeline. First, in Germany there are 83 million people, excellent demographics but Sunrise experienced a rough roll out. Our decision to purchase our option was based on the fact that we had 100% of the risk in the German venture but we did not have control. The purchase of the option and the closing of the acquisition did not alter in any way the non-recourse provisions of our loan.

We have been asked why we don't just pull out of Germany, sell and take our losses. We have a simple choice. We can bail out, take a large loss and face a huge debt payment, or we could see that in several of our German communities, our occupancy growth has gained traction as our brand in Germany has become a real asset.

The fees are growing core assisted living properties. We intend to double our focus on our several growing assets, and we will weigh the best course on the few clear lagers. I am confident that operations team that can successfully manage 450 communities can apply this successfully to Germany. We have been adding two to three residents per month per community in our German communities.

Regarding development, Sunrise is a proven developer and manager, growing our core business and future development of our mansions continues to be our long-term growth drivers. However, in these very tough times, we will delay development until markets become more hospitable.

We are not forecasting any additional starts for the remainder of the 2008. We have tightened our underwriting standards and we have closely examined our pipeline. We have identified 17 projects that we intend to develop once the markets revive. We also expect to develop three to five new communities in the U.K. per year for the next few years.

We determined in the third quarter that we would discontinue developing 54 projects resulting in a write off of $47.5 million for the three months ending September 30, 2008. Development fees will reduce as we reduce our pipeline and we are decreasing our development spend to match that pace. We are reducing the size of our North American development team from 70 people to approximately 10 people to adjust 2009's with results on an annualized expected cost savings of $10.7 million.

Again, I will shortly turn the call over to Rick Nadeau to provide additional financing details but first, I would like to comment on the company's financial stability.

Sunrise is a traditionally heavy user of capital, is currently unprofitable and is approaching terrible capital markets. While I won't join the ranks of CEO's who say all is well when it isn't, I will point out some facts.

We have been proactively clamping down every outflow of cash that doesn't immediately support our core business. We work hard, openly and carefully with our banks. As indicated by our amendments in our core bank credit facility including our most recent amendment, our banks see what we're doing and they're working with us now to restructure our line. We are committed to getting this done.

We've been working with Goldman Sachs to help us consider other capital sources. I've had a long and fruitful relationship with Goldman Sachs. We've been through real challenges before and we are hopeful for the future.

It is not a virtual business. Sunrise is real. We have long-term contracts, 90% occupied communities and a wildly dedicated team and a leading senior living brand built over 27 years. Now, let me as Rick to review our cash and debt balances and financial results, then Tiffany will comment on our third quarter operating results.

Richard Nadeau

You'll see in today's press release a description of the large and/or unusual items affecting this quarter's results. I will address some of these items as I go through the income statement.

Revenues for the third quarter of 2008 were $436 million as compared to $430 million in the third quarter of 2007. Management fees were up 13% due to increases in rate and occupancy for existing communities, lease up communities and incentive management fees. Resident fees for consolidated communities were up 10%. $7 million of this increase is related to rate increases for existing communities. We also added three consolidated Canadian communities and we consolidated the nine German communities as of September 1, 2008.

The revenue growth was offset in part by a decline in revenues related to our hospice business. This decline was largely the result of Trinity closing centers in non-core markets. As Mark mentioned, we made the decision that we are not going to continue to fund the on-going operations of Trinity. As a result, in the fourth quarter of 2008, we expect to record a $90.8 million pre-tax charge to write off Trinity's good will and intangible assets. This action will have the beneficial effect of mitigating the negative operating cash flows we are incurring today.

Operating expense were $513 million for the third quarter of 2008 as compared to $511 million in the prior year third quarter. Developing venture expense was $17 million as compared to $19 million in the prior year third quarter largely due to decreased marketing costs and fewer communities that were under development.

As Mark said, we have reduced our development pipeline, and therefore we expect this number to continue to decline over the next few quarters as the pace of development spending is reduced.

Consolidated community expense was $84.3 million, up from $72 million in the prior year third quarter. $7 million of this increase is due to higher costs for labor, repairs and maintenance and utilities. In addition, as I said previously, we added three communities to our portfolio and we consolidated the nine German communities.

Hospice expense was $16.3 million in the third quarter of 2008 as compared with $18.4 million in the prior year third quarter reflecting the decline in census. You will note that this quarter, we broke out our ancillary services business. In New York, Germany and for our balanced portfolio due largely to regulatory requirements, we provide health care services to these communities through wholly owned Sunrise subsidiaries rather than directly through the community.

Our Care companies in New York and for the Fountains portfolio operate at close to break even. However, in Germany our Care company has been losing money since we have been unable to recover all of the costs of the health care services we provide.

General and administrative expenses were $40.4 million for the third quarter, down from $70.2 million in the prior year third quarter. This decrease of $29.8 million largely relates to a $29 million bonus expense related to our U.K. venture that was reported in the third quarter of 2007. There is not a corresponding amount in 2008. Sequentially, you will see G&A has declined and we expect this trend to continue.

We incurred expenses related to our outstanding SEC investigation and shareholder litigation this quarter of approximately $5 million. We expect to have additional related expenses in the fourth quarter and into 2009.

In connection with our head count reductions, we incurred severance costs of $4.8 million in the third quarter of 2008. We have reduced our head count by 160 persons. We expect these reductions to result in total cost saving of approximately $17 million per year of which $6.2 million will impact G&A and $10.7 million will impact development and venture expense.

Additional severance charges are anticipated in the fourth quarter of 2008 and in the first and second quarters of 2009 of $7.5 million and $2 million respectively.

With respect to our reduction in the development pipeline, we took a $47.5 million charge related to the discontinuation of 54 projects this quarter. We have reduced our 2009 spending for development significantly. On September 30, 2008 we had 34 projects under construction of which five related to our Greystone subsidiary.

We intend to complete construction of these projects and all but two of these constructions have debt financing. These two projects that do not have debt financing yet have a $90 million project cost budget of which $27 million of Sunrise money has been spent to date. We are talking to lenders about these two projects and assuming a 70% loan to cost ratio, we estimate that no additional equity funding is needed for these two projects. We plan to talk to potential capital investors about acquiring 80% of the equity for these two projects.

In total, for all projects under construction, we estimate that we have an additional $2.4 million of remaining Sunrise equity to fund. We will not commence construction on any new projects without committed construction financing.

As a result of our decisions and our secession of condo projects earlier this year, we have $74 million of land that we intend to sell. We have loans against this land of $31 million.

Continuing down the income statement, gain on sale was $4.7 million in the third quarter of 2008 as compared to $52.8 million in the third quarter of 2007. In the third quarter of 2007, we recognized a $52.2 million gain related to the expiration of a guarantee to a venture.

Sunrise's share of equity and earnings was a loss of $15.5 million in the third quarter of 2008 as compared to income of $80 million in the prior period. This quarter's results include a charge of $7.4 million related to an impairment for our portion of the investment in four acquired communities that are inside the Fountains venture.

We also experienced $7.8 million in increases losses related to our pro rata share of income from ventures. These losses related to communities and lease up as well as our accounting treatment for some of our U.K. communities where we are required to use hypothetical liquidation net book value or what we call HLBV accounting.

The prior year third quarter results included a gain of $82.9 million related to the sale of six communities by one of our U.K. ventures.

Finally, you will see that we had a non-cash extraordinary loss this quarter of $20.5 million before taxes which is $13.3 million after taxes, and this relates to the consolidation of our German venture.

I will try to explain how the accounting for this venture works. From 2003 through 2006, we invested $13.1 million for our portion of the equity required for our Germany venture. Our partner invested $52.4 million. Our equity investment was reduced to zero due to start up losses recorded from 2003 through 2006 and accordingly, we had no investment carrying value at the end of 2006.

In 2006 we recorded at $50 million loss for expected payments under financial guarantees. We call these financial guarantees operating deficit guarantees and they were given to lenders to our nine German communities. In 2009, we recorded an additional loss of $16 million for a cumulative loss of $66 million for expenditure, non-recoverable payments under financial guarantees.

Essentially, this $66 million charge was the difference between the cash we expected to fund of $99 million and the $33 million of recovery we projected from the proceeds from the sale or refinancing of communities at the debt maturity date. On September 1, 2008 we paid 3 million Euros or $4.4 million to the majority partner in our Germany venture for an option to purchase their entire equity interest in the venture in 2009. We expect to exercise this option in January 2009.

Also on September 1, we entered into an agreement with our partner that gives us permission to immediately pursue potential restructuring of loans with venture lenders, pursue potential sales of some or all of the nine communities in the venture, and to merge certain subsidiaries of the venture to improve operational efficiency and reduce VAT taxes paid.

As Mark explained, our decision to purchase this option was based on the fact that we had 100% of the financial risk for the Germany venture, but did not have control, and had only 20% of the equity ownership. Neither the purchase or the option, the exercise of the option planned for January 2009 or the consolidation for financial reporting purposes, alters our obligations under any of the financial guarantees for which we are responsible, or alters any of the recourse or non-recourse provisions in any of these loans.

The German venture is a variable interest entity and we are the primary beneficiary which requires us to consolidate the venture as of September 1, 2008. The accounting rules require that assets and liabilities be consolidated as estimated current fair value. Since the liabilities are in excess of the assets, we recorded a non-cash extraordinary pre-tax loss of $20.5 million.

The properties are recorded at fair value based on appraisals reflecting the estimated fair value. The fair value of the debt recorded reflects all of the terms of the debt instrument including the operating deficit guarantee and the recourse or non-recourse provisions of the agreement. The expected operating deficit guarantee payments are considered in the determination of the fair value of the debt recorded.

By way of example, assume that the fair value of a community is 5 million Euro's but the related debt is 15 million Euro's and the debt is non-recourse to the parent, except the parent has guaranteed operating deficits and therefore, principal and interest until the maturity date. The fair value of the debt is calculated to be the sum of the fair value of the property and the fair value of the required principal and interest payment until the maturity date because there is an assumption that the property is disposed of in satisfaction of the debt.

After our purchase of the option, we restructured the debt of four of the nine communities. We assumed $25.6 million as recourse debt to Sunrise and received a discount of $12.3 million on the remaining debt for these four properties. However, upon any future sale of the four properties, we are required to pay the lender any shortfall to the extent that we do not receive proceeds of at least 50 million Euro's. The current estimated fair value of these four properties is 47 million Euro's.

Debt for the other five communities is non-recourse to Sunrise except to the extent of the operating deficit financial guarantees. We expect to close or sell two or three of these communities within the several months. For the remaining communities in Germany, we believe that operations can achieve stabilization and be profitable.

For all nine of the communities, we would expect to pay approximately $32 million in operating deficit in interest through 2011. We would also have scheduled principal payments for all nine of the communities of $35 million through the maturity date of the loans. Total contractual debt maturities for Germany are $247 million, and therefore there is $212 million of loans that will be satisfied at maturity by either refinancing the debt if the value of the related property is sufficient or by providing deem in lieu of foreclosure to the lender.

A few other comments on other operating deficit obligations facing Sunrise. We are funding operating deficits for the Fountains venture, and the Aston Gardens portfolio. These are not Sunrise built assets. Through September 30, 2008 we have paid $5 million in operating deficit payments to the Fountains venture.

This portfolio has a number of entrance fee communities which have been particularly hard hit in this current economic environment. This payment is recoverable from the venture after debt service and before distributions to equity partners.

Aston Gardens has a large independent living component and is based in Florida. We paid $3 million under our operating deficit agreements through September 30, 2008. We expect that we will be terminated as the manager for the Aston Gardens portfolio at the end of 2008 and this should end our future payments. Again, we hope to recover the ODA payments from future operating cash flow of the venture.

With respect to our remaining senior living condominium projects, to date we have funded $48 million to this project for cost overruns. This project is scheduled to open by the end of 2008. We do not currently estimate any additional payments by Sunrise for expected cost overruns. The venture currently has pre-sales for condominiums that are held refundable deposits.

To the extent the pace of sales of condominium units is slower than anticipated, or if the venture is unable to realize the prices projected for the condominium units, we could be subject to additional operating deficit payments.

Now some detail on our cash and debt; at September 30, 2008 we have $53 million of unrestricted cash, borrowings of $95 million under our bank credit facility and $22 million of letters of credit. We have $43 million available under the bank credit facility.

We believe that we have enough cash to allow us to meet our upcoming financing needs including payments under our operating deficit agreements and completion of projects through January 31, 2009. I will come back to that in a minute.

The actions we have taken relating to Germany and our development pipeline have had a significant effect on our income statement and balance sheet, but each was necessary to either conserve cash or address our long-term liquidity or profitability concerns. Unfortunately, these actions had the result of reducing our net worth below our requirement in the bank credit facility of $450 million.

We are appreciative to our banks for waiving the net worth covenant for the third quarter of 2008 so that we could take these actions. We do not expect to be able to satisfy our required financial covenants under the bank credit facility as the end of the fourth quarter of 2008; This means we will be unable to borrow after January 1, 2009 on the bank facility unless we are able to obtain further amendment to this facility.

In the nine amendment that we signed yesterday, we have agreed that failure of the lenders and Sunrise to agree to a restructuring of the bank credit facility by January 31, 2009 is an event of default. We are working of alternatives including a new facility and hope to have this resolved prior to January 31.

We are also continuing to pursue additional sources of capital as discussed in our press release including potential financing of one of the company's real estate ventures that would yield an estimated $8 million in proceeds in the fourth quarter. Also as previously mentioned, we are working to sell 15 land parcels related to abandoned projects. These parcels have book value of $74 million and related debt of $31 million. However, I need to caution that these sales will be difficult in the current market conditions, but the property is in good locations.

We have three consolidated operating portfolios that we are expecting to sell into a venture in the first half of 2009 with Sunrise retaining 20%. The proceeds would be approximately $10 million. Additionally, our community under construction is scheduled to close into a joint venture before the end of 2008. Again, we caution that the current capital markets are challenging for both venture equity and debt.

Our Greystone subsidiary is open for business and hopes to reach financial closing for up to six projects over the next several months. We caution that the capital markets are challenging and may not be helpful to this objective and we may be forced to reduce further spending in this business. However, there are at least two projects forecasted to close in late 2008 or early 2009 generating estimated proceeds of $11 million. We will be very careful about committing Sunrise funds to new seed capital projects at Greystone until we see financing visibility in the non-profit sector.

In October and November of 2008, we received $30 million of our tax refunds. We believe we will be able to receive additional tax refunds of up to $27 million by mid 2009. I will also mention capital expenditures since this is one of Jerry Doctrow's favorite questions.

As you know, we spent $169 million on capital expenditures for the nine months ended September 30, 2008. Of this amount, $153 million related to investments in construction projects that were not yet in ventures and $16 million for maintenance CapEx for consolidated assets. Our CapEx for consolidated assets has been largely maintenance CapEx and not what Jerry would call revenue enhancing.

We have done a number of revenue enhancing projects at some of our venture properties such as converting independent living rooms to assisted living, and converting rooms to doubles where there is demand. But, CapEx related to the ventures is reflected in our investment unconsolidated ventures.

Our construction in progress balance at September 30, 2008 was $138 million after writing off project costs. Of this balance, $73 million relates to three wholly owned properties we are developing. $53 million relates to land parcels and the remainder is related to new projects we expect to be successful.

On the debt side, we have significant 2009 maturities including our bank credit facility borrowing of $95 million which is considered a short-term liability. There are two individual loans related to communities due in 2009. The largest is a $40 million that is collateralized by a mature community. The loan to value for this loan is higher than is currently available in the market place and we expect we will need to infuse us up to $10 million of equity. This loan matures in August 2009.

The other community loan of $8 million relates to an entrance fee community as being repaid by unit sale proceeds. There are also loans for $4.3 million that mature in 2009, and are collateralized by land. Much of this land we expect to sell. In addition, we have $20 million of a margin loan on the auction rate securities held by the insurance captive. The auction rate securities have a fair value of $36 million.

We plan to repay the land loans, the entrance fee loan and the margin loan from proceeds of the related assets. We expect to refinance the loan on the consolidated property.

Speaking of consolidated properties; we currently own 36 properties and lease 29 properties. Of the wholly owned properties we have mortgage loans on 25 of these properties and we plan to continue to operate these communities. There is not borrowing capacity associated with the remaining properties as some analysts have speculated. The remaining 11 consolidated properties are smaller, good assets that we plan to sell or close.

Now, let me turn the call over to Tiffany to review this quarter's operating results.

Tiffany Tomasso

In spite of the current economic environment the Sunrise team was successful at growing overall same store revenues by 4.9% with daily rate growth of 3.8% and occupancy of 89.9%, up from 89.1% in the third quarter of '07. Our growth in average daily rate increase, similar to the second quarter resulted from increases in base room rates, increases in extended care rates as well as increases in extended care utilization.

In our last two quarterly calls I said our biggest opportunity was to drive occupancy in our assisted living product line particularly in the smaller style units. We have been busy and placed an emphasis on studio and companion based vacancies and have seen a reduction in vacant units with minimal decline in average daily rate.

As a result, the same store assisted and memory care occupancy in North America came in at 92% for the third quarter. We continue to see pressure on our independent living portfolio, particularly in those markets most affected by the housing downturn.

Expenses increased related to labor, utilities and repair and maintenance. Labor expenses increased due to the labor hours increase driven by the increased occupancy increase we saw in AO and memory care as well as increases in extended care utilization. The wage rates were essentially flat this quarter over the prior year, largely due to better managements.

Utility expenses continue to be impacted by the recent economic trends and repair and maintenance expenses were slightly higher this quarter.

The increase in expenses was offset in part by a credit of $11 million related to our insurance programs based on favorable lost experiences. No additional credits are expected this year. These credits, expenses grew 5.9% year over year.

For October, occupancy trends have continued in line with what we saw in the third quarter. In summary, the steps we are taking resulted in overall occupancy growth in what I would sum up as a very challenging market. The Sunrise team continues to stay focused on serving our residents well each day in addition to focusing on top line growth and expense control

I'll turn the call back to Mark.

Mark Ordan

It occurred to me listening to Rick that I should also tell people that one of our plans is to make this a simpler company so that in the future he doesn't have to talk quite so long.

I'd like to close by commenting on my new job in a broader perspective. Despite the extraordinary events of the past year at Sunrise, our current financial condition and the economy and market compel us to focus on our ills. Today's call I hope, clearly shows that we are riveted on those issues.

The fact that nobody on this call forgets is that over the past 27 years, Paul and Terry Klaassen created and built an organization that has changed hundreds of thousands of lives. Today, Sunrise represents the senior living sector market and brand leader. This is a company with a great development track record and enormous future opportunities for smart comparable growth.

I am grateful to Paul and my Board for the opportunity to lead Sunrise and our extraordinary team. Sure, we have problems to solve and we will, but that cannot stop us from keeping an excited eye toward our future.

We'll now take questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Ryan Daniels – William Blair.

Ryan Daniels – William Blair

Given that you went through the balance sheet and some of the funding needs in so much detail, let me ask a little bit more on the operations. You mentioned the AL portfolio in the U.S.; it's up to 92% occupancy which is pretty impressive. Can you talk a little bit more about assisted living, what the occupancy is there, what trends you're seeing, how you're trying to solve that and drive occupancy up a little bit?

Tiffany Tomasso

I actually quoted the North America same store AO and that reflects both our purpose filled mansion as well as some stuff that we acquired. And yes, it came in, the things that we're doing, I think the fact that it is very need driven, it's performing slight above where this group was last year at 92%. In terms of independent living, we're continuing to see the pressure both in the housing market but also the decline in people's portfolio's.

We're seeing it probably more broadly across the U.S. and I have seen a quarter ago and the quarter before. The independent living that we built which represents 700 units is a little bit more need driven. They're performing at above 96% occupancy. The pressure is really on more the entry fee communities. We have 19 of those. It's more the entry fee communities, and in Florida even in rental communities where we're more; overall independent living is performing around 91%.

We're taking every, literally every week sales calls with our regional team and we look at community by community in inventory, unit by unit. Teams out there are working hard. We have a great product, they are passionate about what we are doing and they're slugging it out every day.

Ryan Daniels – William Blair

In regards to the Trinity decision, I know you were initially pretty excited about the opportunity to offer that to your residents. Is it really just the need to conserve cash flow that's requiring you to divest that now? That's something that you thought about trying to sell to one of the bigger operators or is it literally just you're going to shut that down and take the loss.

Mark Ordan

It may be aspects of Trinity that we can sell, but we think it's vital. We don't think we're unique as a company to make sure that we conserve every penny that we can. So even though we felt that we could see good long-term prospects at Trinity, we are doing everything we can to stop cash outflows starting immediately accretive to the company.

That was 100% a decision that we had to make. We have a great team at Trinity and this doesn't reflect anything on them. They reflect everything on our determination that we are going to get through this very difficult period where the capital market spigots have been shut of and be able to emerge a stronger and leaner company later.

Tiffany Tomasso

From a problematic perspective aspect in the communities, we will still partner with other hospice providers to offer this support and service to reference to families which we did prior to the acquisition of Trinity in '06 and what we're doing still in a number of the markets where Trinity did not have a presence. So our commitment on that front stays.

Ryan Daniels – William Blair

If I could turn to the German communities, can you talk a little bit more there about the range? It sounds like there's two to three that might be really underperforming and dragging the company down and those are the ones most likely to be sold or shut down? What's the range of occupancy at those versus the other communities? It sounds like if you're adding two to three net residents a month, I would assume the occupancy is jumping up pretty quickly in the other ones.

Mark Ordan

It is two or three communities that are lagging in the occupancy area. Two of the communities, I think in the 10-Q that we filed this morning, the occupancy and the residency capacity before seven of the properties. The other two we would plan to close shortly have less residency count than what you would see on that table, input note 6.

Tiffany Tomasso

We're operating about five markets. One community in Munich, we have four in Frankfurt, two in Hamburg and one at Hanover. As I said on the previous call, the customer acceptance and brand awareness has taken hold in the southern markets, so Frankfurt and Munich, our latest openings. In the north there are details laid out in the supplemental, the occupancy in the two that we're looking to close are well below. We're still gaining traction, albeit less in the other two in the north than in the south. We're seeing the market acceptance slowly, so we're just going to continue on that course.

Mark Ordan

To give you an example, [break in audio] of an area that we can add a lot more focus to, so we didn't see the traction we might consider other courses, but there clearly is that traction and there clearly is that focus now so we are optimistic.

Ryan Daniels – William Blair

Do you have the share count at the end of the quarter? I didn't see that in the release.

Richard Nadeau

On the front of the 10-Q, on October 31, 2008, 5960783.


Your next question comes from Jerry Doctrow – Stifel Nicolaus.

Jerry Doctrow – Stifel Nicolaus

One of the things we think about as we go forward is what's reasonable in terms of occupancy, in terms of rate, in terms of expense growth. Is it flat occupancy, 2%, 3% overall rate growth? 2%, 3%, 5% expense growth? It's some feel of where some of those things trend going forward.

Tiffany Tomasso

I would say that we need to be very cautious about rate growth moving forward at the real rate level, what I would say real estate level, particularly in independent living. That could actually go backwards.

I think in our stronger markets, real core markets in the north east, Chicago, I think can hold their own. In other markets where there's more competition and more impact on the economy and housing, I think we could see a potentially flat to down. I'm not giving you a specific answer, and as we build the budgets for next year it is community by community.

We've looked at resident apartments in communities, the rate increases, the current rate they're paying, what that looks like in the new market rate. So we have to take an unbelievable level of detail focus community by community when we're looking at the revenue build for next year. We do anticipate, although we're going to do everything we can to mitigate it, the seasonal decline that we'll see at some point in Q1 and Q2 including January, February, March, December, January, February.

At some point there's a three-month period that we see now at Sunrise and other public companies have reported, I anticipate that downturn could potentially even be greater as people are looking at the financial aspects of what they're doing. We're going to be looking to address that individually with families in each community.

We're being very cautious about rate growth but looking for ways that we will be able to drive and maintain volume.

Jerry Doctrow – Stifel Nicolaus

On the expense side, there was this little benefit from an insurance or something, and you said without that, expense growth was 5.9%. So as we go forward, obviously maybe utilities come back a little bit, some of your competitors were talking about the fact that expenses were up because what you mentioned was higher acuity levels requiring staffing, but also expenditures for marketing and stuff. Do you have a goal for trying to hold expense growth to a certain level or range?

Tiffany Tomasso

I'd say 4% to 6%. The area that could potentially grow higher just proportionately is going to be on the care side. As you know, our staffing patterns, we increase hours as resident acuity increases, so we'll pay more and there's still profit margin, but a lower contribution level. Just given the economic situation out there, we do see residents, families waiting a little longer to move in and with a higher level of acuity.

I think we're doing all the right things to manage control of the labor, tracking by occupancy and acuity with very good historical trends on overtime management and that even improved this quarter. So we're doing the blocking and tackling, we're managing food costs well. We're leveraging our buying power. The things that we can control, we are controlling. The wild card is the utilities and just other aspects.

Jerry Doctrow – Stifel Nicolaus

If I understand you correctly, expense levels could be up higher than growth in revenue so we could see more decline.

Tiffany Tomasso

I think that's a potential.

Jerry Doctrow – Stifel Nicolaus

Obviously the financing, you talked about it a good deal. I think you mentioned 11 communities which is the stuff that's unencumbered which is potentially are there for sale or divestiture. Is that something that's on the agenda for '09? It's not generally listed in your items.

Richard Nadeau

We've been working on that for the last three months, but I'll caution you. That's not going to be a big cash infusion. That will be something that would be in the $10 million to $12 million range of cash to us. so these are very small communities that came as part of acquisitions. They're not Sunrise built assets and so the fact that they're unencumbered, there's really not borrowing capacity there, and they really are not good fits with the company's objectives.

Jerry Doctrow – Stifel Nicolaus

You talked about retaining Goldman. Is there other financing? It doesn't sound like there's a lot of assets to be sold to Reeds. Any more color how additional capital gets raised, or what are some of those options?

Mark Ordan

We have a strong collateral base in this company. We have excellent long-term management contracts and we have as Tiffany described, very strong core operations. So I think that we're working with capital providers that see what the core is, what we're doing to eliminate the non-core, and see future opportunity.

Jerry Doctrow – Stifel Nicolaus

Is it likely at the corporate level, rather than at the property level.

Mark Ordan

That's right.


Your next question comes from Derrick Dagnan – Avondale Partners.

Derrick Dagnan – Avondale Partners

On the average daily rate growth, is the impact, it's been a little slower than it has been, the economy is slower, but is part of the impact here the fact that you're filling up some of these smaller units at maybe a lower price level or are we also looking at incentive pricing?

Tiffany Tomasso

We're actually seeing three things. One, we moved to January 1 rate increase earlier this year, where before it flowed through per se, where every month rate increases would go through. So the first quarter of the year where we normally see all of that throughout, we captured most of that in the first quarter of this year. So that's one impact if you look at the sequential ADR from Q1 to Q3 of this year.

A second area is we are filling and the focus has been on the smaller units and our companion living, so that is bringing that down. I can't quantify how much of it is that. And then there is also very selective, we're looking at selective pricing by unit by inventory by market. I do want to share that is not across the board.

We don't just go out and say, we're reducing prices by accident. It's very targeted, very specific. Our northeast market is performing very strongly and so we want to make sure that we can preserve rates, actually increase rates where we can. I was at two communities in the Maryland market yesterday. One of them was a bright garden community, fully occupied with a waiting list and they're not doing any kind of discounting there.

So I think it is very market specific, and we're aware of that and we're looking at that. So we're focused on those things and then focused on what we can do to mitigate expense growth so that we're still producing growth on the bottom line.

Derrick Dagnan – Avondale Partners

You mentioned a higher acuity patient, when these new patients move in with higher acuity, there's an initial assessment, where you would put them in some of the higher levels of care at admission.

Tiffany Tomasso

That's correct. And then every resident is reassessed in a scheduled time frame with a change in condition.

Derrick Dagnan – Avondale Partners

On Germany, when you talked about the joint venture, you mentioned you feel like you have 100% of the risk but you didn't have the control. Are there other JV's out there that are structured similar to Germany where you feel like you have the same problem?

Richard Nadeau

No, I don't think so. I think that although we do have operating deficit guarantees at several of our ventures, I think what made this one different is that it was a new market. We have operating deficit guarantees that we provide on projects that we build in the United States, Canada and in the U.K., but we have product acceptance in those markets and have not had significant fundings on those ODA's.

I would say that the funding in Germany was really a product acceptance issue.

Derrick Dagnan – Avondale Partners

So it's not that the structure of Germany is so different, it's that the performance of the market is the problem.

Richard Nadeau

Right. And in that band, where you're struggling under the ODA, you really have 100% of the financial risk. It's a magnitude issue with Germany.

Derrick Dagnan – Avondale Partners

You broke out the hospice versus the ancillary services and we see that the ancillary services is losing money as well. Is that something that you can shut down or is that more of a difficult task?

Richard Nadeau

There are three things in that ancillary services line. One is New York care, the second is Fountains, and the third is Germany. The New York and The Fountains are close to break even. It's the third piece, the Germany piece, the international piece that we are struggling with and that is largely due to the fact that our occupancy was low when we were delivering this service and we were unable to get enough fee to offset the cost that we had in providing that care. That should be reduced in the future.

Tiffany Tomasso

On the New York ancillary ventures, they're designed to operate at breakeven. So that is intentional. We put in the pricing so that it matches the cost structure, and then adjusted the price on the real estate side and the joint venture with the partners. So that's purposeful. We look at that. So there's no concerns that we have relative to that.

Shortfalls in Germany are directly attributable just to the occupancy levels.


You have a follow up question from Jerry Doctrow – Stifel Nicolaus.

Jerry Doctrow – Stifel Nicolaus

I wanted to come back to the condo. I assume this is the one that you're doing, any more color on where pre-sales stand where people were actually starting to move in at this point. I just wondered, an uncertain condo market here, but whether you've got a signal whether you're converting these sales and how much of an issue or risk that might be.

Mark Ordan

If you look in the Form 10-Q that we filed today, back on Page 51, we have a discussion on the senior living condo project. We indicate that there are 240 units in the community and we tell you the units that have been sold and closed on and we tell you how many are being held under refundable funds at this point.

That would be nine that are sold and closed and 102 more that are being held by refundable deposits and we'll be working to convert them to closings in the fourth quarter.


Your next question comes from Rosemary Pugh – Green Street Advisors.

Rosemary Pugh – Green Street Advisors

Can you talk a little bit about what motivated the loss of those management contracts?

Mark Ordan

The portfolios we lost in both cases were portfolios that were at a point where they could easily be terminated. It wasn't in the middle of a turn or anything like that. We had the opportunity to retain those portfolios, but to retain those portfolios would have required an economic head out that we thought didn't make sense. To us, it made more economic sense to let them go.

We have thriving portfolios. These are portfolios that said, "Do we really want to pay up to take them?" And by the way, it's not unwise for us to match them because of today's economy, it's unwise for us to match them because we thought that decision would be a money loser.

We're not in the business of trying to end contracts, but we don't want to make dumb economic decisions.

Rosemary Pugh – Green Street Advisors

What happened to Sunrise's partial ownership position in the Astin Garden portfolio?

Mark Ordan

We have our ownership position. That may also be sold, but for now we turn over management and we continue to own our position. We wouldn't mind if somebody wanted the combination, but we're happy to own our piece of the pie.

Rosemary Pugh – Green Street Advisors

Are there other management agreements that are vulnerable to being cancelled or are there other loan defaults on other management contracts?

Mark Ordan

Overall we have long-term management contracts. The features of the contracts vary. There are performance termination features in some of these projects which is also very standard. From a description of our operations, we're strong operators. Our occupancy levels are high. We work hard.

You have to do a good job, and it's not risk free, but these are long-term agreements and we are strong operators. That's why we're optimistic.


There are no further questions. I'd like to turn the call back to Mr. Ordan for any closing remarks.

Mark Ordan

I want to thank everybody for joining us. We appreciate your support during difficult times. We'll be updating you in February of next year.

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Source: Sunrise Senior Living Q3 2008 Earnings Call Transcript

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