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Executives

Lisa Mayr - Senior Vice President of Investor Relations

Paul J. Klaassen - Chief Executive Officer, Director

Richard J. Nadeau - Chief Financial Officer

Tiffany L. Tomasso - Chief Operating Officer

Mark S. Ordan - Chief Investment and Administrative Officer, Director

Analysts

Analyst for Ryan Daniels - William Blair & Company, LLC

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Derrick Dagnan - Avondale Partners LLC

Jeff Englander - Standard & Poor’s

Analyst for Frank Morgan - Jefferies & Co.

Sunrise Senior Living Center, Inc. (SRZ) Q2 2008 Earnings Call September 10, 2008 4:00 PM ET

Lisa Mayer

Welcome to Sunrise Senior Living’s investor conference call. This is Lisa Mayr, Senior Vice President of Investor Relations for Sunrise. Joining me today are Paul Klaassen, Sunrise’s Founder and CEO, Tiffany Tomasso, our Chief Operating Officer, Mark Ordan, our Chief Investment and Administrative Officer, and Rick Nadeau, our Chief Financial Officer.

Before we begin, let me remind you that this call is being recorded and that 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.

I would now like to turn the call over to Paul Klaassen.

Paul J. Klaassen

As you saw earlier today we filed our 2008 Form 10-Q for the second quarter. We also previously filed our Form 10-Q for the first quarter in August and are now a current filer. We are pleased to have met these major milestones.

As our 10-Q shows, this was a challenging quarter. As we’ve discussed in previous calls we are taking aggressive steps to reduce spending and right-size our business so that we can move toward profitability from the combination of our two key drivers: Developing our core assisted living mansions and managing our growing portfolio of communities. We are confident that the actions that we are taking will get us back to profitability in 2009.

Now Mark Ordan, Rick Nadeau and Tiffany Tomasso will provide additional details on our actions and our results, and then we will move to answer your questions. I’ll ask rick now to review some of those results.

Richard J. Nadeau

As you saw earlier today, we did file our Form 10-Q for the second quarter of 2008 with the Securities and Exchange Commission. I want to once again thank and congratulate the entire Sunrise finance and accounting team for their tremendous efforts. We can now look forward. We do expect to file our third quarter 2008 Form 10-Q on time.

Before I review the financial results, I would like to discuss a transaction that occurred on September 1 related to our Germany venture. As you know, Germany has been an area where we have experienced a number of challenges and we have been focused on improving results. We agreed with the majority partner in this venture for an option to purchase our partner’s equity interest in the venture in 2009, which we do expect to exercise. The purchase price is 100,000 Euros.

This agreement provides Sunrise with the authority to immediately pursue all alternatives for the portfolio including potential restructuring of loans with venture lenders and potential sales of some or all of the nine communities. In addition, we are now able to simplify the operating structure and as a result expect significant operating and VAT tax benefits. As a result of the option, we will consolidate the German venture beginning in the third quarter of 2008. Accordingly, the assets and liabilities of the nine communities including the debt will be included on our balance sheet as of September 30, 2008. The face value of the debt to be included is 187 million Euros which we will record at fair value. We will also record the assets at fair value once our analysis is complete. We believe we can execute this transaction without tripping our debt covenants.

Now let me speak about our operating financial results. I will address year-to-date numbers and I will review only certain line items on the income statement although I am happy to take questions afterwards. Revenues for the six months ended June 30, 2008 were $867 million as compared to $804 million in the same period in 2007. The increase in revenues came from increased management fees and residence fees for consolidated communities as a result of the opening of new communities and rate increases. Also, professional fees increased by $20 million as a result of development fees recognized for new communities as well as an increase in Greystone fees. As you will recall, Greystone is our subsidiary that is a developer of CCRCs for not-for-profit clients.

These revenue increases were partially offset by a reduction in revenues related to our hospice business. As we have disclosed our census has declined over the last year partially due to the fact that we have closed certain operating locations in non-core Sunrise markets. Earlier this year we hired a new management team and we are beginning to see improvements in our census at the remaining locations. It is still early but we have launched 10 de novo locations and we are seeing traction. Tiffany will say more about the hospice business in a few minutes.

Now moving to expenses. Operating expenses were $974 million for the first six months of 2008 as compared to $876 million in the prior year period. Development and venture expense increased $12.5 million largely as a result of increases in salaries and benefits due to the increased number of communities under development, the write-off of prepaid insurance with respect to discontinued development projects, and increased marketing expenses for communities under development. Consolidated community expense growth was slightly higher than revenue growth due to the higher costs for labor, food and utilities that we discussed in our last conference call.

General and administrative expense increased $9 million from June 30, 2007 to June 30, 2008 due to salary increases, bonus expense related to our UK venture, and increased training costs. We have reviewed our G&A. We do have some lumpiness and some one-time costs. We believe that our annual run rate for G&A is approximately $140 million. We recognize that we cannot run this high rate of G&A. Mark will speak to our G&A plans a little later.

We continued to have some expenses this quarter related to the restatement and investigation. We expect this line item to be greatly reduced now that the restatement is complete but we will see some additional amounts in subsequent periods related to the outstanding SEC investigation and the shareholder litigation.

Finally, you will see that we incurred additional charges related to abandoned projects; approximately $26 million related to the discontinuance of three condominium projects and $10 million related to other development projects. As we announced last quarter we have reduced our development pipeline and as a result we wrote off capitalized costs that we spent on these projects. We have reduced the 2008 pipeline even further over the past month and we are now expecting to start construction on between 1,200 to 1,400 new units in 2008 with some projects being delayed and others being canceled. This is based on both the capital markets and our underwriting process. We will only build projects that meet our criteria. It is possible that we could have additional charges next quarter as we assess which projects will be deferred versus canceled.

In addition, we benefited significantly from real estate transactions in 2007. The number and size of real estate transactions in the first six months of 2008 was much less.

Let me also address the recently-announced proposed transaction whereby Health Care REIT announced that it was acquiring 90% of a portfolio of 29 Sunrise properties from a long-time Sunrise capital partner. Health Care REIT is a well-respected company with a long history in the senior living business. In fact, Health Care REIT did a successful transaction with Sunrise about 20 years ago. The properties in this portfolio are 29 high-quality communities in great locations.

We will continue to manage these communities and we will continue to own our 10% share of the real estate through the venture. We expect that the management contract including the management fees will be comparable to our other management agreements. The contract will have performance termination clauses but we are confident that we will be able to meet the required thresholds.

As you heard on the calls hosted by Health Care REIT, although these communities do have high occupancy levels we believe there is room for NOI growth. In addition, you heard that the current agreement contemplates certain non-compete rights in rings around the acquired properties. Of course we have not completed the final contract negotiations.

As part of this transaction we expect to receive a cash distribution in the fourth quarter of between $50 million and $60 million. Since we are providing an indemnification, we expect to record a gain upon closing of this transaction of between $41 million and $51 million. We look forward to working with Health Care REIT. We are pleased with the valuation evidenced in this transaction and believe that it is representative of our development strategy and high consumer acceptance of our product regardless of the state of the capital markets.

In terms of liquidity, we are in compliance with the requirements under our bank credit facility and we believe we have sufficient capital to fund operations and our scaled back development pipeline.

Now I will turn the call over to Mark.

Mark S. Ordan

As Paul mentioned, none of us is satisfied with these results and I’d like to spend a few moments telling you where we’re focused.

First we are managing carefully our core business to drive NOI. We are targeting opportunities to add revenue by driving incremental occupancy without adding expense. We are reorganizing our company to be more sales and expense driven.

You saw that our G&A spending rose materially from Q1 to Q2. We less than one month ago announced the start of a series of cost reduction programs to take direct aim at spending in G&A, development and ventures, and overall spending. Part of this is a voluntary separation program which is virtually completed, will reduce the staff by about 100 people, and along with other cuts already takes us well toward our initial projected $15 million to $20 million savings. Please note though we are not cutting staff in our communities. Obviously we cannot continue at unprofitably high expense levels. The program we began a few weeks ago will be broad and deep. For 2009 we are targeting a G&A run rate of $120 million.

We are developing new mansions since this is the basis for growth and consistent high returns. While we have curtailed our development pipeline and reduced the size of our development team, we have an active pipeline. Our development business is not a current contributor to profitability. However we strongly believe that this is a long-term major contributor to both operating profitability and returns on invested capital. The Health Care REIT transaction Rick described a few minutes ago is a great example of the ongoing success of real estate returns we expect to realize.

I’d now like to turn the call over to Tiffany Tomasso.

Tiffany L. Tomasso

I’d like to address two issues that I know are on investors’ minds, our loss in Trinity and community occupancy.

Let me first address Trinity. We are aggressively addressing the issues in our hospice subsidiary. We have rebuilt our team, we are shedding unprofitable centers, and we are bringing our de novo locations online. Three of our 10 Janova locations have received Medicare certification and are reaching break-even. We expect Trinity to turn a profit during the second half of 2009 and see the value of Trinity increasing both as an investment and as a service to our residents and their families.

Finally, we know that everyone wants to know how our Q3 operating metrics are looking. We are not prepared to provide any updates at this time; however I will say that our North America same-store occupancy was up slightly through July. We continue to see demand for our assisted living and memory care services, and we’re still experiencing some softness in independent living. We will provide more information in our November call.

With that I’ll turn it back to Paul.

Paul J. Klaassen

Even though this has been a challenging period for Sunrise, we are pleased to once again be a current filer and to be taking the necessary steps to return to profitability in 2009. We are fortunate to be a pioneer and a leading firm in such a strong and dynamic field as senior living. Supply and demand fundamentals are encouraging as demand for our core product and services remains healthy and construction of new supply is quite constrained. So we look forward to this next year confident that we have the products, resources and team to build a strong, solid and profitable future.

Now we’ll take questions that people might have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Analyst for Ryan Daniels - William Blair & Company, LLC.

Analyst for Ryan Daniels - William Blair & Company, LLC

Regarding the development pipeline, you mentioned earlier in your prepared remarks that a portion of it is due to delayed versus cancellations. Can you give us a feel for the split there?

Mark S. Ordan

Well it’s a combination when you look at the development pipeline and you scale it back, some projects are pushed out from the original opening date and then others are canceled because you see weakness in the capital markets. I’d also say that we’re being extremely rigorous in our evaluation process to make sure that anything we do go forward with, that we do present to a capital partner is a great development.

Analyst for Ryan Daniels - William Blair & Company, LLC

Sure. So would you say it’s pretty much split evenly or is it more heavily weighted towards delays perhaps to 2009 and 2010?

Mark S. Ordan

That’d be hard to say. It’s a combination of things and we’re being responsive to the capital markets and we’re being responsive to our analytics.

Analyst for Ryan Daniels - William Blair & Company, LLC

Moving on to the corporate headcount reduction, I know Mark you had mentioned in your prepared remarks that in the near term some of the development staff will be cut. Can you give us a sense for what the company is going to pursue to ensure that the right team is there over the coming years as more development opportunities arise?

Mark S. Ordan

Sure. I mean we’ve been sensitive because obviously development is an important cornerstone of our future and we think we’ve had a terrific team, a proven team. Our mansion development has been excellent and provided fantastic returns. So what we’ve done is adjust the size of our development team to fit the size of the pipeline. It wasn’t a qualitative change. We have a group of professionals that have done a great job. We just want to make sure that we bring it down sufficiently to keep our G&A in line but not so much that we can’t move forward.

Analyst for Ryan Daniels - William Blair & Company, LLC

Just to confirm, you had indicated that staff was not cut at the community front?

Mark S. Ordan

That’s right. What we have not done and will not do is anything that could reduce the care level in our communities. We are the sector leader in many ways and we’re going to do nothing to diminish the level of care that has made Sunrise the company that it is. Nothing.

Paul J. Klaassen

I’d like to put the personnel issue in perspective. We’ve got 1,000 people in our corporate and field headquarters so the 100 people in development and in headquarters count or non-community personnel is about a 10% reduction. On the development side we also had about a year or so ago increased our development team as we saw wonderful opportunities. This was before the credit crunch hit the world. So we had increased the size of that development team. We are in the process of shrinking that back a bit as particularly the credit constraints are forcing us and others to do so.

Analyst for Ryan Daniels - William Blair & Company, LLC

Can you discuss a bit about the process that occurred when HCP canceled the management contract on the 11 former Marriott properties and then leased them to another operator? Were you given the option to lease the facilities outright and what was the decision process behind that?

Mark S. Ordan

A few things. We have an excellent relationship with HCP. This was after a series of discussions about that portfolio. That was an agreement that was cancelable at any time. We felt that to keep the portfolio would be uneconomic and we felt we were better off not doing something which in our view was uneconomic. So that’s the reason for it. It was nothing adversarial. As I think you’ve heard in remarks from HCP that we have a strong relationship. So we don’t think it’s indicative of anything other than that.

Operator

Our next question comes from Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Germany, did you move t here because the situation deteriorated further or just because you were trying to take more control?

Paul J. Klaassen

We got the option so that we would have the ability to control certain decisions including merging operating companies and care companies and having more efficient cost structure including a great reduction in value-added tax costs that are being incurred in Germany and to be able to control our destiny with respect to lenders and if we wanted to shut down a community or sell a community.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

You had this forecast of your cost for your operating deficit guarantees. Was that sort of on track or deteriorating or the decision was unrelated to change in outlook?

Mark S. Ordan

It’s on track. If it were not on track, we would have taken an additional charge in this quarter.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

There was a jump in G&A fairly significant in the quarter. I think as we normalize everything out like from $29 million to sort of $40 million, I’m just trying to understand whether there was other unusual items quarter-to-quarter? It seemed like a fairly big move.

Richard J. Nadeau

There was one item in there. It was about $3.7 million of professional fees although the restatement ended in the first quarter of the year. We did continue to have professional fees that we believe are at a run rate that reflects the fact that those are non-recurring costs. We still had some additional costs to get through to get current so we do think there’s at least that in the numbers. As Mark said, we do recognize that this is a high number and it’s not a sustainable number so we are putting all of our efforts on all aspects of the G&A and all aspects of our costs.

Mark S. Ordan

As Rick said, the overall run rate for the year is at about $140 million so we don’t consider the second quarter indicative of any kind of trend. And as I said, we believe given what we’ve done so far and what we see going forward that we’ll be able to hit $120 million overhead number for 09.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

On the recaps, I wanted to get actually a little more color if you could on the cash coming back on the HCNDO]? How much is kind of return of capital? How much is cash in the transaction? Historically some of it’s been sort of management center fees. Any color you can give us there. And then your expectations for further recaps in 08 and 09?

Richard J. Nadeau

With respect to the HCN transaction, our carrying value for the portfolio that is being acquired is 0. That portfolio is not going through a recapitalization. So that’s all related to the transaction. Forecasting recaps is about like forecasting interest rates and where they’re going. We’re not entirely sure what would recap over the short period of time but I wouldn’t be modeling anything at this point Jerry.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

But some are possible; it’s just hard to predict?

Richard J. Nadeau

Some are possible and they are a function of interest rates and when a particular capital partner may decide that it’s necessary or advantageous for them to exit a specific portfolio, other business needs that they might have. Very difficult to predict.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Was there anything that moved our capita? I think that was that seller to act, do you think at this point?

Richard J. Nadeau

I think you should ask them that question. We weren’t surprised that this was their timing but that’s probably a better question for them.

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Any sense of what maintenance cap ex was as opposed to total cap ex in the quarter?

Richard J. Nadeau

You’re asking about maintenance cap ex during the quarter?

Jerry Doctrow - Stifel Nicolaus & Company, Inc.

Yes.

Richard J. Nadeau

We’ll get back to you on that. It’s very hard to pull it out of there. Now that you’ve asked that twice, we’ll make sure we have that number for you next quarter.

Operator

Our next question comes from Derrick Dagnan - Avondale Partners LLC.

Derrick Dagnan - Avondale Partners LLC

Rick, in your discussion of Germany I thought I heard you mention a 100,000 euro figure in relation to the option and I wasn’t exactly sure what that related to. Could you give us some more color there?

Richard J. Nadeau

When I exercise the option, I will turn the option in along with 100,000 Euros and then I will own the nine communities.

Derrick Dagnan - Avondale Partners LLC

On the HCN transaction, could you give us a feel for any difference with the timing of this type of partner or the time horizon for a REIT partner versus some of your more traditional equity partners? Is there a difference between their general time horizon of how long they want to be involved in the JV?

Richard J. Nadeau

We can’t speak for our capital partners. Logic would tell us that a REIT owner would often be someone who would stay in the investment for a longer period of time, but I think that there are so many factors that drive when they decide they want to divest of an investment that’s probably a good question for Health Care REIT or HCP or [Ventoss].

Mark S. Ordan

As Rick said, Health Care REIT certainly has that long-term hold track record and as he referred in the past Paul did a deal with them many years ago. So they are proven in this nature.

Paul J. Klaassen

Yes. They are one of the oldest. And I think Health Care REIT’s [inaudible]. Interestingly enough they were, I believe this is true, the very first health care REIT to do an assisted living transaction something like 18 years ago; coincidentally with us.

Derrick Dagnan - Avondale Partners LLC

A follow up on that, is there a promote structure in that transaction similar to maybe some of the other promotes that you have with other capital partners?

Richard J. Nadeau

You’re referring to the old transaction?

Derrick Dagnan - Avondale Partners LLC

No. For the new one.

Mark S. Ordan

The new one with Health Care REIT.

Richard J. Nadeau

We still have to finish the negotiations on the joint venture agreement with Health Care REIT so I don’t think we should be commenting on the agreement until it’s made.

Derrick Dagnan - Avondale Partners LLC

When you look at scaling back the pace of developments, can you give us a feel for how we may see that in the income statement with the development expense line? Should we expect to see that scale back or is this something where there will be a significant time lag?

Mark S. Ordan

I wouldn’t think it’s a significant time lag but certainly to be able to be prepared to continue to be a developer and to be able to scale back, there is an expense involved. But we think that’s obviously well worth it since there was such a strong basis for future returns. So I don’t think the time lag is huge but admittedly part of that is keeping an eye on the markets and our profitability and making strong decisions as managers.

Paul J. Klaassen

I want to emphasize though that we had planned years ahead to build literally hundreds of new communities. It’s our core growth strategy. And when the credit markets return, which inevitably they will at some point, we have a proven product, we have hundreds of zip codes that we have analyzed. In many cases we have scores and scores of attractively located sites and we expect to be an aggressive developer of senior living properties at the highest quality level. This is about as difficult a credit market as most any of us have seen but when the markets return, we will be ramping that pace back up.

Operator

Our next question comes from Jeff Englander - Standard & Poor’s.

Jeff Englander - Standard & Poor’s

Can you talk or maybe give us a little bit more color on the additional pull-back in the development pipeline kind of since July? I know you’ve talked about the capital markets that they’ve been fairly volatile and relatively ceased up for a while but can you talk about other factors in addition to the credit market that may have contributed to the decision?

Mark S. Ordan

As I said earlier, the actual size of the pipeline and timing of the pipeline; there’s a lot of factors. Capital market’s one of them. Looking at the projects project-by-project based on zoning. There are so many other factors that are involved. There’s not a major reason when we said that the pipeline would decline by 50%. It’s by some order of magnitude a greater decline that that just because it’s hard to be particularly precise. It’s not that our thinking has changed over the last few weeks. It’s just something that we actively manage and try to be opportunistic about.

Jeff Englander - Standard & Poor’s

Can you give any sense of how confident you feel that that number should stay in this range going forward?

Mark S. Ordan

No, not really. I’d say that we’re comfortable obviously with the pace that we’re at right now but since we see this as a great value driver and a core competency of the company, we’re anxious to do more o fit. You balance that with the availability of capital and the availability of sites. As Paul said, we have a lot of sites but these things are a moving target. Part of the reason that we do have to maintain a strong team. You can’t just turn these things on and off with a switch. So I’m not prepared right now to say what our going forward pace will be. We will update you as we move forward.

Operator

Our next question comes from Analyst for Frank Morgan - Jefferies & Co.

Analyst for Frank Morgan - Jefferies & Co.

G&A I thought I heard $120 million and $140 million as a more normalized run rate. What was that number again?

Mark S. Ordan

The two numbers you heard is that the run rate for this year is about $140 million and the target that we have in 2009 is $120 million.

Analyst for Frank Morgan - Jefferies & Co.

On the loss of the management contracts, would that be going into discontinued ops in the third quarter or will those roll off as you lose them?

Richard J. Nadeau

That would probably be accounted for in the period that the loss occurs if we determine that discontinued operations accounting is required. As you know there has been some discussion about giving some more relief on that so that no everything is discontinued operations. It was obviously very difficult for hotel companies to show discontinued operations every quarter as they disposed of individual hotels. We will look at it from a materiality standpoint and discuss it with our auditors. But if we do report it as disco ops, it’ll probably come in at the end of the year.

Operator

That does conclude our question and answer session.

Paul J. Klaassen

I’d like to thank everybody for joining us and we look forward to updating you again in about early November, in less than 60 days. Thanks again.

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