EX-99.3 4 ex993.htm EXHIBIT 99.3 Exhibit 99.3
EXHIBIT 99.3
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS
(in thousands)

   
March 31, 2007
    
December 31, 2006
  
   
(unaudited)
    
(Note 1)
  
Current assets:
            
Cash and cash equivalents
$
99,670
  
$
131,935
  
Restricted cash
  
28,081
    
32,752
  
Accounts receivable, net of allowance for doubtful accounts of $24,880
            
and $24,866 at March 31, 2007 and December 31, 2006,
            
respectively
  
114,499
    
117,091
  
Inventories, net
  
4,728
    
4,808
  
Other receivables, net of allowance of $2,412 and $3,064 at
            
March 31, 2007 and December 31, 2006, respectively
  
1,736
    
2,211
  
Assets held for sale
  
4,500
    
7,172
  
Prepaid expenses
  
8,031
    
3,305
  
             
Total current assets
  
261,245
    
299,274
  
             
Property and equipment, net of accumulated depreciation of $52,028 and
            
$48,233 at March 31, 2007 and December 31, 2006, respectively
  
221,324
    
217,544
  
Intangible assets, net of
            
accumulated amortization of $7,216 and $6,799 at
            
March 31, 2007 and December 31, 2006, respectively
  
12,309
    
13,691
  
Goodwill
  
54,605
    
55,092
  
Restricted cash, non-current
  
33,033
    
29,083
  
Other assets, net
  
7,146
    
6,739
  
             
Total assets
$
589,662
  
$
621,423
  


See accompanying notes.

1

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (CONTINUED)

LIABILITIES AND STOCKHOLDERS' EQUITY
(in thousands, except share data)


   
March 31, 2007
    
December 31, 2006
  
   
(unaudited)
    
(Note 1)
  
Current liabilities:
            
Accounts payable
$
39,090
  
$
43,400
  
Accrued compensation and benefits
  
40,663
    
42,723
  
Accrued self-insurance obligations, current portion
  
40,281
    
48,689
  
Income taxes payable
  
9,135
    
8,799
  
Liabilities held for sale
  
1,826
    
1,672
  
Other accrued liabilities
  
34,143
    
33,736
  
Current portion of long-term debt:
            
Company obligations
  
12,815
    
22,780
  
Clipper partnerships
  
786
    
736
  
Capital leases, current
  
618
    
494
  
             
Total current liabilities
  
179,357
    
203,029
  
             
Accrued self-insurance obligations, net of current portion
  
89,121
    
81,559
  
Long-term debt, net of current portion:
           
Company obligations
  
80,396
    
100,067
  
Clipper partnerships
  
49,181
    
49,392
  
Capital leases, net of current
  
776
    
696
  
Unfavorable lease obligations, net of accumulated amortization of $14,128
            
and $13,558 at March 31, 2007 and December 31, 2006, respectively
  
12,786
    
13,423
  
Other long-term liabilities
  
26,914
    
26,712
  
Deferred income taxes
  
2,412
    
2,412
  
             
Total liabilities
  
440,943
    
477,290
  
             
Commitments and contingencies
            
             
Stockholders' equity:
            
Preferred stock of $.01 par value, authorized
            
10,000,000 shares, no shares were issued or outstanding as of
            
March 31, 2007 and December 31, 2006
  
-
    
-
  
Common stock of $.01 par value, authorized
            
50,000,000 shares, 42,939,602 shares issued and 42,929,420 shares
            
outstanding as of March 31, 2007 and 42,889,918 shares issued
            
and 42,879,736 shares outstanding as of December 31, 2006
  
429
    
429
  
Additional paid-in capital
  
553,938
    
553,275
  
Accumulated deficit
  
(405,557
)
  
(409,480
)
   
148,810
    
144,224
  
Less:
            
Common stock held in treasury, at cost, 10,182 shares
            
   as of March 31, 2007 and December 31, 2006
  
(91
)
  
(91
)
Total stockholders' equity
 
148,719
    
144,133
  
Total liabilities and stockholders' equity
$
589,662
  
$
621,423
  

See accompanying notes.

2

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)

   
For the
  
   
Three Months Ended
  
   
March 31, 2007
    
March 31, 2006
  
   
(unaudited)
    
(unaudited)
  
         
(Note 1)
  
             
Total net revenues
$
273,569
  
$
256,756
  
Costs and expenses:
            
Operating salaries and benefits
  
156,426
    
146,920
  
Self-insurance for workers' compensation and general and
            
professional liability insurance
  
10,564
    
12,672
  
Operating administrative expenses
  
7,591
    
7,874
  
Other operating costs
  
56,612
    
55,465
  
Facility rent expense
  
14,379
    
13,390
  
General and administrative expenses
  
12,832
    
11,645
  
Depreciation and amortization
  
3,920
    
2,867
  
Provision for losses on accounts receivable
  
2,440
    
1,448
  
Interest, net
  
2,059
    
4,367
  
Loss on extinguishment of debt, net
  
19
    
-
  
Loss on sale of assets, net
  
7
    
13
  
Total costs and expenses
  
266,849
    
256,661
  
             
Income before income taxes and discontinued operations
  
6,720
    
95
  
Income tax expense (benefit)
  
2,368
    
(727
)
Income from continuing operations
  
4,352
    
822
  
             
Discontinued operations:
            
(Loss) income from discontinued operations, net of related taxes
  
(79
)
  
383
  
Loss on disposal of discontinued operations, net of related taxes
  
(350
)
  
(66
)
(Loss) income from discontinued operations, net
  
(429
)
  
317
  
             
Net income
$
3,923
  
$
1,139
  
             
Basic earnings per common and common equivalent share:
            
Income from continuing operations
$
0.10
  
$
0.03
  
(Loss) income from discontinued operations, net
  
(0.01
)
  
0.01
  
Net income
$
0.09
  
$
0.04
  
             
Diluted earnings per common and common equivalent share:
            
Loss from continuing operations
$
0.10
  
$
0.03
  
(Loss) income from discontinued operations, net
  
(0.01
)
  
0.01
  
Net income
$
0.09
  
$
0.04
  
             
Weighted average number of common and common
            
equivalent shares outstanding:
            
Basic
  
42,908
    
31,174
  
Diluted
  
44,029
    
31,228
  

See accompanying notes.

3

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

   
For the
  
   
Three Months Ended
  
   
March 31, 2007
    
March 31, 2006
  
   
(unaudited)
    
(unaudited)
  
Cash flows from operating activities:
            
Net income
$
3,923
  
$
1,139
  
Adjustments to reconcile net income to net cash provided by
            
(used for) operating activities, including discontinued
            
operations:
            
Depreciation
  
2,434
    
1,613
  
Amortization
  
1,522
    
1,636
  
Amortization of favorable and unfavorable lease intangibles
  
(213
)
  
(379
)
Provision for losses on accounts receivable
  
2,523
    
1,948
  
Loss (gain) on disposal of discontinued operations, net
  
350
    
66
  
Loss on sale of assets
  
7
    
13
  
Restricted stock and stock option compensation
  
750
    
544
  
Other, net
  
2
    
25
  
Changes in operating assets and liabilities, net of acquisitions:
            
Accounts receivable, net
  
(2,050
)
  
(11,318
)
Inventories, net
  
-
    
(14
)
Other receivables, net
  
537
    
(3,186
)
Restricted cash
  
721
    
119
  
Prepaids and other assets
  
(6,558
)
  
(6,167
)
Accounts payable
  
(3,925
)
  
1,705
  
Accrued compensation and benefits
  
(1,666
)
  
67
  
Accrued self-insurance obligations
  
(846
)
  
3,404
  
Income taxes payable
  
2,426
    
1,856
  
Other accrued liabilities
  
1,230
    
(800
)
Other long-term liabilities
  
404
    
610
  
Net cash provided by (used for) operating activities
  
1,571
   
(7,119
)
             
Cash flows from investing activities:
            
Capital expenditures
  
(7,250
)
  
(3,333
)
Proceeds from sale of assets held for sale
  
3,238
    
-
  
Acquisitions, net
  
-
    
(236
)
Proceeds from sale/leaseback
  
-
    
838
  
Net cash used for investing activities
  
(4,012
)
  
(2,731
)
             
Cash flows from financing activities:
            
Net borrowings under Revolving Loan Agreement
  
6
    
17,720
  
Long-term debt repayments
  
(29,607
)
  
(7,694
)
Principal payments under capital lease obligations
  
(540
)
  
-
  
Net proceeds from exercise of employee stock options
  
573
    
-
  
Distribution of partnership equity
  
(256
)
  
(123
)
Net cash (used for) provided by financing activities
  
(29,824
)
  
9,903
  
             
Net (decrease) increase in cash and cash equivalents
  
(32,265
)
  
53
  
Cash and cash equivalents at beginning of period
  
131,935
    
16,641
  
Cash and cash equivalents at end of period
$
99,670
  
$
16,694
  

See accompanying notes.
4
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)  Nature of Business

References throughout this document to the Company include Sun Healthcare Group, Inc. and our direct and indirect consolidated subsidiaries. In accordance with the Securities and Exchange Commission’s “Plain English” guidelines, this report has been written in the first person. In this document, the words “we,” “our,” “ours,” and “us” refer to Sun Healthcare Group, Inc. and its direct and indirect consolidated subsidiaries and not any other person.

Business

We are a provider, through our subsidiaries, of long-term, subacute and related specialty healthcare in the United States. We operate through three principal business segments: (i) inpatient services, (ii) rehabilitation therapy services, and (iii) medical staffing services. Inpatient services represent the most significant portion of our business. We operated 141 long-term care facilities in 19 states as of March 31, 2007.

Other Information

The accompanying unaudited consolidated financial statements have been prepared in accordance with our customary accounting practices and accounting principles generally accepted in the United States for interim financial statements. In our opinion, the accompanying interim consolidated financial statements present fairly our financial position at March 31, 2007, and the consolidated results of our operations and cash flows for the three-month periods ended March 31, 2007 and 2006, respectively. We believe that all adjustments are of a normal and recurring nature with the exception of certain purchase accounting adjustments made in accordance with the provisions of Statement of Financial Accounting Standards No. 141, Business Combinations (“SFAS No. 141”) (see “Note 2 - Acquisitions”). These statements are unaudited, and certain information and footnote disclosures normally included in our annual consolidated financial statements have been condensed or omitted, as permitted under the applicable rules and regulations. Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2006, which are included in our Annual Report on Form 10-K for the year ended December 31, 2006 (the “2006 Form 10-K”).

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include determination of third-party payor settlements, allowances for doubtful accounts, self-insurance obligations, loss accruals, and income taxes. Actual results could differ from those estimates.

Significant Accounting Policy - Income Taxes

In accordance with Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes (“SFAS No. 109”), deferred tax assets and liabilities are recorded for tax carryforwards and the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting and income tax purposes using enacted tax laws and rates. A valuation allowance is provided on our net deferred tax assets if it is determined that it is more likely than not that the net deferred tax assets will not be realized. FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (“FIN 48”) prescribes a recognition threshold and measurement parameters for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

In accordance with SFAS No. 109, Accounting Principles Board Opinion No. 28, Interim Financial Reporting (“APB No. 28”), and FASB Interpretation No. 18, Accounting for Income Taxes in Interim Periods (“FIN 18”), as of each reporting period, we estimate an effective income tax rate that is expected to be applicable for the full fiscal year. The estimate of our effective income tax rate requires significant judgments regarding any utilization of deferred tax assets and the reduction in the related valuation allowance. Any reduction in the portion of the valuation allowance that was established in fresh-start accounting when we emerged from bankruptcy in February 2002 will first reduce any remaining intangible assets recorded in fresh-start accounting, with any excess being treated as an increase to capital in excess of par value. Any reduction in the
5

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

portion of the valuation allowance that was established after our emergence from bankruptcy will result in a reduction of our income tax expense.

Our effective tax rate is also influenced by the recognition and derecognition of tax positions pursuant to the more likely than not standard established by FIN 48 that such positions will be sustained by the taxing authority. In addition, other factors such as changes in tax laws, rulings by taxing authorities and court decisions, and significant changes in our operations through acquisitions or divestitures, can have a material impact on the effective tax rate. Differences between our estimated and actual effective income tax rates and related liabilities are recorded in the period they become known.

Reclassifications and Adjustments

Certain reclassifications of assets, liabilities, income and expense have been made to the prior period financial statements to conform to the 2007 financial statement presentation. Specifically, we have reclassified the results of operations of material divestitures subsequent to December 31, 2006 (see “Note 5 - Discontinued Operations and Assets and Liabilities Held for Sale”) for all periods presented to discontinued operations within the Statement of Operations, in accordance with accounting principles generally accepted in the United States.

As discussed in our 2006 Form 10-K, we recorded a $2.5 million non-cash charge to pre-tax earnings for the twelve months ended December 31, 2006, to account for certain lease rate escalation clauses pursuant to the adoption of the SEC Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements (“SAB 108”). Consistent with the requirements of SAB 108, this adjustment has been allocated to the appropriate 2006 quarter in the accompanying consolidated financial statements.

(2)  Acquisitions

Harborside

In October 2006, we entered into an agreement to acquire all of the outstanding stock of Harborside Healthcare Corporation (“Harborside”), a privately-held healthcare company based in Boston, Massachusetts that operates 73 skilled nursing facilities, one assisted living facility and one independent living facility with approximately 9,000 licensed beds in ten states. On April 19, 2007, we completed the acquisition of Harborside effective April 1, 2007. In connection with the acquisition of Harborside, we entered into a $485.0 million new senior secured credit facility with a syndicate of financial institutions led by Credit Suisse as the administrative agent and collateral agent (the “Credit Agreement”). The proceeds from the Credit Agreement, plus cash on hand and the net proceeds from our issuance on April 12, 2007, of $200.0 million aggregate principal amount of 9-1/8% Senior Subordinated Notes due 2015, were used to purchase all of the outstanding stock of Harborside for $349.4 million, refinance certain of the debt of Harborside and replace our prior revolving credit facility. The Credit Agreement, which provides for an initial interest rate of the London Interbank Offered Rate (“LIBOR”) plus 2%, also will provide funds for previously-exercised options related to the purchase of nine skilled nursing centers, as well as additional liquidity and a letter of credit facility. See “Note 3 - Loan Agreements.”

(3)  Loan Agreements

In December 2005, we entered into an Amended and Restated Loan and Security Agreement (the “Revolving Loan Agreement”) with CapitalSource Finance LLC, as collateral agent, and certain lenders, which amended and restated an existing revolving credit facility. The Revolving Loan Agreement, among other things, provided for up to $100.0 million of borrowing availability and was scheduled to terminate on January 31, 2009. The interest rate on borrowings equals 2.75%, which percentage is subject to adjustment based on our fixed charge coverage ratio plus the greater of (i) 4.31% or (ii) (a) a floating rate equal to LIBOR for one month adjusted daily or (b), at our option, a rate that is fixed for a period of 30, 60 or 90 days equal to LIBOR two days prior to the commencement of such period. The Revolving Loan Agreement is secured by almost all of our assets.

Availability of amounts under the Revolving Loan Agreement was subject to compliance with financial covenants. Our borrowing availability under the Revolving Loan Agreement was generally limited to up to eighty-five percent (85%) of the value of our accounts receivable that are deemed eligible pursuant to the Revolving Loan Agreement but not to exceed $100.0 million. The defined borrowing base as of March 31, 2007 was $81.4 million, net of specified reserves of $6.4 million.

6

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
As of March 31, 2007, we had $10.0 million in borrowings outstanding, $14.6 million in letters of credit and $56.8 million available to us for additional borrowing.

The Revolving Loan Agreement was terminated on April 19, 2007, when we entered into the Credit Agreement in connection with the acquisition of Harborside (see “Note 2 - Acquisitions”). The Credit Agreement, which is secured by substantially all of our assets, provides for $310.0 million in term loans, $55.0 million in delayed draw term loans, a $50.0 million revolving credit facility and a $70.0 million letter of credit facility. Availability of amounts under the revolving credit facility is subject to compliance with financial covenants including an interest coverage test, a total leverage covenant and a senior leverage covenant. The Credit Agreement contains customary events of default, such as our failure to make payment of amounts due, defaults under other agreements evidencing indebtedness, certain bankruptcy events and a change of control (as defined in the Credit Agreement). The Credit Agreement also contains customary covenants restricting, among other things, incurrence of indebtedness, liens, payment of dividends, repurchase of stock, acquisitions and dispositions, mergers and investments.

(4)  Long-Term Debt and Capital Lease Obligations

Long-term debt and capital lease obligations consisted of the following as of the periods indicated (in thousands):

   
March 31, 2007
    
December 31, 2006
  
             
Revolving loan agreement
$
10,000
  
$
10,000
  
Mortgage notes payable due at various dates through 2037, interest at rates
            
from 5.5% to 10.8%, collateralized by various facilities (1)(2)
  
133,178
    
153,627
  
Capital leases (3)
  
1,394
    
1,190
  
Industrial revenue bonds
  
-
    
4,655
  
Other long-term debt
  
-
    
4,693
  
Total long-term obligations
 
144,572
    
174,165
  
Less amounts due within one year
  
(14,219
)
  
(24,010
)
Long-term obligations, net of current portion
$
130,353
  
$
150,155
  

(1)
Includes fair value premium of $0.3 million related to the acquisition of Peak Medical Corporation (“Peak”) in December 2005.
(2)
Includes $50.0 million and $50.1 million related to the consolidation of Clipper as of March 31, 2007 and December 31, 2006, respectively (see “Note 6 - Variable Interest Entities”).
(3)
Excludes $0.8 million reclassified to liabilities held for sale (See “Note 5 - Discontinued Operations and Assets and Liabilities Held for Sale”).

The scheduled or expected maturities of long-term debt, excluding premiums, as of March 31, 2007, were as follows (in thousands):

     
2008
$
14,219
2009
  
23,796
2010
  
3,551
2011
  
11,368
2012
  
32,141
Thereafter
  
59,200
 
$
144,275

Included in the expected maturities of long-term debt are the following amounts related to the consolidation of Clipper, (in thousands): $786, $845, $902, $962, $1,020, and $45,451 for 2008, 2009, 2010, 2011, 2012 and thereafter, respectively (see “Note 6 - Variable Interest Entities”).

7

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(5) Discontinued Operations and Assets and Liabilities Held for Sale

(a) Discontinued Operations

In accordance with the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), the results of operations of assets to be disposed of, disposed assets and the gains (losses) related to these divestitures have been classified as discontinued operations for all periods presented in the accompanying consolidated statements of operations.

Inpatient Services: We sold a skilled nursing facility for $1.6 million in the fourth quarter of 2006. Although the sale of the facility was final, we continued to operate the facility in the first quarter of 2007 as the new owner was still in the process of obtaining licensure. The result of such operations was included in our discontinued operations for the first quarter of 2007. During the first quarter of 2007, we sold another skilled nursing facility for $4.9 million. The facility was reclassified as held for sale with a carrying amount of $3.7 million and we recorded a net loss of $0.5 million.

Home Health Services: In December 2006, we sold SunPlus Home Health Services (“SunPlus”), for a purchase price of $19.3 million.

(b) Assets and Liabilities Held for Sale

As of March 31, 2007, assets held for sale consisted of (i) SunAlliance, our remaining laboratory and radiology services operations, with a net carrying amount of $1.8 million, consisting of $3.6 million in assets, offset in part by $1.8 million in liabilities, and (ii) an undeveloped parcel of land valued at $0.9 million, which is classified in our Corporate segment in our consolidated financial statements. SunAlliance was sold on April 30, 2007, for $2.5 million plus a working capital adjustment yet to be determined.

As of December 31, 2006, assets held for sale consisted of (i) SunAlliance with a net carrying amount of $0.9 million, consisting of $1.7 million in assets, offset in part by $0.8 million in liabilities, (ii) a skilled nursing facility with a carrying amount of $3.8 million, consisting of $4.6 million in assets, offset in part by $0.8 million in liabilities, and (iii) an undeveloped parcel of land valued at $0.9 million, which is classified in our Corporate segment in our consolidated financial statements.

A summary of the discontinued operations for the periods presented is as follows (in thousands):

   
For the
  
   
Three Months Ended
  
   
March 31, 2007
  
   
Inpatient
    
Pharmaceutical
    
Laboratory/
    
Home
              
   
Services
    
Services
    
Radiology
    
Health
    
Other
    
Total
  
                                     
Net operating revenues
$
2,815
  
$
-
  
$
4,120
  
$
-
  
$
4,139
  
$
11,074
  
                                     
(Loss) income from discontinued
                                    
operations, net(1)
$
(425
)
$
16
  
$
236
  
$
5
  
$
89
  
$
(79
)
(Loss) gain on disposal of
                                    
discontinued operations, net(2)
  
(376
)
  
(14
)
  
-
    
41
    
(1
)
  
(350
)
(Loss) income on discontinued
                                    
operations, net
$
(801
)
$
2
  
$
236
  
$
46
  
$
88
  
$
(429
)

(1)  Net of related tax benefit of $43
(2)  Net of related tax benefit of $190


8

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


   
For the
  
   
Three Months Ended
  
   
March 31, 2006
  
   
Inpatient
    
Pharmaceutical
    
Laboratory/
    
Home
              
   
Services
    
Services
    
Radiology
    
Health
    
Other
    
Total
  
                                     
Net operating revenues
$
5,344
  
$
-
  
$
3,689
  
$
15,467
  
$
5,758
  
$
30,258
  
                                     
(Loss) income from discontinued
$
(445
)
$
-
  
$
(179
)
$
4
  
$
1,003
  
$
383
  
operations, net(1)
                                    
Loss on disposal of
                                    
discontinued operations, net 
  
(51
)
  
(8
)
  
(6
)
  
-
    
(1
)
  
(66
)
(Loss) income on discontinued
                                    
operations, net
$
(496
)
$
(8
)
$
(185
)
$
4
  
$
1,002
  
$
317
  

(1)  Net of related tax expense of $215


(6)  Variable Interest Entities

In December 2003, the FASB issued a revision to Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN No. 46R”), which was originally issued in January 2003. FIN No. 46R provides guidance on the consolidation of certain entities when control exists through means other than ownership of voting (or similar) interests and was effective for public entities that have interests in variable interest entities commonly referred to as special purpose entities for the first reporting period that ends after March 15, 2004. FIN No. 46R requires consolidation by the majority holder of expected residual gains and losses of the activities of a variable interest entity (“VIE”).

As of March 31, 2007, we currently owned less than 16% of the voting interest in nine entities (collectively known as “Clipper”), each of which owns one facility that we operate in New Hampshire. Clipper's objective is to achieve rental income from the leasing of its facilities. In April 2004, we entered into an agreement with the owners of the remaining interests in those nine entities. That agreement granted us options, exercisable sequentially over a period of seven years, pursuant to which we can acquire 100% of the ownership of those nine entities for an aggregate amount of up to $10.3 million. We have paid an aggregate option purchase price for the first three option exercises of $0.9 million through March 31, 2007. The agreement also provides the owners the right to require us to purchase those ownership interests at the above described option prices. These put rights can be exercised for any options that have come due but which were not exercised up to that point in time, but no later than December 31, 2010.

We have concluded that Clipper, as identified above, meets the definition of a VIE because we have agreements with the majority owners granting to us the option to acquire, and to the owners, the right to put to us, 100% ownership of Clipper. We have recognized $9.3 million of the option value in other long-term liabilities in our consolidated balance sheets. The remaining $0.4 million is recorded as current in other accrued liabilities in our consolidated balance sheets. We have not recorded any minority interest associated with the 84% interest in which we do not own since the partnerships' net equity was a deficit and as the primary beneficiary, we would be responsible for all of their losses. Pursuant to FIN No. 46R, we have eliminated facility rent expense of $0.4 million and $0.9 million for each of the three months ended March 31, 2007 and 2006, respectively, and included $50.0 million and $50.1 million of mortgage debt of Clipper in our consolidated balance sheets as of March 31, 2007 and December 31, 2006, respectively, although we own less than 16% of the voting interest in the Clipper properties and are not directly obligated on the debt. The debt is collateralized by the fixed assets of the respective partnerships and limited liability companies that own the Clipper properties and none of our assets. Creditors do not have any general recourse against us for the mortgage debt.

The following provides a summary of the balance sheet impact of Clipper upon consolidation as of March 31, 2007 and December 31, 2006 (in thousands):
9
 
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
   
March 31, 2007
    
December 31, 2006
  
             
Current assets:
            
Cash and cash equivalents
$
638
  
$
546
  
Other receivables
  
138
    
565
  
Restricted cash, current
  
996
    
767
  
Prepaids and other assets
  
57
    
126
  
Total current assets
  
1,829
    
2,004
  
             
Property and equipment, net:
            
Land
  
6,171
    
6,171
  
Land improvements
  
33
    
34
  
Buildings
  
34,803
    
35,034
  
Building improvements
  
2,971
    
2,830
  
Equipment
  
176
    
185
  
Construction-in-process
  
-
    
-
  
Total property and equipment, net
  
44,154
    
44,254
  
             
Favorable lease intangibles, net
  
8,594
    
9,122
  
Intercompany
  
4,836
    
4,836
  
             
Total assets
$
59,413
  
$
60,216
  
Current liabilities:
            
Mortgages, current
$
786
  
$
736
  
Other accrued liabilities
  
677
    
597
  
Total current liabilities
  
1,463
    
1,333
  
             
Mortgages, net of current
  
49,181
    
49,392
  
Other long-term liabilities
  
16,834
    
16,464
  
Total long-term liabilities
  
66,015
    
65,856
  
             
Total liabilities
  
67,478
    
67,189
  
             
Stockholders' deficit:
            
Accumulated deficit
  
(8,065
)
  
(6,973
)
             
Total liabilities and stockholders' deficit
$
59,413
  
$
60,216
  

For the three months ended March 31, 2007, the consolidation of Clipper resulted in the recording in our financial statements of a net loss of $0.5 million comprised of a $0.6 million charge to interest expense, and a $0.4 million charge to depreciation expense, partially offset by a $0.4 million credit to rent expense and a $0.1 million credit to taxes and other expense. For the three months ended March 31, 2006, the consolidation of Clipper included a net loss of $0.4 million comprised of a $1.0 million charge to interest expense, and a $0.3 million charge to depreciation expense, partially offset by a $0.9 million credit to rent expense.

(7)  Commitments and Contingencies

(a)  Insurance

We self-insure for certain insurable risks, including general and professional liability, workers' compensation liability and employee health insurance liability, through the use of self-insurance or retrospective and self-funded insurance policies and other hybrid policies, which vary by the states in which we operate. There is a risk that amounts funded to our self-insurance programs may not be sufficient to respond to all claims asserted under those programs. Provisions for estimated reserves, including incurred but not reported losses, are provided in the period of the related coverage. These provisions are

10

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
based on actuarial analyses, internal evaluations of the merits of individual claims, and industry loss development factors or lag analyses. The methods of making such estimates and establishing the resulting reserves are reviewed periodically and are based on historical paid claims information and nationwide nursing home trends. Any resulting adjustments are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.

Prior to January 1, 2000, the maximum loss exposure with respect to the third-party insurance policies was $100,000 per claim for general and professional liability. Since January 2000, we have relied upon self-funded insurance programs for general and professional liability claims up to a base amount per claim and an aggregate per location, and have obtained excess insurance policies for claims above those amounts. The programs had the following self-insured retentions: (i) for events occurring from January 1, 2000 to December 31, 2002, $1.0 million per claim, and $3.0 million aggregate per location, (ii) for claims made in 2003, $10.0 million per claim with excess coverage above this level, and (iii) for claims made in 2004, 2005, 2006, and 2007, $5.0 million per claim with a $5.0 million excess layer that attaches at $5.0 million of liability and a $40.0 million excess layer that attaches at $10.0 million of liability. For locations, other than in the state of Oklahoma, acquired as part of our acquisition of Peak in December 2005, claims reported from 2003 until the acquisition date were covered by commercial insurance programs having limits of $1.0 million per occurrence/$3.0 million annual aggregate and featuring a $100,000 per occurrence deductible. Peak locations in Oklahoma had no insurance coverage in effect. Former Peak locations, including Oklahoma operations, were added to our general and professional liability programs effective December 9, 2005.

An independent actuarial analysis is prepared twice a year, in June and December, in order to determine the expected losses and reserves for estimated settlements for general and professional liability under the per claim retention level, including incurred but not reported losses. Claims paid for the three months ended March 31, 2007 and March 31, 2006 were $4.8 million and $5.7 million, respectively.

The majority of our workers' compensation risks are insured through high-retention insurance policies with third parties. Our reserves are estimated by independent actuaries beginning with the 1998 policy year and by company analysis using industry development factors for prior years. Effective with the policy period beginning January 1, 2002, we discount our workers' compensation reserves based on a 4% discount rate. Claims paid for the three months ended March 31, 2007 and March 31, 2006 were $3.5 million and $5.9 million, respectively.

The provision for insurance risks was as indicated (in thousands):

   
For the
  
   
Three Months Ended
  
   
March 31, 2007
    
March 31, 2006
  
             
Professional Liability:
            
Continuing operations
$
6,432
  
$
7,433
  
Discontinued operations
  
108
    
346
  
 
$
6,540
  
$
7,779
  
             
Workers' Compensation:
            
Continuing operations
$
4,132
  
$
5,239
  
Discontinued operations
  
162
    
677
  
 
$
4,294
  
$
5,916
  
 
A summary of the assets and liabilities related to insurance risks at March 31, 2007 and December 31, 2006 is as indicated (in thousands):
 
11

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
 
   
March 31, 2007
      
December 31, 2006
  
   
Professional
    
Workers'
        
|
  
Professional
    
Workers'
        
   
Liability
    
Compensation
    
Total
  
|
  
Liability
    
Compensation
    
Total
  
Assets (1):
                  
|
                  
Restricted cash
                  
|
                  
Current
$
3,363
  
$
17,807
  
$
21,170
  
|
$
4,311
  
$
21,073
  
$
25,384
  
Non-current
  
-
    
29,923
    
29,923
  
|
  
-
    
25,977
    
25,977
  
Total
$
3,363
  
$
47,730
  
$
51,093
  
|
$
4,311
  
$
47,050
  
$
51,361
  
                   
|
                  
Liabilities (2)(3):
                  
|
                  
Self-insurance
                  
|
                  
liabilities
                  
|
                  
Current
$
19,957
  
$
17,096
  
$
37,053
  
|
$
23,967
  
$
21,073
  
$
45,040
  
Non-current
  
54,910
    
34,211
    
89,121
  
|
  
51,111
    
30,448
    
81,559
  
Total
$
74,867
  
$
51,307
  
$
126,174
  
|
$
75,078
  
$
51,521
  
$
126,599
  

(1)
  
Total restricted cash excluded $10,021 and $10,474 at March 31, 2007 and December 31, 2006, respectively, held for bank collateral, various mortgages, bond payments and reserves for capital expenditures required by HUD guaranteed mortgages.
     
(2)
  
Total self-insurance liabilities in the table excluded $3,228 and $3,649 at March 31, 2007 and December 31, 2006, respectively, related to our health insurance liabilities.
     
(3)
  
Total self-insurance liabilities are collateralized, in addition to the restricted cash, by letters of credit of $750 and $11,322 for general and professional liability insurance and workers' compensation, respectively, as of March 31, 2007 and $750 and $10,694 for general and professional liability insurance and workers' compensation, respectively, as of December 31, 2006.

(8)  Capital Stock

(a)  Common Stock

As of March 31, 2007, we had issued 42,939,602 shares, inclusive of 10,182 treasury shares. The shares issued included (i) 9,972,777 shares issued in connection with the extinguishment of liabilities subject to compromise pursuant to our Plan of Reorganization implemented in connection with our emergence from Chapter 11 bankruptcy proceedings in 2002 (“Plan of Reorganization”), (ii) 4,425,232 shares issued in a private placement of our common stock in February 2004, (iii) 760,000 shares issued in payment of deferred rent as part of our restructuring plan initiated in 2003, (iv) 8,871,890 shares issued in connection with the acquisition of Peak, (v) 6,900,000 shares issued in a public offering in December 2005, (vi) 11,500,000 shares issued in a public offering in December 2006, and (vii) 509,703 shares issued pursuant to stock options and stock awards to our employees and directors.

(b)  Warrants

In February 2004, in conjunction with our private equity offering, we issued warrants to purchase 2,017,897 shares of our common stock, of which 1,707,924 shares have a strike price of $12.65, 62,160 shares have a strike price of $12.82, and 247,813 shares have a strike price of $15.87. The warrants expire in February 2009.

(c)  Equity Incentive Plans

Our 2004 Equity Incentive Plan (the “2004 Plan”), as amended, allows for the issuance of up to 5.6 million shares of our common stock. Restricted stock awards are outright stock grants. Option awards are granted with an exercise price equal to the market price of our stock at the date of grant; those option awards generally vest based on four years of continuous service and have seven-year contractual terms. Share awards generally vest over four years and no dividends are paid on unexercised options or unvested share awards. Pursuant to the 2004 Plan, certain option and share awards provide for accelerated vesting if there is a change in control (as defined in the 2004 Plan).

12

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

    Pursuant to the 2004 Plan, as of March 31, 2007, our employees and directors held options to purchase 1,783,515 shares of common stock, 10,398 shares of unvested restricted common stock, and 945,043 unvested restricted stock units. As of March 31, 2007, 31,193 shares of restricted common stock valued at $11.25 per share were held by our executive officers and key employees. During the three months ended March 31, 2007, we issued 86,809 shares of common stock upon the vesting of restricted stock shares, restricted stock units and the exercise of stock options.

As of March 31, 2007, our directors held options to purchase 20,000 shares under our 2002 Non-employee Director Equity Incentive Plan (the “Director Plan”). Upon the adoption of the 2004 Plan, the grant of further awards under the Director Plan was suspended so that no additional awards could be made under the Director Plan.

Upon our acquisition of Peak, we assumed the Peak 1998 Stock Incentive Plan (the “Peak Plan”).  As of March 31, 2007, our employees held options to purchase 15,369 shares of common stock under the Peak Plan, and 85,468 shares had been issued upon the exercise of stock options.  No additional awards will be made under the Peak Plan.

All share-based payments to employees, including grants of employee stock options, are recognized in the statement of operations based on their fair values. Pursuant to Statement of Financial Accounting Standard No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”), cash flows resulting from the tax benefits in excess of the compensation cost recognized for employee stock options (excess tax benefits) are to be classified as financing cash flows; however, since we have a net operating loss carryforward that is increased by any excess tax benefit, the tax benefit will not be recognized until the deduction actually reduces current taxes payable. As of March 31, 2007, total unrecognized compensation cost related to stock option awards was $4.4 million and the related weighted-average period over which it is expected to be recognized is approximately 2.7 years. Recognition of share based payments at fair value reduced income before income taxes and discontinued operations, and net income, for the three months ended March 31, 2007 and March 31, 2006 by $.4 million and $.2 million, respectively. Basic and diluted earnings per share were $0.09 and $0.04 for the three months ended March 31, 2007 and March 31, 2006, respectively.

A summary of option activity under the 2004 Plan, the Director Plan, and the Peak Plan during the three months ended March 31, 2007 is presented below:

               
Weighted
        
               
Average
    
Aggregate
  
         
Weighted
    
Remaining
    
Intrinsic
  
   
Shares
    
Average
    
Contractual
    
Value
  
Options
  
(in thousands)
    
Exercise Price
    
Term
    
(in thousands)
  
Outstanding at January 1, 2007
  
1,492
  
$
7.52
    
-
    
-
  
Granted
  
418
    
12.36
    
-
    
-
  
Exercised
  
(70
)
  
7.48
    
-
    
-
  
Forfeited or expired
  
(21
)
  
7.52
    
-
    
-
  
Outstanding at March 31, 2007
  
1,819
  
$
8.62
    
5 years
  
$
6,785
  
                         
Exercisable at March 31, 2007
  
650
  
$
7.42
    
5 years
  
$
3,206
  
                         

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table. Expected volatility is based on the historical volatility of our stock. The expected term of options granted is derived using a temporary “shortcut approach” for our “plain vanilla” employee stock options. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term. The risk-free rate for the period within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The weighted-average grant-date fair value of stock options granted during the three months ended March 31, 2007 and 2006 was $6.31 and $3.44, respectively.

Expected volatility
55.47% - 80.62%
Weighted-average volatility
65.36%
Expected term (in years)
4.75
Risk-free rate
3.02% - 4.66%


13

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Compensation cost associated with the restricted stock awards granted to employees is recognized over the requisite service period with an offsetting credit to equity; the full fair value of the share-based payment is not recognized until the instrument is vested. A summary of restricted stock activity during the three months ended March 31, 2007 is as follows: 

         
Weighted-
  
         
Average
  
   
Shares
    
Grant-Date
  
Nonvested Shares
  
(in thousands)
    
Fair Value
  
             
Nonvested at January 1, 2007
  
587
  
$
7.92
  
Granted
  
418
  
$
12.36
  
Vested
  
(16
)
$
10.24
  
Forfeited
  
(33
)
$
7.91
  
Nonvested at March 31, 2007
  
956
  
$
9.82
  

The total fair value of restricted shares vested during the three months ended March 31, 2007 was $0.3 million, and $0.3 million for the three months ended March 31, 2006.

(9)  Net Income per Share

Basic net income per share is based upon the weighted average number of common shares outstanding during the period. The weighted average number of common shares for the three months ended March 31, 2007 and 2006, include all the common shares that are presently outstanding, common shares to be issued pursuant to our Plan of Reorganization, and the common shares issued as common stock awards. See “Note 8 - Capital Stock.”

The diluted calculation of income per common share includes the dilutive effect of warrants, stock options and non-vested restricted stock using the treasury stock method.

(10)  Income Taxes

The provision for income taxes was based upon our estimate of taxable income or loss for each respective accounting period. We recognized an asset or liability for the deferred tax consequences of temporary differences between the tax bases of assets and liabilities and their reported amounts in the financial statements. These temporary differences would result in taxable or deductible amounts in future years when the reported amounts of the assets are recovered or liabilities are settled. We also recognized as deferred tax assets the future tax benefits from net operating loss (“NOL”) and tax credit carryforwards. A valuation allowance was provided for deferred tax assets as it is more likely than not that some portion or all of the net deferred tax assets will not be realized.

The provision for income taxes of $2.4 million for the three months ended March 31, 2007 is based on a combined federal and state effective income tax rate of approximately 35%. This combined effective rate reflects the impact of both permanent differences and the reversal of our valuation allowance on our net deferred tax assets that were generated after our emergence from bankruptcy in February 2002. This rate is subject to change if assumptions relating to the allocation of tax attributes between pre- and post-emergence periods change or if our ability to use our deferred tax assets were to change. The current benefit for income taxes of $0.7 million for the three months ended March 31, 2006 consisted of $1.2 million of IRS refunds received due to NOL carrybacks and $0.5 million of provision for federal and state income taxes based on operations for that period.

In connection with the fresh-start accounting adopted in 2002, our assets and liabilities were recorded at their respective fair values. Deferred tax assets and liabilities were then recognized for the tax effects of the differences between fair values and tax bases. In addition, deferred tax assets were recognized for future tax benefits of NOL, capital loss and tax credit carryforwards, and a valuation allowance was recorded for the overall net increase in deferred tax assets recognized in connection with fresh-start accounting.
14

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

To the extent management believes the pre-emergence net deferred tax assets will more likely than not be realized, a reduction in the valuation allowance established in fresh-start accounting will be recorded. The reduction in this valuation allowance will first reduce any remaining intangible assets recorded in fresh-start accounting, with any excess being treated as an increase to capital in excess of par value. During the three months ended March 31, 2007, the fresh-start valuation allowance was reduced by $1.9 million, and remaining intangible assets recorded in fresh-start accounting were reduced accordingly.
 
Internal Revenue Code Section 382 imposes a limitation on the use of a company's NOL carryforwards and other losses when the company has an ownership change. In general, an ownership change occurs when shareholders owning 5% or more of a "loss corporation" (a corporation entitled to use NOL or other loss carryovers) have increased their ownership of stock in such corporation by more than 50 percentage points during any 3-year testing period beginning on the first day following the change date for an earlier ownership change. The annual base Section 382 limitation is calculated by multiplying the loss corporation's value at the time of the ownership change times the greater of the long-term tax-exempt rate determined by the IRS in the month of the ownership change or the two preceding months.

The issuance of our common stock in connection with the acquisition of Peak in 2005 resulted in an ownership change under Section 382. The annual base Section 382 limitation to be applied to our tax attribute carryforwards as a result of this ownership change is approximately $10.0 million. Accordingly, our NOL, capital loss, and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes. Our application of the rules under Section 382 is subject to challenge upon IRS review. A successful challenge could significantly impact our ability to utilize deductions, losses and tax credits generated prior to the date of the Peak acquisition.

After considering the reduction in tax attributes resulting from the preliminary calculation of the Section 382 limitation, we have Federal NOL carryforwards of approximately $152.5 million with expiration dates from 2007 through 2026. Various subsidiaries have state NOL carryforwards totaling approximately $75.4 million with expiration dates through the year 2026.

We adopted FIN 48 effective January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority. The adoption of FIN 48 did not have a material effect on our consolidated financial position or results of operations.

In addition to the full valuation allowance offsetting our net deferred tax assets, we had unrecognized tax benefits of $18.0 million as of January 1, 2007, the adoption date. If recognized, $9.6 million of these unrecognized tax benefits would impact the effective tax rate. Unrecognized tax benefits are not expected to change significantly over the next twelve months except for a possible increase resulting from our acquisition of Harborside (see “Note 2 - Acquisitions”).

We recognized potential accrued interest related to unrecognized tax benefits in income tax expense. Penalties, if incurred, would also be recognized as a component of income tax expense. The amount of accrued interest expense related to unrecognized benefits was $3.2 million as of the adoption date.

We file numerous consolidated and separate state and local income tax returns in addition to our consolidated U.S. federal income tax return. With few exceptions, we are no longer subject to U.S. federal, state or local income tax examinations for years before 2003. These jurisdictions can, however, adjust NOL carryforwards from earlier years.

(11)  Other Events

(a)  Litigation

We are a party to various legal actions and administrative proceedings and are subject to various claims arising in the ordinary course of our business, including claims that our services have resulted in injury or death to the residents of our facilities, claims relating to employment and commercial matters. Although we intend to vigorously defend ourselves in these matters, there can be no assurance that the outcomes of these matters will not have a material adverse effect on our results of operations, financial condition and cash flows. In certain states in which we have or have had operations, insurance coverage
15

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

for the risk of punitive damages arising from general and professional liability litigation may not be available due to state law public policy prohibitions. There can be no assurance that we will not be liable for punitive damages awarded in litigation arising in states for which punitive damage insurance coverage is not available.

We operate in industries that are extensively regulated. As such, in the ordinary course of business, we are continuously subject to state and federal regulatory scrutiny, supervision and control. Such regulatory scrutiny often includes inquiries, investigations, examinations, audits, site visits and surveys, some of which are non-routine. In addition to being subject to direct regulatory oversight of state and federal regulatory agencies, these industries are frequently subject to the regulatory supervision of fiscal intermediaries. If a provider is found by a court of competent jurisdiction to have engaged in improper practices, it could be subject to civil, administrative or criminal fines, penalties or restitutionary relief, and reimbursement authorities could also seek the suspension or exclusion of the provider or individual from participation in their program. We believe that there has been, and will continue to be, an increase in governmental investigations of long-term care providers, particularly in the area of Medicare/Medicaid false claims, as well as an increase in enforcement actions resulting from these investigations. Adverse determinations in legal proceedings or governmental investigations, whether currently asserted or arising in the future, could have a material adverse effect on our financial position, results of operations and cash flows.

In December 2006, Harborside was notified by the United States Department of Justice (“DOJ”) that one of its subsidiaries is one of a significant number of unrelated defendants in a qui tam lawsuit filed under the Federal False Claims Act. In response to a request by the DOJ, Harborside has cooperated with the DOJ’s investigation and has supplied information relating to the matter, which relates to Harborside’s Medicare billings for durable medical equipment. Although the complaint remains under seal pending completion of the DOJ’s investigation, it is our understanding that neither we nor any of our other subsidiaries is a defendant in this litigation. We have met with a representative of the DOJ to discuss the litigation and intend to continue to cooperate with the investigation and respond to the litigation in a timely fashion. Based on our understanding of the allegations as described by the DOJ, we do not believe that the litigation will have a material impact on our operations or financial condition.

(b)  Other Inquiries

From time to time, fiscal intermediaries and Medicaid agencies examine cost reports filed by predecessor operators of our skilled nursing facilities. If, as a result of any such examination, it is concluded that overpayments to a predecessor operator were made, we, as the current operator of such facilities, may be held financially responsible for such overpayments. At this time we are unable to predict the outcome of any existing or future examinations.

(c)  Legislation, Regulations and Market Conditions

We are subject to extensive federal, state and local government regulation relating to licensure, conduct of operations, ownership of facilities, expansion of facilities and services and reimbursement for services. As such, in the ordinary course of business, our operations are continuously subject to state and federal regulatory scrutiny, supervision and control. Such regulatory scrutiny often includes inquiries, investigations, examinations, audits, site visits and surveys, some of which may be non-routine. We believe that we are in substantial compliance with the applicable laws and regulations. However, if we are ever found to have engaged in improper practices, we could be subject to civil, administrative or criminal fines, penalties or restitutionary relief, which may have a material adverse impact on our financial position, results of operations and cash flows.

We entered into a Corporate Integrity Agreement (the “CIA”) with the HHS/OIG in July 2001. It became effective on February 28, 2002 and terminated February 28, 2007. Notwithstanding the termination of the CIA, certain obligations under the CIA will continue until HHS/OIG completes its review of our final report under the CIA, which we expect to submit in May 2007.

(12)  Segment Information

We operate predominantly in the long-term care segment of the healthcare industry. We are a provider of long-term, sub-acute and related ancillary care services to nursing home patients.

In December 2006, we sold SunPlus, our home health services operations, for a purchase price of $19.3 million (see “Note 5 - Discontinued Operations and Assets and Liabilities Held for Sale”). The home health services and the laboratory
16

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
and radiology services operations have been reclassified to assets and liabilities held for sale, and pursuant to SFAS No. 144, their net revenues and net operating income have been reclassified to discontinued operations for all periods presented and is no longer considered a reportable segment.

The following summarizes the services provided by our reportable and other segments:

Inpatient Services:  This segment provides, among other services, inpatient skilled nursing and custodial services as well as rehabilitative, restorative and transitional medical services. We provide 24-hour nursing care in these facilities by registered nurses, licensed practical nurses and certified nursing aids.  At March 31, 2007, we operated 141 long-term care facilities (consisting of 118 skilled nursing facilities, 13 assisted living and independent living facilities, seven mental health facilities, and three specialty acute care hospitals) with 15,447 licensed beds as compared with 148 long-term care facilities (consisting of 124 skilled nursing facilities, 14 assisted living and independent living facilities, seven mental health facilities, and three specialty acute care hospitals) with 15,923 licensed beds at March 31, 2006.

Rehabilitation Therapy Services: This segment provides primarily physical, occupational and speech services to affiliated and nonaffiliated skilled nursing facilities. At March 31, 2007, this segment provided services to 390 facilities, of which 303 were nonaffiliated and  87 were affiliated, as compared to  439 facilities, of which  346 were nonaffiliated and  93 were affiliated at March 31, 2006.

Medical Staffing Services:  As of March 31, 2007, this segment derived 59.4% of its revenues from hospitals and other providers, 21.5% from skilled nursing facilities, 12.7% from schools and 6.4% from prisons. We provide (i) licensed therapists skilled in the areas of physical, occupational and speech therapy, (ii) nurses, (iii) pharmacists, pharmacist technicians and medical imaging technicians, (iv) physicians, and (v) related medical personnel.  As of March 31, 2007, this segment had 30 division offices, which provided temporary therapy, nursing and physician staffing services in major metropolitan areas and two division offices, which specialize in the placement of temporary traveling therapists and one division office specializing in permanent placement of healthcare professionals.

Corporate assets primarily consist of cash and cash equivalents, receivables from subsidiary segments, notes receivable, property and equipment and unallocated intangible assets. Although corporate assets include unallocated intangible assets, the amortization, if applicable, is reflected in the results of operations of the associated segment.

The accounting policies of the segments are the same as those described in the “Note 3 - Summary of Significant Accounting Policies" of our 2006 Form 10-K. We primarily evaluate segment performance based on profit or loss from operations after allocated expenses and before reorganization and restructuring items, income taxes and extraordinary items. Gains or losses on sales of assets and certain items including impairment of assets recorded in connection with SFAS No. 144 and Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”), and restructuring costs are not considered in the evaluation of segment performance. Allocated expenses include intersegment charges assessed to segments for management services and asset use based on segment operating results and average asset balances, respectively. We account for intersegment sales and provision of services at estimated market prices.

Our reportable segments are strategic business units that provide different products and services. They are managed separately, among other reasons, because each business has different marketing strategies due to differences in types of customers, different distribution channels and different capital resource needs.
17

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

The following tables summarize, for the periods indicated, operating results and other financial information, by business segment:

As of and for the
                                          
Three Months Ended
                                          
March 31, 2007
  
 Segment Information (in thousands):
                                           
         
Rehabilitation
    
Medical
                          
   
Inpatient
    
Therapy
    
Staffing
          
Intersegment
          
Discontinued
  
   
Services
    
Services
    
Services
    
Corporate
    
Eliminations
    
Consolidated
    
Operations
  
                                           
Revenues from external customers
$
229,135
  
$
20,680
  
$
23,747
  
$
7
  
$
-
  
$
273,569
  
$
11,073
  
                                           
Intersegment revenues
  
-
    
10,262
    
187
    
-
    
(10,449
)
  
-
    
-
  
                                           
Total revenues
  
229,135
    
30,942
    
23,934
    
7
    
(10,449
)
  
273,569
    
11,073
  
                                           
Operating salaries and benefits
  
111,478
    
26,048
    
18,900
    
-
    
-
    
156,426
    
4,635
  
                                           
Self insurance for workers'
                                          
compensation and general and
                                          
professional liability insurance
  
9,786
    
397
    
294
    
87
    
-
    
10,564
    
271
  
                                           
Other operating costs
 
63,539
    
1,717
    
1,806
    
18
    
(10,449
)
  
56,631
    
5,956
  
                                           
General and administrative expenses
  
5,306
    
1,257
    
1,026
    
12,834
    
-
    
20,423
    
55
  
                                           
Provision for losses on accounts
                                          
receivable
  
2,408
    
(80
)
  
112
    
-
    
-
    
2,440
    
83
  
                                           
Segment operating income (loss)
$
36,618
  
$
1,603
  
$
1,796
  
$
(12,932
)
$
-
  
$
27,085
  
$
73
  
                                           
Facility rent expense
  
14,130
    
50
    
199
    
-
    
-
    
14,379
    
119
  
                                           
Depreciation and amortization
  
3,199
    
116
    
169
    
436
    
-
    
3,920
    
35
  
                                           
Interest, net
  
2,480
    
10
    
15
    
(446
)
  
-
    
2,059
    
41
  
                                           
Net segment income (loss)
$
16,809
  
$
1,427
  
$
1,413
  
$
(12,922
)
$
-
  
$
6,727
  
$
(122
)
                                           
Identifiable segment assets
$
381,153
  
$
13,211
  
$
34,632
  
$
675,884
  
$
(521,053
)
$
583,827
  
$
5,835
  
                                           
Segment capital expenditures
$
5,857
  
$
794
  
$
97
  
$
397
  
$
-
  
$
7,145
  
$
105
  

______________________________________
General and administrative expenses include operating administrative expenses.
 
The term "segment operating income (loss)" is defined as earnings before facility rent expense, depreciation and amortization, interest, restructuring costs, net, loss on contract termination, gain on sale of assets, net, income taxes and discontinued operations.
 
The term "net segment income (loss)" is defined as earnings before restructuring costs, net, loss on contract termination, gain on sale of assets, net, income taxes and discontinued operations.
 
Other operating costs include loss on extinguishment of debt.

18

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


As of and for the
                                          
Three Months Ended
                                          
March 31, 2006
  
 Segment Information (in thousands):
  
                                           
         
Rehabilitation
    
Medical
                          
   
Inpatient
    
Therapy
    
Staffing
          
Intersegment
          
Discontinued
  
   
Services
    
Services
    
Services
    
Corporate
    
Eliminations
    
Consolidated
    
Operations
  
                                           
Revenues from external customers
$
215,435
  
$
20,000
  
$
21,318
  
$
3
  
$
-
  
$
256,756
  
$
30,258
  
                                           
Intersegment revenues
  
-
    
9,384
    
129
    
-
    
(9,513
)
  
-
    
-
  
                                           
Total revenues
  
215,435
    
29,384
    
21,447
    
3
    
(9,513
)
  
256,756
    
30,258
  
                                           
Operating salaries and benefits
  
103,497
    
25,898
    
17,525
    
-
    
-
    
146,920
    
18,004
  
                                           
Self insurance for workers'
                                          
  compensation and general and
                                          
  professional liability insurance
  
11,824
    
459
    
294
    
95
    
-
    
12,672
    
1,023
  
                                           
Other operating costs
  
61,949
    
1,853
    
1,176
    
-
    
(9,513
)
  
55,465
    
8,671
  
                                           
General and administrative expenses
  
4,309
    
2,667
    
895
    
11,648
    
-
    
19,519
    
304
  
                                           
Provision for losses on accounts
                                          
Receivable
  
1,384
    
(84
)
  
148
    
-
    
-
    
1,448
    
499
  
                                           
Segment operating income (loss)
$
32,472
  
$
(1,409
)
$
1,409
  
$
(11,740
)
$
-
  
$
20,732
  
$
1,757
  
                                           
Facility rent expense
  
13,118
    
58
    
214
    
-
    
-
    
13,390
    
726
  
                                           
Depreciation and amortization
  
2,189
    
89
    
187
    
402
    
-
    
2,867
    
382
  
                                           
Interest, net
  
3,433
    
(6
)
  
36
    
904
    
-
    
4,367
    
51
  
                                           
Net segment income (loss)
$
13,732
  
$
(1,550
)
$
972
  
$
(13,046
)
$
-
  
$
108
  
$
598
  
                                           
Identifiable segment assets
$
374,931
  
$
12,608
  
$
35,257
  
$
598,143
  
$
(520,989
)
$
499,950
  
$
31,183
  
                                           
Segment capital expenditures
$
2,460
  
$
61
  
$
127
  
$
351
  
$
-
  
$
2,999
  
$
334
  
 
______________________________________
General and administrative expenses include operating administrative expenses.
 
The term "segment operating income (loss)" is defined as earnings before facility rent expense, depreciation and amortization, interest, restructuring costs, net, loss on contract termination, gain on sale of assets, net, income taxes and discontinued operations.
 
The term "net segment income (loss)" is defined as earnings before restructuring costs, net, loss on contract termination, gain on sale of assets, net, income taxes and discontinued operations.
19

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

Measurement of Segment Income

We evaluate financial performance and allocate resources primarily based on income or loss from operations before income taxes, excluding any unusual items. The following table reconciles net segment income to consolidated income before income taxes and discontinued operations (in thousands):

   
For the
  
   
Three Months Ended
  
   
March 31, 2007
    
March 31, 2006
  
             
Net segment income
$
6,727
    
108
  
Loss on sale of assets, net
  
(7
)
  
(13
)
Consolidated income before income taxes and
            
discontinued operations
$
6,720
    
95
  


(13) Summarized Consolidating Information
 
In connection with the Company's offering of the 9 1/8% Senior Subordinated Notes in April 2007, certain subsidiaries of the Company and substantially all of Harborside Healthcare Corporation and its subsidiaries (the "Guarantors") have, jointly and severally, unconditionally guaranteed the 9 1/8% Notes. These guarantees are subordinated to all existing and future senior debt and guarantees of the Guarantors and are unsecured.

The Company conducts all of its business through and derives virtually all of its income from its subsidiaries. Therefore, the Company's ability to make required payments with respect to its indebtedness (including the 9 1/8% Notes) and other obligations depends on the financial results and condition of its subsidiaries and its ability to receive funds from its subsidiaries.

Pursuant to Rule 3-10 of Regulation S-X, the following summarized consolidating information is for the Company (the "Parent"), the wholly-owned Guarantors, and the Company's non-Guarantor subsidiaries with respect to the 9 1/8% Notes. This summarized financial information has been prepared from the books and records maintained by the Company, the Guarantors and the non-Guarantor subsidiaries. The summarized financial information may not necessarily be indicative of the results of operations or financial position had the Guarantors or non-Guarantor subsidiaries operated as independent entities. The separate financial statements of the Guarantors are not presented because management has determined they would not be material to investors. Current and deferred taxes are provided for by the Parent. In addition, intercompany activities between subsidiaries and the Parent are presented within operating activities on the condensed consolidating statement of cash flows.

Condensed consolidating financial statements for the Company and its subsidiaries, including the Parent only, the combined Guarantor Subsidiaries and the combined Non-Guarantor Subsidiaries are as follows:
20

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATING BALANCE SHEET

As of March 31, 2007
(in thousands)
 
       
 Combined
  
 Combined
            
   
Parent
  
 Guarantor
  
 Non-Guarantor
            
   
Company
  
 Subsidiaries
  
 Subsidiaries
  
 Elimination
  
 Consolidated
  
                                 
Current assets:
                                
Cash and cash equivalents
  
$
88,965
  
$
9,409
  
$
1,296
  
$
-
  
$
99,670
  
Restricted cash
    
23,151
    
3,573
    
1,357
    
-
    
28,081
  
Accounts receivable, net
    
-
    
115,831
    
(1,319
)
  
(13
)
  
114,499
  
Inventories, net
    
-
    
4,728
   
-
    
-
    
4,728
  
Other receivables, net
    
395
    
777
    
564
    
-
    
1,736
  
Assets held for sale
    
896
    
-
    
3,604
    
-
    
4,500
  
Prepaid expenses
    
6,165
    
1,858
    
8
    
-
    
8,031
  
Total current assets
    
119,572
    
136,176
    
5,510
    
(13
)
  
261,245
  
Property and equipment, net
    
6,469
    
161,265
    
53,590
    
-
    
221,324
  
Intangible assets, net
    
1,646
    
9,384
    
1,279
    
-
    
12,309
  
Goodwill, net
    
(3,834
)
  
58,439
    
-
    
-
    
54,605
  
Restricted cash, non-current
    
29,923
    
3,110
    
-
    
-
    
33,033
  
Other assets, net
    
2,708
    
(8,766
)
  
(7,711
)
  
20,915
    
7,146
  
Investment in subsidiaries
    
117,385
    
-
    
-
    
(117,385
)
  
-
  
Total assets
  
$
273,869
  
$
359,608
  
$
52,668
  
$
(96,483
)
$
589,662
  
                                 
Current liabilities:
                                
Accounts payable
  
$
10,622
  
$
27,814
  
$
667
  
$
(13
)
$
39,090
  
Accrued compensation and benefits
    
4,851
    
35,443
    
369
    
-
    
40,663
  
Accrued self-insurance obligations, current portion
    
(11,828
)
  
47,121
    
4,988
    
-
    
40,281
  
Income taxes payable
    
9,184
    
(1
)
  
(48
)
  
-
    
9,135
  
Liabilities held for sale
    
-
    
-
    
1,826
    
-
    
1,826
  
Other accrued liabilities
    
8,977
    
20,189
    
4,977
    
-
    
34,143
  
Current portion of long-term debt
    
10,154
    
2,442
    
1,005
    
-
    
13,601
  
Capital leases, current
    
194
    
424
   
-
    
-
    
618
  
Total current liabilities
    
32,154
    
133,432
    
13,784
    
(13
)
  
179,357
  
Accrued self-insurance obligations, net of current portion
    
42,703
    
45,989
    
429
    
-
    
89,121
  
Long-term debt, net of current portion
    
7,077
    
68,421
    
54,079
    
-
    
129,577
  
Capital leases, net of current
    
228
    
548
    
-
    
-
    
776
  
Unfavorable lease obligations, net
    
-
    
20,273
    
(7,487
)
  
-
    
12,786
  
Intercompany balances
    
40,284
    
(42,911
)
  
(18,288
)
  
20,915
    
-
  
Other long-term liabilities
    
292
    
17,323
    
9,299
    
-
    
26,914
  
Deferred income taxes
    
2,412
    
-
    
-
    
-
    
2,412
  
Total liabilities
    
125,150
    
243,075
    
51,816
    
20,902
    
440,943
  
                                 
Stockholders’ equity:
                                
Common stock
    
429
    
-
    
-
    
-
    
429
  
Additional paid-in capital
    
553,938
    
-
    
-
    
-
    
553,938
  
Accumulated deficit
    
(405,557
 )   
116,533
    
852
    
(117,385
)
  
(405,557
)
Less: common stock held in treasury, at cost
    
(91
)
  
-
    
-
    
-
    
(91
)
Total stockholders' equity (deficit)
    
148,719
    
116,533
    
852
    
(117,385
)
  
148,719
  
Total liabilities and stockholders' equity (deficit)
  
$
273,869
  
$
359,608
  
$
52,668
  
$
(96,483
)
$
589,662
  
 
21
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2006
(in thousands)
 
 

         
Combined
    
Combined
              
   
Parent
    
Guarantor
    
Non-Guarantor
              
   
Company
    
Subsidiaries
    
Subsidiaries
    
Elimination
    
Consolidated
  
                               
Current assets:
                              
Cash and cash equivalents
$
119,810
 
$
11,337
  
$
788
  
$
-
  
$
131,935
  
Restricted cash
  
27,335
    
4,571
    
846
    
-
    
32,752
  
Accounts receivable, net
  
-
    
116,710
    
381
    
-
    
117,091
  
Inventories, net
  
-
    
4,808
   
-
    
-
    
4,808
  
Other receivables, net
  
261
    
835
    
1,115
    
-
    
2,211
  
Assets held for sale
  
897
    
4,614
    
1,661
    
-
    
7,172
  
Prepaid expenses
  
1,856
    
1,374
    
75
    
-
    
3,305
  
Total current assets
  
150,159
    
144,249
    
4,866
    
-
    
299,274
  
Property and equipment, net
  
6,508
    
157,310
    
53,726
    
-
    
217,544
  
Intangible assets, net
  
1,876
    
10,509
    
1,306
    
-
    
13,691
  
Goodwill, net
  
(3,834
)
  
58,926
    
-
    
-
    
55,092
  
Restricted cash, non-current
  
25,977
    
3,106
    
-
    
-
    
29,083
  
Other assets, net
  
2,329
    
(9,165
)
  
(7,340
)
  
20,915
    
6,739
  
Investment in subsidiaries
  
98,180
    
-
    
-
    
(98,180
)
  
-
  
Total assets
$
281,195
  
$
364,935
  
$
52,558
  
$
(77,265
)
$
621,423
  
                               
Current liabilities:
                              
Accounts payable
$
12,350
  
$
29,854
  
$
1,196
  
$
-
  
$
43,400
  
Accrued compensation and benefits
  
8,561
    
33,025
    
1,137
    
-
    
42,723
  
Accrued self-insurance obligations, current portion
  
(3,345
)
  
45,225
    
6,809
    
-
    
48,689
  
Income taxes payable 
  
8,848
    
(1
)
  
(48
)
  
-
    
8,799
  
Liabilities held for sale
  
-
    
825
    
847
    
-
    
1,672
  
Other accrued liabilities
  
4,356
    
23,438
    
5,942
    
-
    
33,736
  
Current portion of long-term debt
  
3,696
    
18,861
    
959
    
-
    
23,516
  
Capital leases, current
  
189
    
305
   
-
    
-
    
494
  
Total current liabilities
  
34,655
    
151,532
    
16,842
    
-
    
203,029
  
Accrued self-insurance obligations, net of current portion
  
35,141
    
45,989
    
429
    
-
    
81,559
  
Long-term debt, net of current portion
  
16,707
    
78,308
    
54,444
    
-
    
149,459
  
Capital leases, net of current
  
278
    
418
    
-
    
-
    
696
  
Unfavorable lease obligations, net
  
-
    
21,409
    
(7,986
)
  
-
    
13,423
  
Intercompany balances
  
47,559
    
(47,060
)
  
(21,414
)
  
20,915
    
-
  
Other long-term liabilities
  
310
    
17,110
    
9,292
    
-
    
26,712
  
Deferred income taxes 
  
2,412
    
-
    
-
    
-
    
2,412
  
Total liabilities
  
137,062
    
267,706
    
51,607
    
20,915
    
477,290
  
                               
Stockholders’ equity:
                              
Common stock
  
429
    
-
    
-
    
-
    
429
  
Additional paid-in capital
  
553,275
    
-
    
-
    
-
    
553,275
  
Accumulated deficit
  
(409,480
)
  
97,229
    
951
    
(98,180
)
  
(409,480
)
Less: common stock held in treasury, at cost
  
(91
)
  
-
    
-
    
-
    
(91
)
Total stockholders' equity (deficit)
  
144,133
    
97,229
    
951
    
(98,180
)
  
144,133
  
Total liabilities and stockholders' equity (deficit)
$
281,195
  
$
364,935
  
$
52,558
  
$
(77,265
)
$
621,423
  

22
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Three Months Ended March 31, 2007
(in thousands)

 
 
Parent
Company
  
Combined
Guarantor
Subsidiaries
  
Combined
Non-Guarantor
Subsidiaries
  
Elimination
  
Consolidated
  
                     
Total net revenues
$                   7
  
$        281,936
  
$               2,075
  
$     (10,449
)
$     273,569
  
Costs and expenses:
                    
Operating salaries and benefits
-
  
155,310
  
1,116
  
-
  
156,426
  
Self insurance for workers’ compensation and
  general and professional liability insurance 
87
  
10,381
  
96
 
-
  
10,564
  
Other operating costs
16
 
66,664
  
381
  
(10,449
)
56,612
  
Facility rent expense
-
  
14,804
  
(425
)
-
  
14,379
  
General and administrative expenses(1)
12,829
  
7,589
  
5
  
-
  
20,423
  
Depreciation and amortization
435
  
3,032
  
453
  
-
  
3,920
  
Provision for losses on accounts receivable
-
  
2,436
  
4
  
-
  
2,440
  
Interest, net
(446
)
1,732
  
773
  
-
  
2,059
  
Loss on extinguishment of debt, net
-
  
19
  
-
  
-
  
19
  
Loss on sale of assets, net
-
  
7
  
-
  
-
  
7
  
Income from investment in subsidiaries
(19,205
)
-
  
-
  
19,205
  
-
  
Total costs and expenses
(6,284
)
261,974
  
2,403
  
8,756
  
266,849
  
                     
Income (loss) before income taxes and
   discontinued operations
6,291
  
19,962
  
(328
)
(19,205
)
6,720
  
Income tax expense
2,368
  
-
  
-
  
-
  
2,368
  
Income (loss) from continuing operations
3,923
  
19,962
  
(328
)
(19,205
)
4,352
  
                     
Discontinued operations:
                    
(Loss) income from discontinued operations, net
-
  
(102
)
23
  
-
  
(79
)
(Loss) gain on disposal of discontinued
    operations, net
-
  
(556
)
206
  
-
  
(350
)
(Loss) income on discontinued operations, net
-
  
(658
)
229
  
-
  
(429
)
                     
Net income (loss)
$         3,923
  
$           19,304
  
$                   (99
)
$      (19,205
)
$        3,923
  

(1) Includes operating administrative expenses

23
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

For the Three Months Ended March 31, 2006
(in thousands)
 
 
Parent
Company
  
Combined
Guarantor
Subsidiaries
  
Combined
Non-Guarantor
Subsidiaries
  
Elimination
  
Consolidated
  
                     
Total net revenues
$                  3
  
$       264,204
  
$               2,062
  
$      (9,513
)
$       256,756
  
Costs and expenses:
                    
Operating salaries and benefits
-
  
145,925
  
995
  
-
  
146,920
  
Self insurance for workers’ compensation and
   general and professional liability insurance 
93
  
12,475
  
104
 
-
  
12,672
  
Other operating costs
-
  
64,495
 
483
  
(9,513
)
55,465
  
Facility rent expense
-
  
14,266
  
(876
)
-
  
13,390
  
General and administrative expenses(1)
11,488
  
8,023
  
8
  
-
  
19,519
  
Depreciation and amortization
402
  
2,074
  
391
  
-
  
2,867
  
Provision for losses on accounts receivable
-
  
1,438
  
10
  
-
  
1,448
  
Interest, net
904
  
2,360
  
1,103
  
-
  
4,367
  
Loss on sale of assets, net
7
  
6
  
-
  
-
  
13
  
Income from investment in subsidiaries
(13,314
)
-
  
-
  
13,314
  
-
  
Total costs and expenses
(420
 ) 
251,062
  
2,218
  
3,801
  
256,661
  
                     
Income (loss) before income taxes and
discontinued operations
423
 
13,142
  
(156
)
(13,314
)
95
  
Income tax benefit
(727
)
-
  
-
  
-
  
(727
)
Income (loss) from continuing operations
1,150
 
13,142
  
(156
)
(13,314
)
822
  
                     
Discontinued operations:
                    
(Loss) income from discontinued operations, net
(2
 ) 
484
  
(99
)
-
  
383
  
(Loss) gain on disposal of discontinued
    operations, net
(9
)
5
  
(62
)
-
  
(66
)
    (Loss) income on discontinued operations, net
(11
)
489
  
(161
)
-
  
317
  
                     
Net income (loss)
$         1,139
 
$          13,631
 
$              (317
)
$        (13,314
)
$           1,139
  
 
(1) Includes operating administrative expenses


24
SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Three Months Ended March 31, 2007
(in thousands)
 

   
Parent
Company
    
Combined
Guarantor
Subsidiaries
    
Combined
Non-Guarantor
Subsidiaries
    
Elimination
    
Consolidated
  
                               
Net cash provided by (used for) operating activities
$
(27,802
)
$
27,880
  
$
1,493
  
$
-
  
$
1,571
  
                               
Cash flows from investing activities:
                              
Capital expenditures
  
(399
)
  
(6,473
)
  
(378
)
  
-
    
(7,250
)
Proceeds from sale of assets held for sale
  
-
    
3,238
    
-
    
-
    
3,238
  
Net cash used for investing activities
  
(399
)
  
(3,235
)
  
(378
)
  
-
    
(4,012
)
                               
Cash flows from financing activities:
                              
Net borrowings under Revolving Loan Agreement
 
6
    
-
    
-
    
-
    
6
  
Long-term debt repayments
  
(3,177
)
  
(26,111
)
  
(319
)
  
-
    
(29,607
)
Principal payments under capital lease obligation
  
(46
)
  
(462
)
  
(32
)
  
-
    
(540
)
Net proceeds from exercise of employee stock options
  
573
    
-
    
-
    
-
    
573
  
Distribution of partnership equity
  
-
    
-
    
(256
)
  
-
    
(256
)
Net cash used for financing activities
  
(2,644
)
  
(26,573
)
  
(607
)
  
-
    
(29,824
)
Net (decrease) increase in cash and cash equivalents
  
(30,845
)
  
(1,928
)
  
508
    
-
    
(32,265
)
Cash and cash equivalents at beginning of period
  
119,810
    
11,337
    
788
    
-
    
131,935
  
Cash and cash equivalents at end of period
$
88,965
  
$
9,409
 
$
1,296
  
$
-
  
$
99,670
  



For the Three Months Ended March 31, 2006
(in thousands)

   
Parent
Company
    
Combined
Guarantor
Subsidiaries
    
Combined
Non-Guarantor
Subsidiaries
    
Elimination
    
Consolidated
  
                               
Net cash (used for) provided by operating activities
$
(13,625
)
$
5,945
  
$
561
  
$
-
  
$
(7,119
)
                               
Cash flows from investing activities:
                              
Capital expenditures, net
  
(352
)
  
(2,532
)
  
(449
)
  
-
    
(3,333
)
Acquisitions, net
  
-
    
(236
)
  
-
    
-
    
(236
)
Proceeds from sale/leaseback
  
-
    
838
    
-
    
-
    
838
  
Net cash used for investing activities
  
(352
)
  
(1,930
)
  
(449
)
  
-
    
(2,731
)
                               
Cash flows from financing activities:
                              
Net borrowings under Revolving Loan Agreement
 
17,720
    
-
    
-
    
-
    
17,720
  
Long-term debt repayments
  
(3,157
)
  
(4,163
)
  
(374
)
  
-
    
(7,694
)
Distribution of partnership equity
  
-
    
-
    
(123
)
  
-
    
(123
)
Net cash provided by (used for) financing activities
  
14,563
    
(4,163
)
  
(497
)
  
-
    
9,903
  
Net increase (decrease) in cash and cash equivalents
  
586
    
(148
)
  
(385
)
  
-
    
53
  
Cash and cash equivalents at beginning of period
  
5,352
    
10,486
    
803
    
-
    
16,641
  
Cash and cash equivalents at end of period
$
5,938
  
$
10,338
  
$
418
  
$
-
  
$
16,694
  

25