UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[ X ]     Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2008

or

[    ]     Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 1-12040

SUN HEALTHCARE GROUP, INC.

(Exact name of Registrant as specified in its charter)

Delaware	85-0410612
(State of Incorporation)	(I.R.S. Employer Identification No.)

18831 Von Karman, Suite 400

Irvine, CA  92612

(949) 255-7100

(Address, zip code and telephone number of Registrant)

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

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

Large accelerated filer   o	Accelerated filer    x
Non-accelerated filer   o (Do not check if a smaller reporting company)	Smaller reporting company   o

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

As of August 5, 2008, there were 43,351,649 shares of the Registrant’s $.01 par value Common Stock outstanding.

1

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Index

		Page Numbers
PART I.  FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets (unaudited)	3-4
	As of June 30, 2008
	As of December 31, 2007
	Consolidated Income Statements (unaudited)	5-6
	For the three months ended June 30, 2008 and 2007
	For the six months ended June 30, 2008 and 2007
	Consolidated Statements of Cash Flows (unaudited)	7
	For the three months ended June 30, 2008 and 2007
	For the six months ended June 30, 2008 and 2007
	Notes to Consolidated Financial Statements (unaudited)	8-30
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31-44
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	45
Item 4.	Controls and Procedures	45
PART II.  OTHER INFORMATION
Item 4.	Submission of Matters to a Vote of Security Holders	46
Item 5.	Other Information	46
Item 6.	Exhibits	47
Signature		47

References throughout this document to the “Company,” “Sun,” “we,” “our,” “ours” and “us” refer to Sun Healthcare Group, Inc. and its subsidiaries.

STATEMENT REGARDING FORWARD LOOKING STATEMENTS

Information provided in this Quarterly Report on Form 10-Q (this “10-Q”) contains “forward-looking” information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”).  All statements regarding our expected future financial position, results of operations, cash flows, integration of the operations of Harborside Healthcare Corporation, indebtedness, lease obligations and liquidity, financing plans, business strategies, budgets, projected costs and capital expenditures, the occupancy and payor mix at our skilled nursing centers, the anticipated impact of changes in Medicare, Medicaid and other governmental reimbursement programs,  the impact of regulatory initiatives and government investigations and audits that may affect our business, our ability to defend lawsuits, the ability of our self-insurance programs to satisfy claims, plans of management for future operations, interest rate risk exposure and words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” "intend,” “may” and other similar expressions are forward-looking statements.

We caution investors that any forward-looking statements made by us are not guarantees of future performance.  Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results in future periods to differ materially from those projected or contemplated in the forward-looking statements. Such material differences may result from the factors described in our 2007 Annual Report on Form 10-K (see Item 1A – “Risk Factors”) and other factors that are unknown to us or may be beyond our control.  Such risks should be carefully considered before any investment is made in our securities.  Given these risks and other uncertainties, we can give no assurances that any of the events or circumstances described in our forward-looking statements will in fact transpire, or that the impact of such events or circumstances will be material to our business and financial condition.  Therefore undue reliance should not be placed on such forward-looking statements. We do not intend, and undertake no obligation, to update our forward-looking statements to reflect future events or circumstances.

___________________

2

PART I.     FINANCIAL INFORMATION

ITEM 1.     FINANCIAL STATEMENTS

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited)

ASSETS

(in thousands)

		June 30, 2008		December 31, 2007
				(Note 1)
Current assets:
Cash and cash equivalents	$	68,369	$	55,832
Restricted cash		34,850		37,365
Accounts receivable, net of allowance for doubtful accounts
of $43,525 and $42,144 at June 30, 2008 and
December 31, 2007, respectively		201,587		188,882
Prepaid expenses and other assets		28,902		13,290
Assets held for sale		4,218		9,924
Deferred tax assets		33,268		35,354
Total current assets		371,194		340,647
Property and equipment, net		587,432		585,972
Intangible assets, net		54,640		57,044
Goodwill		324,277		324,277
Restricted cash, non-current		3,281		3,829
Deferred tax assets		45,707		51,892
Other assets		6,317		10,165
Total assets	$	1,392,848	$	1,373,826

See accompanying notes.

3

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited) (CONTINUED)

LIABILITIES AND STOCKHOLDERS’ EQUITY

(in thousands, except share data)

		June 30, 2008			December 31, 2007
					(Note 1)
Current liabilities:
Accounts payable	$	51,379		$	52,836
Accrued compensation and benefits		59,118			61,956
Accrued self-insurance obligations, current portion		46,423			48,646
Income taxes payable		3,397			3,000
Liabilities held for sale		78			3,181
Other accrued liabilities		60,822			58,002
Current portion of long-term debt and capital lease obligations:
Company obligations		11,325			28,480
Clipper partnerships		859			825
Total current liabilities		233,401			256,926
Accrued self-insurance obligations, net of current portion		108,578			106,534
Long-term debt and capital lease obligations, net of current portion:
Company obligations		669,843			651,403
Clipper partnerships		48,120			48,560
Unfavorable lease obligations, net		17,282			18,960
Other long-term liabilities		47,820			44,717
Total liabilities		1,125,044			1,127,100
Commitments and contingencies (Note 6)
Minority interest		1,167			470
Stockholders’ equity:
Preferred stock of $.01 par value, authorized 10,000,000
shares, no shares were issued or outstanding as of
June 30, 2008 and December 31, 2007		-			-
Common stock of $.01 par value, authorized 125,000,000
shares; 43,197,359 and 43,016,042 shares issued and
outstanding as of June 30, 2008 and December 31, 2007,
respectively		432			430
Additional paid-in capital		602,457			600,199
Accumulated deficit		(333,708	)		(351,970	)
Accumulated other comprehensive loss, net		(2,544	)		(2,403	)
		266,637			246,256
Total liabilities and stockholders’ equity	$	1,392,848		$	1,373,826

See accompanying notes.

4

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (unaudited)

(in thousands, except per share data)

		For the
		Three Months Ended
		June 30, 2008			June 30, 2007
Total net revenues	$	454,192		$	429,979
Costs and expenses:
Operating salaries and benefits		253,498			242,021
Self-insurance for workers’ compensation and general and
professional liability insurance		11,892			7,959
Operating administrative expenses		12,944			10,497
Other operating costs		93,354			89,922
Center rent expense		18,757			20,862
General and administrative expenses		16,111			17,297
Depreciation and amortization		9,818			9,659
Provision for losses on accounts receivable		2,963			3,401
Interest, net of interest income of $569 and $1,136, respectively		13,643			11,999
Loss on sale of assets		-			3
Total costs and expenses		432,980			413,620
Income before income taxes and discontinued operations		21,212			16,359
Income tax expense		8,485			5,725
Income from continuing operations		12,727			10,634
Discontinued operations:
(Loss) income from discontinued operations, net of related taxes		(1,235	)		2,059
(Loss) gain on disposal of discontinued operations, net of
related taxes		(1,807	)		347
(Loss) income from discontinued operations, net		(3,042	)		2,406
Net income	$	9,685		$	13,040
Basic earnings per common and common equivalent share:
Income from continuing operations	$	0.29		$	0.25
(Loss) income from discontinued operations, net		(0.07	)		0.05
Net income	$	0.22		$	0.30
Diluted earnings per common and common equivalent share:
Income from continuing operations	$	0.29		$	0.24
(Loss) income from discontinued operations, net		(0.07	)		0.06
Net income	$	0.22		$	0.30
Weighted average number of common and common
equivalent shares outstanding:
Basic		43,188			42,993
Diluted		43,928			43,735

See accompanying notes.

5

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (unaudited)

(in thousands, except per share data)

		For the
		Six Months Ended
		June 30, 2008			June 30, 2007
Total net revenues	$	907,757		$	689,701
Costs and expenses:
Operating salaries and benefits		509,913			392,985
Self-insurance for workers’ compensation and general and
professional liability insurance		26,862			18,059
Operating administrative expenses		24,883			18,086
Other operating costs		187,453			141,272
Center rent expense		37,412			34,136
General and administrative expenses		32,696			30,131
Depreciation and amortization		19,462			13,530
Provision for losses on accounts receivable		6,312			5,488
Interest, net of interest income of $1,114 and $2,325, respectively		28,074			14,061
(Gain) loss on sale of assets		(76	)		10
Total costs and expenses		872,991			667,758
Income before income taxes and discontinued operations		34,766			21,943
Income tax expense		13,906			7,680
Income from continuing operations		20,860			14,263
Discontinued operations:
(Loss) income from discontinued operations, net of related taxes		(729	)		2,703
Loss on disposal of discontinued operations, net of related
taxes		(1,869	)		(3	)
(Loss) income from discontinued operations, net		(2,598	)		2,700
Net income	$	18,262		$	16,963
Basic earnings per common and common equivalent share:
Income from continuing operations	$	0.48		$	0.33
(Loss) income from discontinued operations, net		(0.06	)		0.06
Net income	$	0.42		$	0.39
Diluted earnings per common and common equivalent share:
Income from continuing operations	$	0.47		$	0.33
(Loss) income from discontinued operations, net		(0.06	)		0.06
Net income	$	0.41		$	0.39
Weighted average number of common and common
equivalent shares outstanding:		43,122			42,951
Basic		44,034			43,761
Diluted

See accompanying notes.

6

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in thousands)

		For the						For the
		Three Months Ended						Six Months Ended
		June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Cash flows from operating activities:
Net income	$	9,685		$	13,040		$	18,262		$	16,963
Adjustments to reconcile net income to net cash provided by
operating activities, including discontinued operations:
Depreciation and amortization		9,883			9,809			19,600			13,765
Amortization of favorable and unfavorable lease intangibles		(488	)		(196	)		(991	)		(409	)
Provision for losses on accounts receivable		3,210			3,737			6,511			6,260
Loss (gain) on sale of assets, including discontinued
operations, net		1,807			(347	)		1,792			13
Impairment charge for discontinued operation		1,800			-			1,800			-
Stock-based compensation expense		1,368			943			2,333			1,694
Deferred taxes		6,442			-			8,271			-
Minority interest		590			50			697			50
Other		79			(111	)		79			(112	)
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(3,951	)		(7,187	)		(19,452	)		(9,237	)
Restricted cash		3,058			896			3,063			1,617
Prepaid expenses and other assets		(1,856	)		15,312			(7,190	)		9,291
Assets and liabilities held for sale		(516	)		-			(1,044	)		-
Accounts payable		(1,528	)		(2,918	)		(3,126	)		(6,843	)
Accrued compensation and benefits		(4,020	)		7,875			(2,906	)		6,209
Accrued self-insurance obligations		(2,130	)		(5,982	)		(179	)		(6,828	)
Income taxes payable		1,121			4,961			1,591			7,387
Other accrued liabilities		(10,173	)		14,452			(3,645	)		15,681
Other long-term liabilities		3,676			(3,571	)		5,355			(3,167	)
Net cash provided by operating activities		18,057			50,763			30,821			52,334
Cash flows from investing activities:
Capital expenditures		(10,223	)		(7,705	)		(16,139	)		(14,955	)
Purchase of leased real estate		(727	)		(30,236	)		(727	)		(30,236	)
Proceeds from sale of assets held for sale		180			2,251			3,957			5,489
Acquisitions		(6	)		(368,515	)		(313	)		(368,515	)
Accrued acquisition costs, net		-			3,585			-			3,585
Net cash used for investing activities		(10,776	)		(400,620	)		(13,222	)		(404,632	)
Cash flows from financing activities:
Net borrowings under Credit Agreement		-			5,000			-			5,006
Principal repayments of long-term debt and capital lease obligations		(22,115	)		(4,651	)		(25,199	)		(34,798	)
Borrowings under long-term debt and capital lease obligations		20,290			327,000			20,290			327,000
Proceeds from issuance of common stock		31			92			70			665
Distribution of partnership equity		-			(255	)		(223	)		(511	)
Release of third-party collateral		-			25,640			-			25,640
Distribution of minority interest		-			(57	)		-			(57	)
Deferred financing costs		-			(18,045	)		-			(18,045	)
Net cash (used for) provided by financing activities		(1,794	)		334,724			(5,062	)		304,900
Net increase (decrease) in cash and cash equivalents		5,487			(15,133	)		12,537			(47,398	)
Cash and cash equivalents at beginning of period		62,882			99,670			55,832			131,935
Cash and cash equivalents at end of period	$	68,369		$	84,537		$	68,369		$	84,537

See accompanying notes.

7

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

(1)  Nature of Business

References throughout this document to the Company include Sun Healthcare Group, Inc. and our 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

Our subsidiaries provide long-term, post-acute 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 211 long-term care centers in 25 states as of June 30, 2008.

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 are a fair statement of our financial position at June 30, 2008, and the consolidated results of our operations and cash flows for the three-month periods ended June 30, 2008 and 2007, respectively.  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, 2007, which are included in our Annual Report on Form 10-K for the year ended December 31, 2007 (the “2007 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 significant 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.

Recent Accounting Pronouncements

In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 161, Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS No. 161”), which expands quarterly disclosure requirements in Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activity(“SFAS No. 133”), about an entity’s derivative instruments and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008.  We are currently assessing the impact of SFAS No. 161 on our consolidated financial position and results of operations.

Reclassifications and Adjustments

Certain reclassifications have been made to the prior period financial statements to conform to the 2008 financial statement presentation.  Specifically, we have reclassified the results of operations of two centers held for sale (see Note 4 – “Discontinued Operations and Assets and Liabilities Held for Sale”) for all periods presented to discontinued operations within the income statement, in accordance with accounting principles generally accepted in the United States.

8

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(2)  Long-Term Debt and Capital Lease Obligations

In June 2008 we entered into a $25.6 million mortgage note payable for purposes of refinancing an existing mortgage note payable of approximately $20.0 million.  The additional $5.6 million was used in connection with our purchase of two previously leased centers.

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

		June 30, 2008			December 31, 2007
Revolving credit agreement	$	-		$	-
Mortgage notes payable due at various dates through 2037, interest at rates
from 5.7% to 11.1%, collateralized by various centers (1)(2)(3)		180,329			177,712
Term loan agreement		348,108			349,857
Senior subordinated notes		200,000			200,000
Capital leases (3)		1,710			1,699
Total long-term obligations		730,147			729,268
Less amounts due within one year		(12,184	)		(29,305	)
Long-term obligations, net of current portion	$	717,963		$	699,963

(1)	Includes fair value premium of $0.1 million related to the acquisition of Peak Medical Corporation (“Peak”) in December 2005 and $0.6 million related to our acquisition of Harborside Healthcare Corporation (“Harborside”) in April 2007.
(2)	Includes $49.0 million and $49.4 million related to the consolidation of Clipper as of June 30, 2008 and December 31, 2007, respectively (see Note 5 – “Variable Interest Entities”).
(3)	Excludes $0.8 million, at December 31, 2007, reclassified to liabilities held for sale (see Note 4 – “Discontinued Operations and Assets and Liabilities Held for Sale”).

The scheduled or expected maturities of long-term obligations, excluding premiums, as of June 30, 2008, were as follows (in thousands):

For the twelve months ended June 30:
2009	$	12,184
2010		8,362
2011		51,395
2012		25,701
2013		7,769
Thereafter		624,029
	$	729,440

Included in the expected maturities of long-term debt are the following amounts related to the consolidation of Clipper (in thousands):  $859, $916, $978, $1,037, $1,113, and $44,076 for 2009, 2010, 2011, 2012, 2013 and thereafter, respectively (see Note 5 – “Variable Interest Entities”).

(3)  Fair Value of Financial Instruments

Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”), establishes a common definition for fair value to be applied to U.S. generally accepted accounting principles requiring use of fair value, establishes a framework for measuring fair value, and expands disclosures about such fair value measurements.  Issued in February 2008, FASB Staff Position No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, removed leasing transactions accounted for under Statement No. 13 and related guidance

9

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

from the scope of SFAS No. 157.  FASB Staff Position No. 157-2, Partial Deferral of the Effective Date of Statement 157, deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.

We adopted SFAS No. 157 as of January 1, 2008 for financial assets and financial liabilities. There was no material impact on our consolidated financial position and results of operations for the three months ended June 30, 2008.  We are currently assessing the impact of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities on our consolidated financial position and results of operations.

SFAS No. 157 establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The statement requires that assets and liabilities carried at fair value be classified and disclosed in one of the following three categories:

Level 1:	Unadjusted quoted market prices in active markets for identical assets or liabilities.
Level 2:	Unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or inputs other than quoted prices that are observable for the asset or liability.
Level 3:	Unobservable inputs for the asset or liability.

We endeavor to utilize the best available information in measuring fair value.  Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.  We have determined that the $4.2 million long-term liability for our interest rate swap agreement is Level 2 in the fair value hierarchy above.  At June 30, 2008, a portion of our restricted cash, $1.3 million, is in money market funds, which qualifies for Level 1 in the fair value hierarchy above.  We also had $10.0 million of cash and cash equivalents in money market funds and a certificate of deposit, which qualifies for Level 1 in the fair value hierarchy above.  We currently have no other financial instruments subject to fair value measurement on a recurring basis.

Our interest rate swap agreement qualifies for hedge accounting treatment under SFAS No. 133 and has been designated as a cash flow hedge.  Hedge effectiveness testing indicates that the swap is a fully effective hedge and as such, the derivative mark-to-market adjustment increased our other comprehensive income by $1.6 million, net of tax, for the three months ended June 30, 2008 and increased our other comprehensive loss by $0.1 million, net of tax, for the six months ended June 30, 2008.  The full balance of accumulated other comprehensive loss is due to accounting for our interest rate swap.  We do not anticipate any of this balance to be reclassified into earnings within the next year.  Also, since the swap is a fully effective hedging arrangement, there is no amount related to hedging ineffectiveness to expense.

(4) 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 income statements.

Inpatient Services:  We transferred operations of a leased skilled nursing center in June 2008 to an outside party, and the center has been reclassified into discontinued operations.  As a result of June 2008 flooding in the Midwest, our center in Terre Haute, Indiana was severely damaged and the operation discontinued.  The operating results for the Terre Haute center have been reclassified to discontinued operations and we have recorded a $1.8 million fixed assets impairment charge for the three ended June 30, 2008, due to the damage to the building and contents.

During the third quarter of 2007, we reclassified two hospitals to discontinued operations in accordance with SFAS No. 144.  On June 30, 2008, we sold the operations of these two hospitals for $10.1 million (subject to a final working

10

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

capital reconciliation), which was recorded in other current assets as of June 30, 2008 and received $9.5 million in cash proceeds on July 1, 2008.  The remaining $0.6 million of sales price is expected to be received by the end of the third quarter of 2008 in conjunction with the final working capital adjustment.  A $2.7 million loss on disposal of these operations was recognized in the three months ended June 30, 2008.  The lessor of the two hospitals did not fully release us from our rent obligation subsequent to the sale.  Therefore, in accordance with Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the $2.7 million loss includes an accrued liability of $6.3 million for continuing costs incurred without economic benefit as of the date of disposal of the operations (i.e., the “cease-use” date).

We sold our remaining laboratory and radiology services operations in the second quarter of 2007 for $2.5 million plus the value of the working capital.  We received $2.25 million at closing and recognized a gain of $0.6 million. In the third quarter of 2007, following adjustment of the working capital amount, the buyer paid us $0.9 million in full satisfaction of the purchase price and we recognized an additional $1.0 million gain on disposal.

In the first quarter of 2007, we sold a skilled nursing center that was classified as held for sale since 2006 for $4.9 million and recorded a net loss of $0.5 million.

Other discontinued operations are principally comprised of the operations of a regional provider of adolescent rehabilitation and special education services.

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

		For the Three Months Ended
		June 30, 2008
		Inpatient			Laboratory/		Home
		Services			Radiology		Health		Other		Total
Net operating revenues	$	14,260		$	-	$	-	$	5,271	$	19,531
(Loss) income from discontinued
operations, net (1)	$	(1,450	)	$	3	$	5	$	207	$	(1,235	)
Loss on disposal of
discontinued operations, net (2)		(1,807	)		-		-		-		(1,807	)
Loss from discontinued
operations, net	$	(3,257	)	$	3	$	5	$	207	$	(3,042	)

(1)  Net of related tax benefit of $823

(2)  Net of related tax benefit of $1,204

		For the Three Months Ended
		June 30, 2007
		Inpatient			Laboratory/			Home
		Services			Radiology			Health			Other		Total
Net operating revenues	$	16,789		$	1,240		$	1,643		$	5,108	$	24,780
Income (loss) from discontinued
operations, net (1)	$	2,412		$	(85	)	$	(420	)	$	152	$	2,059
(Loss) gain on disposal of
discontinued operations, net (2)		(267	)		605			-			9		347
Income (loss) from discontinued
operations, net	$	2,145		$	520		$	(420	)	$	161	$	2,406

(1)  Net of related tax expense of $1,180

(2)  Net of related tax expense of $189

11

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

		For the Six Months Ended
		June 30, 2008
		Inpatient			Laboratory/			Home
		Services			Radiology			Health			Other			Total
Net operating revenues	$	31,072		$	-		$	-		$	9,590		$	40,662
(Loss) income from discontinued
operations, net (1)	$	(565	)	$	(39	)	$	41		$	(166	)	$	(729	)
Loss on disposal of
discontinued operations, net (2)		(1,823	)		-			(46	)		-			(1,869	)
Loss from discontinued
operations, net	$	(2,388	)	$	(39	)	$	(5	)	$	(166	)	$	(2,598	)

(1)  Net of related tax benefit of $463

(2)  Net of related tax benefit of $1,195

		For the Six Months Ended
		June 30, 2007
		Inpatient			Laboratory/		Home
		Services			Radiology		Health			Other			Total
Net operating revenues	$	33,450		$	5,360	$	1,643		$	9,248		$	49,701
Income (loss) from discontinued
operations, net (1)	$	2,711		$	152	$	(415	)	$	255		$	2,703
(Loss) gain on disposal of
discontinued operations, net (2)		(643	)		605		41			(6	)		(3	)
Income (loss) from discontinued
operations, net	$	2,068		$	757	$	(374	)	$	249		$	2,700

(1)  Net of related tax expense of $1,552

(2)  Net of related tax benefit of $1

(b) Assets and Liabilities Held for Sale

As of June 30, 2008, assets held for sale consisted of (i) two skilled nursing centers with a net carrying amount of $3.3 million, primarily consisting of property and equipment and (ii) an undeveloped parcel of land valued at $0.9 million, which is classified in our Corporate segment in our consolidated financial statements.

(5)  Variable Interest Entities

As of June 30, 2008, we owned 34% of the voting interest (15.5% at June 30, 2007) in the nine Clipper entities, each of which owns one center that we operate in New Hampshire. Clipper’s objective is to achieve rental income from the leasing of its centers. 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, of which we have paid an aggregate of $3.0 million through June 30, 2008.  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.

FASB’s revised Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN No. 46(R)”) provides guidance on the consolidation of certain entities when control exists through means other than ownership of voting (or similar) interests and requires consolidation by the majority holder of expected residual gains and losses of the activities of a variable interest entity (“VIE”).

12

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

      We have concluded that Clipper 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 $5.3 million of the option value in other long-term liabilities in our consolidated balance sheets.  The remaining $2.0 million is recorded as current in other accrued liabilities in our consolidated balance sheets.  We have not recorded any minority interest associated with the 66% interest 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. 46(R), we have eliminated center rent expense of $0.7 million for each of the three months ended June 30, 2008 and 2007, and included $49.0 million and $49.4 million of mortgage debt of Clipper in our consolidated balance sheets as of June 30, 2008 and December 31, 2007, respectively, although we own 34% 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 the balance sheet impact of Clipper upon consolidation as of June 30, 2008 and December 31, 2007 (in thousands):

		June 30, 2008			December 31, 2007
Current assets:
Cash and cash equivalents	$	524		$	592
Restricted cash, current		1,449			1,588
Prepaid expenses and other assets		131			130
Total current assets		2,104			2,310
Property and equipment, net:
Land		6,171			6,171
Land improvements		26			29
Buildings		33,696			34,133
Building improvements		2,691			2,835
Equipment		158			153
Construction in progress		-			-
Total property and equipment, net		42,742			43,321
Intangible assets, net		5,960			7,014
Intercompany		5,557			4,836
Total assets	$	56,363		$	57,481
Current liabilities:
Mortgages, current	$	859		$	825
Other accrued liabilities		2,278			2,224
Total current liabilities		3,137			3,049
Mortgages, net of current		48,120			48,560
Other long-term liabilities		14,707			15,163
Total long-term liabilities		62,827			63,723
Total liabilities		65,964			66,772
Stockholders’ deficit:
Accumulated deficit		(9,601	)		(9,291	)
Total liabilities and stockholders’ deficit	$	56,363		$	57,481

For the three months ended June 30, 2008, the consolidation of Clipper included a net loss of $0.3 million comprised of a $0.8 million charge to interest expense, and a $0.3 million charge to depreciation expense, partially offset by a $0.7 million credit to rent expense and a $0.1 million credit to taxes and other expense. For the three months ended June 30, 2007, the consolidation of Clipper included a net loss of $0.4 million comprised of a $0.8 million charge to interest expense,

13

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

and a $0.4 million charge to depreciation expense, partially offset by a $0.7 million credit to rent expense and a $0.1 million credit to taxes and other expense.

For the six months ended June 30, 2008, the consolidation of Clipper included a net loss of $0.6 million comprised of a $1.6 million charge to interest expense, and a $0.6 million charge to depreciation expense, partially offset by a $1.4 million credit to rent expense and a $0.2 million credit to taxes and other expense. For the six months ended June 30, 2007, the consolidation of Clipper included a net loss of $0.9 million comprised of a $1.5 million charge to interest expense, and a $0.8 million charge to depreciation expense, partially offset by a $1.2 million credit to rent expense and a $0.2 million credit to taxes and other expense.

(6)  Commitments and Contingencies

Insurance

Since January 2000, we have relied upon self-funded insurance programs for general and professional liability claims ($5.0 million per claim since January 1, 2004), which amounts we are responsible for funding, and we have maintained excess insurance policies for claims above those amounts. The Harborside operations, which we acquired in April 2007, and the Peak operations, which we acquired in December 2005, utilized several different general and professional insurance programs.  We have added the Harborside and Peak operations to our general and professional liability programs.  Insurance coverage for punitive damages arising from general and professional liability litigation may not be available due to state law public policy prohibitions and our insurance coverages. There can be no assurance that we will not be liable for punitive damages awarded in litigation in which insurance coverage is not available.

With the exception of state-controlled workers’ compensation plans, our workers’ compensation risks are insured through high-retention insurance policies with third parties.

We evaluate the adequacy of our self-insurance reserves on a quarterly basis and perform actuarial analyses semi-annually in the second and fourth quarters. The analyses use generally accepted actuarial methods in evaluating the workers’ compensation reserves and general and professional liability reserves.  For both the workers’ compensation reserves and the general and professional liability reserves, those methods include reported and paid loss development methods, expected loss method and the reported and paid Bornhuetter-Ferguson methods.  The foundation for each of these methods is our actual historical reported and/or paid loss data.  In cases where our historical data is not statistically credible, stable, or mature, we supplement our experience with industry benchmark reporting and payment patterns. The use of multiple methods tends to eliminate any biases that one particular method might have. The results of each of the methods is an estimate of ultimate losses which includes the case reserves plus an estimate for future development of these reserves based on past trends, and an estimate for losses incurred but not reported. These results are compared by accident year and an estimated unpaid loss and allocated loss adjustment expense is determined for the open accident years based on judgment reflecting the range of estimates produced by the methods.

14

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Activity in our insurance reserves as of and for the six months ended June 30, 2008 and 2007 is as follows (in thousands):

		Professional			Workers’
		Liability			Compensation			Total
Balance as of January 1, 2007	$	75,078		$	51,521		$	126,599
Current year provision, continuing operations		6,305			3,981			10,286
Current year provision, discontinued operations		234			313			547
Claims paid, continuing operations		(1,849	)		(2,276	)		(4,125	)
Claims paid, discontinued operations		(2,938	)		(1,172	)		(4,110	)
Amounts paid for administrative services and other		(1,963	)		(1,060	)		(3,023	)
Balance as of March 31, 2007		74,867			51,307			126,174
Current year provision, continuing operations		7,986			6,157			14,143
Current year provision, discontinued operations		153			268			421
Prior year reserve adjustments, continuing operations		(3,962	)		(1,994	)		(5,956	)
Prior year reserve adjustments, discontinued operations		(1,538	)		(1,506	)		(3,044	)
Claims paid, continuing operations		(3,277	)		(4,405	)		(7,682	)
Claims paid, discontinued operations		(1,430	)		(926	)		(2,356	)
Amounts paid for administrative services and other		(1,472	)		(1,290	)		(2,762	)
Reserve established through purchase accounting		17,796			14,352			32,148
Balance as of June 30, 2007	$	89,123		$	61,963		$	151,086
Balance as of January 1, 2008	$	86,291		$	61,439		$	147,730
Current year provision, continuing operations		8,647			6,555			15,202
Current year provision, discontinued operations		139			172			311
Claims paid, continuing operations		(4,308	)		(4,673	)		(8,981	)
Claims paid, discontinued operations		(1,066	)		(693	)		(1,759	)
Amounts paid for administrative services and other		(1,052	)		(2,026	)		(3,078	)
Balance as of March 31, 2008		88,651			60,774			149,425
Current year provision, continuing operations		6,713			7,829			14,542
Current year provision, discontinued operations		(9	)		417			408
Prior year reserve adjustments, continuing operations		(5,250	)		2,600			(2,650	)
Prior year reserve adjustments, discontinued operations		(770	)		400			(370	)
Claims paid, continuing operations		(4,475	)		(5,822	)		(10,297	)
Claims paid, discontinued operations		(691	)		(268	)		(959	)
Amounts paid for administrative services and other		(1,044	)		(1,156	)		(2,200	)
Balance as of June 30, 2008	$	83,125		$	64,774		$	147,899

15

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

A summary of the assets and liabilities related to insurance risks at June 30, 2008 and December 31, 2007 is as indicated (in thousands):

		June 30, 2008							December 31, 2007
		Professional		Workers’			|		Professional		Workers’
		Liability		Compensation		Total	|		Liability		Compensation		Total
Assets (1):							|
Restricted cash							|
Current	$	3,466	$	19,973	$	23,439	|	$	3,717	$	20,933	$	24,650
Non-current		-		-		-	|		-		566		566
Total	$	3,466	$	19,973	$	23,439	|	$	3,717	$	21,499	$	25,216
							|
Liabilities (2)(3):							|
Self-insurance							|
Liabilities							|
Current	$	20,418	$	18,903	$	39,321	|	$	20,263	$	20,933	$	41,196
Non-current		62,707		45,871		108,578	|		66,028		40,506		106,534
Total	$	83,125	$	64,774	$	147,899	|	$	86,291	$	61,439	$	147,730

(1)	Total restricted cash above excludes $14,692 and $15,978 at June 30, 2008and December 31, 2007, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD insured buildings.
(2)	Total self-insurance liabilities in the table exclude $7,102 and $7,450 at June 30, 2008 and December 31, 2007, respectively, related to our employee health insurance liabilities.
(3)	Total self-insurance liabilities are collateralized, in addition to the restricted cash, by letters of credit of $750 and $49,980 for general and professional liability insurance and workers’ compensation, respectively, as of June 30, 2008 and $750 and $50,619 for general and professional liability insurance and workers’ compensation, respectively, as of December 31, 2007.

(7)  Income Taxes

The provision for income taxes of $8.5 million and $13.9 million for the three and six months, respectively, ended June 30, 2008 is based on a combined federal and state income tax rate of approximately 40%.  The provision for income taxes of $5.7 million and $7.7 million for the three and six months ended June 30, 2007, respectively, was based on a combined income tax rate of approximately 35%.  The lower tax rate in 2007 resulted from a partial reversal of our valuation allowance on net deferred tax assets that were generated after our emergence from bankruptcy in February 2002.

We have established a valuation allowance of $132.9 million for deferred tax assets.  The realization of deferred tax assets is dependent upon generation of taxable income during periods in which deductions and/or credits can be utilized.  As a result, we consider the level of historical taxable income, historical non-recurring credits and charges, the scheduled reversal of deferred tax liabilities, tax-planning strategies and projected future taxable income in determining the amount of the valuation allowance.  Based on these considerations, we believe that a reversal of some or all of the valuation allowance may occur in 2008 if appropriate levels of profitability are attained.

The Internal Revenue Code (“IRC”) Section 382 annual base limitation to be applied to our tax attribute carryforwards is approximately $24.9 million, which includes approximately $14.6 million due to our acquisition of Harborside in 2007. Accordingly, our net operating loss (“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.  In addition, a separate annual base IRC Section 382 limitation of approximately $14.6 million is to be applied to the tax attribute carryforwards of Harborside due to our acquisition of Harborside.  As a result of unused IRC Section 382 limitations from prior years and post-ownership change NOLs, there is approximately $107.0 million of NOLs which can be used to offset U.S. taxable income in 2008.

16

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(8)  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 centers, 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 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 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. It is our understanding that Harborside’s involvement relates to its 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 Sun Healthcare Group, Inc. nor any of its 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, financial condition and cash flows.

The Kentucky Attorney General’s office has commenced an investigation that relates to our centers in Kentucky, which we acquired in April 2007 in the Harborside acquisition.  We became aware of this investigation after receipt of subpoenas by many of our centers for records of certain of our current and former residents for specified periods of time between 2005 and 2008.  At present, the investigation appears to be focused on one center, but it has not been concluded.  We have not been informed of the precise nature of the investigation, although we are cooperating with the Attorney General’s office.

(b)  Other Inquiries

From time to time, fiscal intermediaries and Medicaid agencies examine cost reports filed by predecessor operators of our skilled nursing centers. 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 centers, may be held financially responsible for such overpayments. At this time we are unable to predict the outcome of any existing or future examinations.

17

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(9)  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.

The following summarizes the services provided by our reportable 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 centers by registered nurses, licensed practical nurses and certified nursing aids.  At June 30, 2008, we operated 211 long-term care centers (consisting of 188 skilled nursing centers, 15 assisted living and independent living centers and eight mental health centers) in 25 states with 23,678 licensed beds as compared with 216 long-term care centers (consisting of 191 skilled nursing centers, 15 assisted living and independent living centers, two specialty acute care hospitals and eight mental health centers) with 24,414 licensed beds at June 30, 2007.

Rehabilitation Therapy Services:  This segment provides primarily physical, occupational and speech and respiratory therapy supplies and services to affiliated and nonaffiliated skilled nursing centers.  At June 30, 2008, this segment provided services in 32 states to 425 centers, of which 317 were nonaffiliated and 108 were affiliated, as compared to 379 centers, of which 293 were nonaffiliated and 86 were affiliated at June 30, 2007.

Medical Staffing Services: As of June 30, 2008, this segment provided services in 34 states and derived 23.9% of its revenues from hospitals and other providers,60.0% from skilled nursing centers, 11.7% from schools and4.4% 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 June 30, 2008, this segment had 29 branch offices which provided temporary therapy, nursing and physician staffing services in major metropolitan areas, one branch office which specialized in the placement of temporary traveling therapists, and one branch office which specialized in temporary pharmaceutical staffing.

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 Note 3 – “Summary of Significant Accounting Policies” of our 2007 Form 10-K.  We primarily evaluate segment performance based on profit or loss from operations 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, and restructuring costs are not considered in the evaluation of segment performance.  Interest expense is recorded in the segment carrying the obligation to which the interest relates.

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

18

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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

As of and for the
Three Months Ended
June 30, 2008
				Rehabilitation		Medical
		Inpatient		Therapy		Staffing						Intersegment
		Services		Services		Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	402,945	$	21,142	$	30,096		$	9		$	-		$	454,192
Intersegment revenues		-		14,462		794			-			(15,256	)		-
Total revenues		402,945		35,604		30,890			9			(15,256	)		454,192
Operating salaries and benefits		202,420		28,847		22,231			-			-			253,498
Self-insurance for workers’
compensation and general and
professional liability insurance		10,849		527		401			115			-			11,892
Other operating costs		102,590		1,758		4,262			-			(15,256	)		93,354
General and administrative expenses		10,382		1,515		1,047			16,111			-			29,055
Provision for losses on accounts receivable		2,738		164		61			-			-			2,963
Segment operating income (loss)	$	73,966	$	2,793	$	2,888		$	(16,217	)	$	-		$	63,430
Center rent expense		18,418		99		240			-			-			18,757
Depreciation and amortization		8,769		132		200			717			-			9,818
Interest, net		3,263		-		(8	)		10,388			-			13,643
Net segment income (loss)	$	43,516	$	2,562	$	2,456		$	(27,322	)	$	-		$	21,212
Identifiable segment assets	$	1,118,499	$	13,462	$	37,133		$	731,213		$	(521,050	)	$	1,379,257
Goodwill	$	319,744	$	-	$	4,533		$	-		$	-		$	324,277
Segment capital expenditures	$	9,201	$	48	$	76		$	893		$	-		$	10,218

______________________________________

General and administrative expenses include operating administrative expenses.

The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, net gain (loss) on sale of assets, income tax expense and discontinued operations.

The term “net segment income (loss)” is defined as earnings, net gain (loss) on sale of assets, net, income tax expense and discontinued operations.

19

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

As of and for the
Three Months Ended
June 30, 2007
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing						Intersegment
		Services		Services			Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	381,145	$	20,789		$	28,018		$	27		$	-		$	429,979
Intersegment revenues		-		10,332			1,201			-			(11,533	)		-
Total revenues		381,145		31,121			29,219			27			(11,533	)		429,979
Operating salaries and benefits		193,880		25,374			22,767			-			-			242,021
Self-insurance for workers’
compensation and general and
professional liability insurance		6,925		444			461			129			-			7,959
Other operating costs		97,153		1,684			2,618			-			(11,533	)		89,922
General and administrative expenses		8,457		1,245			794			17,298			-			27,794
Provision (adjustment) for losses on    accounts receivable		3,397		(95	)		99			-			-			3,401
Segment operating income (loss)	$	71,333	$	2,469		$	2,480		$	(17,400	)	$	-		$	58,882
Center rent expense		20,579		53			230			-			-			20,862
Depreciation and amortization		8,598		135			194			732			-			9,659
Interest, net		2,493		-			(1	)		9,507			-			11,999
Net segment income (loss)	$	39,663	$	2,281		$	2,057		$	(27,639	)	$	-		$	16,362
Identifiable segment assets	$	832,483	$	13,382		$	36,528		$	965,592		$	(570,799	)	$	1,277,186
Goodwill	$	227,002	$	-		$	5,011		$	-		$	-		$	232,013
Segment capital expenditures	$	5,357	$	351		$	64		$	1,818		$	-		$	7,590

______________________________________

General and administrative expenses include operating administrative expenses.

The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, net gain (loss) on sale of assets, income tax expense and discontinued operations.

The term “net segment income (loss)” is defined as earnings, net gain (loss) on sale of assets, net, income tax expense and discontinued operations.

20

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

As of and for the
Six Months Ended
June 30, 2008
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing						Intersegment
		Services		Services			Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	805,121	$	42,851		$	59,764		$	21		$	-		$	907,757
Intersegment revenues		-		28,752			1,328			-			(30,080	)		-
Total revenues		805,121		71,603			61,092			21			(30,080	)		907,757
Operating salaries and benefits		406,436		58,772			44,705			-			-			509,913
Self-insurance for workers’
compensation and general and
professional liability insurance		24,835		1,054			743			230			-			26,862
Other operating costs		206,142		3,260			8,131			-			(30,080	)		187,453
General and administrative expenses		19,891		3,132			1,858			32,698			-			57,579
Provision for losses on    accounts receivable		5,666		253			393			-			-			6,312
Segment operating income (loss)	$	142,151	$	5,132		$	5,262		$	(32,907	)	$	-		$	119,638
Center rent expense		36,739		185			488			-			-			37,412
Depreciation and amortization		17,405		258			395			1,404			-			19,462
Interest, net		6,582		(1	)		(9	)		21,502			-			28,074
Net segment income (loss)	$	81,425	$	4,690		$	4,388		$	(55,813	)	$	-		$	34,690
Identifiable segment assets	$	1,118,499	$	13,462		$	37,133		$	731,213		$	(521,050	)	$	1,379,257
Goodwill	$	319,744	$	-		$	4,533		$	-		$	-		$	324,277
Segment capital expenditures	$	14,478	$	99		$	110		$	1,375		$	-		$	16,062

______________________________________

General and administrative expenses include operating administrative expenses.

The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, net gain (loss) on sale of assets, income tax expense and discontinued operations.

The term “net segment income (loss)” is defined as earnings, net gain (loss) on sale of assets, net, income tax expense and discontinued operations.

21

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

As of and for the
Six Months Ended
June 30, 2007
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing					Intersegment
		Services		Services			Services		Corporate			Eliminations			Consolidated
Revenues from external customers	$	596,433	$	41,469		$	51,765	$	34		$	-		$	689,701
Intersegment revenues		-		20,594			1,388		-			(21,982	)		-
Total revenues		596,433		62,063			53,153		34			(21,982	)		689,701
Operating salaries and benefits		299,899		51,421			41,665		-			-			392,985
Self-insurance for workers’
compensation and general and
professional liability insurance		16,247		841			756		215			-			18,059
Other operating costs		155,411		3,401			4,424		18			(21,982	)		141,272
General and administrative expenses		13,763		2,502			1,820		30,132			-			48,217
Provision (adjustment) for losses on
accounts receivable		5,451		(174	)		211		-			-			5,488
Segment operating income (loss)	$	105,662	$	4,072		$	4,277	$	(30,331	)	$	-		$	83,680
Center rent expense		33,604		103			429		-			-			34,136
Depreciation and amortization		11,747		251			364		1,168			-			13,530
Interest, net		4,976		10			14		9,061			-			14,061
Net segment income (loss)	$	55,335	$	3,708		$	3,470	$	(40,560	)	$	-		$	21,953
Identifiable segment assets	$	832,483	$	13,382		$	36,528	$	965,592		$	(570,799	)	$	1,277,186
Goodwill	$	227,002	$	-		$	5,011	$	-		$	-		$	232,013
Segment capital expenditures	$	11,170	$	1,144		$	162	$	2,216		$	-		$	14,692

______________________________________

General and administrative expenses include operating administrative expenses.

The term “segment operating income (loss)” is defined as earnings before center rent expense, depreciation and amortization, interest, net gain (loss) on sale of assets, income tax expense and discontinued operations.

The term “net segment income (loss)” is defined as earnings, net gain (loss) on sale of assets, net, income tax expense and discontinued operations.

22

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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
		June 30,
		2008		2007
Net segment income	$	21,212	$	16,362
Loss on sale of assets		-		(3	)
Consolidated income before income taxes and
discontinued operations	$	21,212	$	16,359

		For the Six Months Ended
		June 30,
		2008		2007
Net segment income	$	34,690	$	21,953
Gain (loss) on sale of assets		76		(10	)
Consolidated income before income taxes and
discontinued operations	$	34,766	$	21,943

(10) Summarized Consolidating Information

In connection with the Company’s offering of 9-1/8% Senior Subordinated Notes due 2015 (the “Notes”) in April 2007, certain of our subsidiaries (the “Guarantors”) have, jointly and severally and fully, unconditionally guaranteed the Notes. The proceeds of the Notes from time to time have been and will be used to benefit the operations of the Guarantors.  These guarantees are subordinated to all existing and future senior debt and guarantees of the Guarantors and are unsecured.

We conduct all of our business through and derive virtually all of our income from our subsidiaries. Therefore, our ability to make required payments with respect to indebtedness (including the Notes) and other obligations depends on the financial results and condition of our subsidiaries and their ability to fund such payments.

Pursuant to Rule 3-10 of Regulation S-X, the following summarized consolidating information is for the Company (the “Parent”), the 100% owned Guarantors, and the Parent’s non-Guarantor subsidiaries with respect to the Notes. This summarized financial information has been prepared from the books and records maintained by the Parent, 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. 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:

23

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING BALANCE SHEETS

As of June 30, 2008

(in thousands)

					Combined		Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries		Subsidiaries		Elimination			Consolidated
Current assets:
Cash and cash equivalents	$	43,523		$	23,304	$	1,542	$	-		$	68,369
Restricted cash		26,099			5,098		3,653		-			34,850
Accounts receivable, net		-			199,373		2,223		(9	)		201,587
Prepaid expenses and other assets		7,138			21,928		876		(1,040	)		28,902
Assets held for sale		938			3,270		10		-			4,218
Deferred tax assets		-			38,537		1,341		(6,610	)		33,268
Total current assets		77,698			291,510		9,645		(7,659	)		371,194
Property and equipment, net		8,894			509,501		69,037		-			587,432
Intangible assets, net		39,467			13,960		1,213		-			54,640
Goodwill		-			324,277		-		-			324,277
Restricted cash, non-current		-			3,281		-		-			3,281
Deferred tax assets		9,411			49,842		-		(13,546	)		45,707
Other assets		1,485			4,796		36		-			6,317
Intercompany balances		483,510			-		12,777		(496,287	)		-
Investment in subsidiaries		301,606			-		-		(301,606	)		-
Total assets	$	922,071		$	1,197,167	$	92,708	$	(819,098	)	$	1,392,848
Current liabilities:
Accounts payable	$	15,250		$	35,751	$	387	$	(9	)	$	51,379
Accrued compensation and benefits		7,903			50,613		602		-			59,118
Accrued self-insurance obligations, current portion		3,855			40,799		1,769		-			46,423
Income taxes payable		3,397			-		-		-			3,397
Liabilities held for sale		-			78		-		-			78
Other accrued liabilities		7,407			50,828		3,627		(1,040	)		60,822
Current portion of long-term debt and capital lease obligations		3,657			7,342		1,185		-			12,184
Deferred tax liabilities		6,610			-		-		(6,610	)		-
Total current liabilities		48,079			185,411		7,570		(7,659	)		233,401
Accrued self-insurance obligations, net of current portion		41,479			66,670		429		-			108,578
Long-term debt and capital lease obligations, net of current portion		545,163			107,785		65,015		-			717,963
Unfavorable lease obligations, net		-			17,282		-		-			17,282
Deferred tax liabilities		-			-		13,546		(13,546	)		-
Intercompany balances		-			496,287		-		(496,287	)		-
Other long-term liabilities		20,713			27,107		-		-			47,820
Total liabilities		655,434			900,542		86,560		(517,492	)		1,125,044
Minority interest		-			1,167		-		-			1,167
Stockholders’ equity:
Common stock		432			-		-		-			432
Additional paid-in capital		602,457			-		-		-			602,457
Accumulated deficit		(333,708	)		295,458		6,148		(301,606	)		(333,708	)
Accumulated other comprehensive loss, net		(2,544	)		-		-		-			(2,544	)
Total stockholders’ equity		266,637			295,458		6,148		(301,606	)		266,637
Total liabilities and stockholders’ equity	$	922,071		$	1,197,167	$	92,708	$	(819,098	)	$	1,392,848

24

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING BALANCE SHEETS

As of  December 31, 2007

(in thousands)

					Combined		Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries		Subsidiaries			Elimination			Consolidated
Current assets:
Cash and cash equivalents	$	30,221		$	23,547	$	2,064		$	-		$	55,832
Restricted cash		27,441			6,370		3,554			-			37,365
Accounts receivable, net		-			187,144		1,747			(9	)		188,882
Prepaid expenses and other assets		2,060			11,130		100			-			13,290
Assets held for sale		912			9,015		(3	)		-			9,924
Deferred tax assets		35,344			-		10			-			35,354
Total current assets		95,978			237,206		7,472			(9	)		340,647
Property and equipment, net		8,924			507,022		70,026			-			585,972
Intangible assets, net		41,612			14,142		1,290			-			57,044
Goodwill		-			324,277		-			-			324,277
Restricted cash, non-current		566			3,263		-			-			3,829
Deferred tax assets		51,993			-		(101	)		-			51,892
Other assets		5,190			4,939		36			-			10,165
Investment in subsidiaries		249,903			-		-			(249,903	)		-
Total assets	$	454,166		$	1,090,849	$	78,723		$	(249,912	)	$	1,373,826
Current liabilities:
Accounts payable	$	14,203		$	38,095	$	547		$	(9	)	$	52,836
Accrued compensation and benefits		8,100			53,270		586			-			61,956
Accrued self-insurance obligations, current portion		5,509			39,822		3,315			-			48,646
Income taxes payable		3,000			-		-			-			3,000
Liabilities held for sale		-			3,181		-			-			3,181
Other accrued liabilities		15,063			36,667		6,272			-			58,002
Current portion of long-term debt and capital lease obligations		3,760			24,397		1,148			-			29,305
Total current liabilities		49,635			195,432		11,868			(9	)		256,926
Accrued self-insurance obligations, net of current portion		36,415			69,690		429			-			106,534
Long-term debt and capital lease obligations, net of current portion		546,739			87,606		65,618			-			699,963
Unfavorable lease obligations, net		-			24,949		(5,989	)		-			18,960
Intercompany balances		(444,757	)		448,544		(3,787	)		-			-
Other long-term liabilities		18,986			18,064		7,667			-			44,717
Total liabilities		207,018			844,285		75,806			(9	)		1,127,100
Minority interest		892			100		(522	)		-			470
Stockholders’ equity:
Common stock		430			-		-			-			430
Additional paid-in capital		600,199			-		-			-			600,199
Accumulated deficit		(351,970	)		246,464		3,439			(249,903	)		(351,970	)
Accumulated other comprehensive loss, net		(2,403	)		-		-			-			(2,403	)
Total stockholders’ equity		246,256			246,464		3,439			(249,903	)		246,256
Total liabilities and stockholders’ equity	$	454,166		$	1,090,849	$	78,723		$	(249,912	)	$	1,373,826

25

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING INCOME STATEMENTS

For the Three Months Ended June 30, 2008

(in thousands)

					Combined			Combined
		Parent			Guarantor			Non-Guarantor
		Company			Subsidiaries			Subsidiaries		Elimination			Consolidated
Total net revenues	$	8		$	462,578		$	6,862	$	(15,256	)	$	454,192
Costs and expenses:
Operating salaries and benefits		-			250,586			2,912		-			253,498
Self-insurance for workers’ compensation and
general and professional liability insurance		114			11,616			162		-			11,892
General and administrative expenses (1)		16,112			12,943			-		-			29,055
Other operating costs		-			107,091			1,519		(15,256	)		93,354
Center rent expense		-			18,589			168		-			18,757
Depreciation and amortization		716			8,539			563		-			9,818
Provision for losses on accounts receivable		-			2,918			45		-			2,963
Interest, net		10,389			2,108			1,146		-			13,643
Gain on sale of assets		-			-			-		-			-
Income from investment in subsidiaries		(26,079	)		-			-		26,079			-
Total costs and expenses		1,252			414,390			6,515		10,823			432,980
(Loss) income before income taxes and
discontinued operations		(1,244	)		48,188			347		(26,079	)		21,212
Income tax (benefit) expense		(10,929	)		19,275			139		-			8,485
Income from continuing operations		9,685			28,913			208		(26,079	)		12,727
Discontinued operations:
(Loss) income from discontinued operations, net		-			(2,551	)		1,316		-			(1,235	)
(Loss) gain on disposal of discontinued
operations, net		-			(3,011	)		1,204		-			(1,807	)
(Loss) income on discontinued operations, net		-			(5,562	)		2,520		-			(3,042	)
Net income	$	9,685		$	23,351		$	2,728	$	(26,079	)	$	9,685

(1) Includes operating administrative expenses

26

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING INCOME STATEMENTS

For the Three Months Ended June 30, 2007

(in thousands)

					Combined			Combined
		Parent			Guarantor			Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	26		$	434,896		$	6,590		$	(11,533	)	$	429,979
Costs and expenses:
Operating salaries and benefits		-			239,316			2,705			-			242,021
Self-insurance for workers’ compensation and
general and professional liability insurance		128			7,674			157			-			7,959
General and administrative expenses (1)		17,600			10,189			5			-			27,794
Other operating costs		-			100,232			1,223			(11,533	)		89,922
Center rent expense		-			20,664			198			-			20,862
Depreciation and amortization		732			8,564			363			-			9,659
Provision for losses on accounts receivable		-			3,345			56			-			3,401
Interest, net		9,339			1,436			1,224			-			11,999
Loss on sale of assets		-			3			-			-			3
Income from investment in subsidiaries		(46,538	)		-			-			46,538			-
Total costs and expenses		(18,739	)		391,423			5,931			35,005			413,620
Income before income taxes and
discontinued operations		18,765			43,473			659			(46,538	)		16,359
Income tax expense		5,725			-			-			-			5,725
Income from continuing operations		13,040			43,473			659			(46,538	)		10,634
Discontinued operations:
Income (loss) from discontinued operations, net		-			2,493			(434	)		-			2,059
(Loss) gain on disposal of discontinued
operations, net		-			(69	)		416			-			347
Income (loss) on discontinued operations, net		-			2,424			(18	)		-			2,406
Net income	$	13,040		$	45,897		$	641		$	(46,538	)	$	13,040

(1)   Includes operating administrative expenses

27

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING INCOME STATEMENTS

For the Six Months Ended June 30, 2008

(in thousands)

					Combined			Combined
		Parent			Guarantor			Non-Guarantor
		Company			Subsidiaries			Subsidiaries		Elimination			Consolidated
Total net revenues	$	21		$	923,818		$	13,998	$	(30,080	)	$	907,757
Costs and expenses:
Operating salaries and benefits		-			503,943			5,970		-			509,913
Self-insurance for workers’ compensation and
general and professional liability insurance		229			26,312			321		-			26,862
General and administrative expenses (1)		32,697			24,882			-		-			57,579
Other operating costs		-			214,550			2,983		(30,080	)		187,453
Center rent expense		-			37,082			330		-			37,412
Depreciation and amortization		1,405			16,934			1,123		-			19,462
Provision for losses on accounts receivable		-			6,148			164		-			6,312
Interest, net		21,502			4,262			2,310		-			28,074
Gain on sale of assets		(76	)		-			-		-			(76	)
Income from investment in subsidiaries		(51,703	)		-			-		51,703			-
Total costs and expenses		4,054			834,113			13,201		21,623			872,991
(Loss) income before income taxes and
discontinued operations		(4,033	)		89,705			797		(51,703	)		34,766
Income tax (benefit) expense		(22,295	)		35,882			319		-			13,906
Income from continuing operations		18,262			53,823			478		(51,703	)		20,860
Discontinued operations:
(Loss) income from discontinued operations, net		-			(1,814	)		1,085		-			(729	)
(Loss) gain on disposal of discontinued
operations, net		-			(3,015	)		1,146		-			(1,869	)
(Loss) income on discontinued operations, net		-			(4,829	)		2,231		-			(2,598	)
Net income	$	18,262		$	48,994		$	2,709	$	(51,703	)	$	18,262

     (1) Includes operating administrative expenses

28

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING INCOME STATEMENTS

For the Six Months Ended June 30, 2007

(in thousands)

					Combined			Combined
		Parent			Guarantor			Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	34		$	701,811		$	9,838		$	(21,982	)	$	689,701
Costs and expenses:
Operating salaries and benefits		-			389,161			3,824			-			392,985
Self-insurance for workers’ compensation and
general and professional liability insurance		215			17,591			253			-			18,059
General and administrative expenses (1)		30,696			17,512			9			-			48,217
Other operating costs		-			161,402			1,852			(21,982	)		141,272
Center rent expense		-			33,939			197			-			34,136
Depreciation and amortization		1,168			11,887			475			-			13,530
Provision for losses on accounts receivable		-			5,428			60			-			5,488
Interest, net		8,722			3,342			1,997			-			14,061
Loss on sale of assets		-			10			-			-			10
Income from investment in subsidiaries		(65,410	)		-			-			65,410			-
Total costs and expenses		(24,609	)		640,272			8,667			43,428			667,758
Income before income taxes and
discontinued operations		24,643			61,539			1,171			(65,410	)		21,943
Income tax expense		7,680			-			-			-			7,680
Income from continuing operations		16,963			61,539			1,171			(65,410	)		14,263
Discontinued operations:
Income (loss) from discontinued operations, net		-			3,528			(825	)		-			2,703
(Loss) gain on disposal of discontinued
operations, net		-			(625	)		622			-			(3	)
Income (loss) on discontinued operations, net		-			2,903			(203	)		-			2,700
Net income	$	16,963		$	64,442		$	968		$	(65,410	)	$	16,963

(1)   Includes operating administrative expenses

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30, 2008

(in thousands)

					Combined			Combined
		Parent			Guarantor			Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination		Consolidated
Net cash provided by operating activities	$	12,684		$	17,824		$	313		$	-	$	30,821
Cash flows from investing activities:
Capital expenditures		(1,375	)		(14,719	)		(45	)		-		(16,139	)
Purchase of leased real estate		-			(727	)		-			-		(727	)
Proceeds from sale of assets held for sale		3,777			180			-			-		3,957
Acquisitions		-			(313	)		-			-		(313	)
Net cash provided by (used for) investing activities		2,402			(15,579	)		(45	)		-		(13,222	)
Cash flows from financing activities:
Long-term debt borrowings		-			20,290			-			-		20,290
Long-term debt repayments		(1,854	)		(22,778	)		(567	)		-		(25,199	)
Proceeds from issuance of common stock		70			-			-			-		70
Distribution of partnership equity		-			-			(223	)		-		(223	)
Net cash used for financing activities		(1,784	)		(2,488	)		(790	)		-		(5,062	)
Net increase (decrease) in cash and cash equivalents		13,302			(243	)		(522	)		-		12,537
Cash and cash equivalents at beginning of period		30,221			23,547			2,064			-		55,832
Cash and cash equivalents at end of period	$	43,523		$	23,304		$	1,542		$	-	$	68,369

For the Six Months Ended June 30, 2007

(in thousands)

		Parent Company			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Elimination		Consolidated
Net cash (used for) provided by operating activities	$	(9,481	)	$	72,291		$	(10,476	)	$	-	$	52,334
Cash flows from investing activities:
Capital expenditures		(2,250	)		(12,311	)		(394	)		-		(14,955	)
Purchase of leased real estate		-			(30,236	)		-			-		(30,236	)
Proceeds from sale of assets held for sale		2,251			3,238			-			-		5,489
Acquisitions, net		(368,515	)		-			-			-		(368,515	)
Accrued acquisition costs, net		3,585			-			-			-		3,585
Net cash used for investing activities		(364,929	)		(39,309	)		(394	)		-		(404,632	)
Cash flows from financing activities:
Net borrowings under Revolving Credit Facility		5,006			-			-			-		5,006
Long-term debt borrowings		304,142			10,404			12,454			-		327,000
Long-term debt repayments		(6,488	)		(27,793	)		(517	)		-		(34,798	)
Proceeds from issuance of common stock		665			-			-			-		665
Distribution of partnership equity		-			-			(511	)		-		(511	)
Distribution of minority interest		-			-			(57	)		-		(57	)
Release of third party collateral		25,640			-			-			-		25,640
Deferred financing costs		(18,045	)		-			-			-		(18,045	)
Net cash provided by (used for) financing activities		310,920			(17,389	)		11,369			-		304,900
Net (decrease) increase in cash and cash equivalents		(63,490	)		15,593			499			-		(47,398	)
Cash and cash equivalents at beginning of period		119,810			11,337			788			-		131,935
Cash and cash equivalents at end of period	$	56,320		$	26,930		$	1,287		$	-	$	84,537

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Sun Healthcare Group, Inc.’s subsidiaries are providers of long-term, subacute and related specialty healthcare services primarily to the senior population in the United States. Our core business is providing inpatient services, primarily through 188 skilled nursing centers, 15 assisted and independent living centers and eight mental health centers with 23,678 licensed beds located in 25 states as of June 30, 2008. Our subsidiaries also provide hospice services, rehabilitation therapy services and temporary medical staffing services to skilled nursing centers.

Revenues from Medicare, Medicaid and Other Sources

We receive revenues from Medicare, Medicaid, commercial insurance, self-pay residents, other third party payors and long-term care centers that utilize our specialty medical services. The sources and amounts of our inpatient services revenues are determined by a number of factors, including the number of licensed beds and occupancy rates of our centers, the acuity level of patients and the rates of reimbursement among payors. Federal and state governments continue to focus on methods to curb spending on health care programs such as Medicare and Medicaid. This focus has not been limited to skilled nursing centers, but includes other services provided by us, such as skilled therapy services. We cannot at this time predict the extent to which proposals limiting federal or state expenditures will be adopted or, if adopted and implemented, what effect, if any, such proposals will have on us. Efforts to impose reduced coverage, greater discounts and more stringent cost controls by government and other payors are expected to continue.

The following table sets forth the total nonaffiliated revenues and percentage of revenues by payor source for our continuing operations, on a consolidated and on an inpatient operations only basis, for the periods indicated (data includes revenues for acquired centers following the date of acquisition only):

		For the								For the
		Three Months Ended								Six Months Ended
Sources of Revenues		June 30, 2008				June 30, 2007				June 30, 2008				June 30, 2007
Consolidated:
Medicaid	$	180,606	39.8	%	$	179,051	41.6	%	$	360,927	39.8	%	$	279,161	40.5	%
Medicare		130,313	28.7			118,382	27.5			260,518	28.7			184,701	26.8
Private pay and other		143,273	31.5			132,546	30.9			286,312	31.5			225,839	32.7
Total	$	454,192	100.0	%	$	429,979	100.0	%	$	907,757	100.0	%	$	689,701	100.0	%
Inpatient Only:
Medicaid	$	180,563	44.8	%	$	179,004	47.0	%	$	360,865	44.8	%	$	279,088	46.8	%
Medicare		127,534	31.7			116,388	30.5			254,994	31.7			180,930	30.3
Private pay and other		94,848	23.5			85,753	22.5			189,262	23.5			136,415	22.9
Total	$	402,945	100.0	%	$	381,145	100.0	%	$	805,121	100.0	%	$	596,433	100.0	%

Medicare

Medicare is available to nearly every United States citizen 65 years of age and older. It is a broad program of health insurance designed to help the nation’s elderly meet hospital, hospice, home health and other health care costs. Health insurance coverage extends to certain persons under age 65 who qualify as disabled or those having end-stage renal disease. Medicare is comprised of four related health insurance programs.  Medicare Part A provides for inpatient services including hospital, skilled long-term care, and home healthcare.  Medicare Part B provides for outpatient services including physicians’ services, diagnostic service, durable medical equipment, skilled therapy services and medical supplies.  Medicare Part C is a managed care option (“Medicare Advantage”) for beneficiaries who are entitled to Part A and enrolled in Part B.  Medicare Part D is a benefit that provides prescription drug benefits for both Medicare and Medicare/Medicaid dually eligible patients.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Medicare reimburses our skilled nursing centers for Medicare Part A services under the Prospective Payment System (“PPS”) as defined by the Balanced Budget Act of 1997 and subsequently refined in 1999, 2000 and 2005.  PPS regulations predetermine a payment amount per patient, per day, based on the 1995 costs of treating patients indexed forward. The amount to be paid is determined by classifying each patient into one of 53 resource utilization group (“RUG”) categories that are based upon each patient’s acuity level.

The following table sets forth the average amounts of inpatient Medicare Part A revenues per patient, per day, recorded by our long-term care (“LTC”) centers for the periods indicated (data includes revenues for acquired centers following the date of acquisition only):

	For the				For the
	Three Months Ended				Six Months Ended
	June 30, 2008		June 30, 2007		June 30, 2008		June 30, 2007
$	415.37	$	383.97	$	413.92	$	377.58

In 2007, the Centers for Medicare and Medicaid Services of the Department of Health and Human Services (“CMS”) issued a final rule which included a 3.3% market basket increase effective for the 2008 federal fiscal year which commenced on October 1, 2007.  We estimate that the implementation of this market basket increase has increased our revenues by approximately $3.5 million per quarter.

On July 31, 2008, CMS issued a final rule to implement a 3.4% market basket increase for the 2009 federal fiscal year which will commence on October 1, 2008. The rule also contained an update of the wage indices.   We estimate that the net impact of these changes will be a 3.3% increase in our reimbursement rates, which should result in increased revenues of approximately $3.8 million per quarter. 

The Balanced Budget Act of 1997 established limits on reimbursement provided under Medicare Part B for therapy services.  An automatic exception is currently in place for LTC patients until at least December 31, 2009.

Medicaid

Medicaid is a state-administered program financed by state funds and federal matching funds. The program provides for medical assistance to the indigent and certain other eligible persons. Although administered under broad federal regulations, states are given flexibility to construct programs and payment methods. Each state in which we operate nursing centers has its own unique Medicaid reimbursement program.  State Medicaid programs include systems that will reimburse a nursing center for reasonable costs it incurs in providing care to its patients, based upon cost from a prior base year, adjusted for inflation and per diems based upon patient acuity.

The following table sets forth the average amounts of inpatient Medicaid revenues per patient, per day (excluding any impact of state-imposed provider taxes), recorded by our LTC centers for the periods indicated (data includes revenues for acquired centers following the date of acquisition only):

	For the				For the
	Three Months Ended				Six Months Ended
	June 30, 2008		June 30, 2007		June 30, 2008		June 30, 2007
$	166.69	$	159.87	$	166.61	$	155.72

Medicaid outlays are a significant component of state budgets, and there have been increased cost containment pressures on Medicaid outlays for nursing homes. It is not certain whether reductions in Medicaid rates would be imposed in the future for any states in which we operate.

Eighteen of the states in which we operate impose a provider tax on nursing homes as a method of increasing federal matching funds paid to those states for Medicaid.  Those states that have imposed the provider tax have used some or all of the matching funds to fund Medicaid reimbursement to nursing homes.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Private Payors

During the three months ended June 30, 2008, we received 31.5% of our revenues from commercial insurance, long-term care centers that utilize our specialty medical services, self-pay center residents, and other third party payors. These private third party payors are continuing their efforts to control healthcare costs through direct contracts with healthcare providers, increased utilization review and greater enrollment in managed care programs and preferred provider organizations. These private payors increasingly are demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk.

Other Reimbursement Matters

Net revenues realizable under third-party payor agreements are subject to change due to examination and retroactive adjustment by payors during the settlement process. Under cost-based reimbursement plans, payors may disallow, in whole or in part, requests for reimbursement based on determinations that certain costs are not reimbursable or reasonable or because additional supporting documentation is necessary. We recognize revenues from third-party payors and accrue estimated settlement amounts in the period in which the related services are provided. We estimate these settlement balances by making determinations based on our prior settlement experience and our understanding of the applicable reimbursement rules and regulations.

Critical Accounting Policies Update

In October 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”), which effectively defines fair value for purposes of accounting principles generally accepted in the United States and expands disclosures of fair value measurements.  SFAS No. 157 changes the underlying methodology of establishing fair value for our financial instruments, including our interest rate swap agreement (see Note 3 – “Fair Value of Financial Instruments”).  There was no material impact on our financial condition upon adoption of SFAS No. 157 for our financial assets and financial liabilities.

We believe there have been no significant changes, other than the adoption of SFAS No. 157, during the three and six months ended June 30, 2008 to the items that we disclosed as our critical accounting policies and estimates in our discussion and analysis of financial condition and results of operations in our Annual Report on Form 10-K for the year ended December 31, 2007.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures About Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133 (“SFAS No. 161”), which expands quarterly disclosure requirements in Statement of Financial Accounting Standards No. 133,Accounting for Derivative Instruments and Hedging Activity, about an entity’s derivative instruments and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008.  We are currently assessing the impact of SFAS No. 161 on our consolidated financial position and results of operations.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Results of Operations

The following unaudited table sets forth our historical consolidated income statements and certain percentage relationships for the periods presented (dollars in thousands):

		For the Three			For the Three	As a Percentage of Net Revenues
		Months Ended			Months Ended
		June 30, 2008			June 30, 2007	June 30, 2008		June 30, 2007
Total net revenues	$	454,192		$	429,979	100.0	%	100.0	%
Costs and expenses:
Operating salaries and benefits		253,498			242,021	55.8		56.3
Self-insurance for workers’ compensation and general
and professional liabilities		11,892			7,959	2.6		1.9
Other operating costs		106,298			100,419	23.4		23.4
Center rent expense		18,757			20,862	4.1		4.9
General and administrative expenses		16,111			17,297	3.5		4.0
Depreciation and amortization		9,818			9,659	2.2		2.2
Provision for losses on accounts receivable		2,963			3,401	0.7		0.8
Interest, net		13,643			11,999	3.0		2.8
Other (income) expenses		-			3	-		-
Income before income taxes and discontinued
operations		21,212			16,359	4.7		3.8
Income tax expense		8,485			5,725	1.9		1.3
Income from continuing operations		12,727			10,634	2.8		2.5
Income from discontinued operations, net		(3,042	)		2,406	(0.7	)	0.5
Net income	$	9,685		$	13,040	2.1	%	3.0	%

		For the Six			For the Six	As a Percentage of Net Revenues
		Months Ended			Months Ended
		June 30, 2008			June 30, 2007	June 30, 2008		June 30, 2007
Total net revenues	$	907,757		$	689,701	100.0	%	100.0	%
Costs and expenses:
Operating salaries and benefits		509,913			392,985	56.2		57.0
Self-insurance for workers’ compensation and general
and professional liabilities		26,862			18,059	3.0		2.6
Other operating costs		212,336			159,358	23.4		23.1
Center rent expense		37,412			34,136	4.1		4.9
General and administrative expenses		32,696			30,131	3.6		4.4
Depreciation and amortization		19,462			13,530	2.1		2.0
Provision for losses on accounts receivable		6,312			5,488	0.7		0.8
Interest, net		28,074			14,061	3.1		2.0
Other (income) expenses		(76	)		10	-		-
Income before income taxes and discontinued
operations		34,766			21,943	3.8		3.2
Income tax expense		13,906			7,680	1.5		1.1
Income from continuing operations		20,860			14,263	2.3		2.1
Income from discontinued operations, net		(2,598	)		2,700	(0.3	)	0.4
Net income	$	18,262		$	16,963	2.0	%	2.5	%

The following discussion of the “Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007” and the “Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007” is based, in part, on the financial information presented in Note 9 – “Segment Information” in our consolidated financial statements.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Three Months Ended June 30, 2008 Compared to Three Months Ended June 30, 2007

The following summarizes our results of operations on a consolidated basis.  A more detailed discussion and analysis of the results of operations of each of our segments (Inpatient Services, Rehabilitation Therapy Services, Medical Staffing Services and Corporate) is provided below under “Segment Information.”

Net revenue increased $24.2 million, or 5.6%, to $454.2 million for the three months ended June 30, 2008 from $430.0 million for the three months ended June 30, 2007. We reported net income for the three months ended June 30, 2008 of $9.7 million compared to net income of $13.0 million for the three months ended June 30, 2007.

The increase in net revenue for the 2008 period included $21.8 million of additional revenue in our Inpatient Services segment due to increases in Medicare Part A, Medicaid, private payor rates, and commercial insurance revenues, offset by decreases due to a lower Medicaid and private pay customer base.  The remainder of the increase primarily resulted from $1.7 million of revenue from our Medical Staffing segment mainly due to an increase in billable hours, increases in temporary placement of physicians and increases in average bill rates and $4.5 million of revenue from our Rehabilitation Therapy segment due to increases in billable minutes and billing rates.

Operating salaries and benefits, excluding workers’ compensation insurance costs, increased $11.5 million, or 4.8%, to $253.5 million (55.8% of net revenues) for the three months ended June 30, 2008 from $242.0 million (56.3% of net revenues) for the three months ended June 30, 2007.  The increase resulted primarily from $8.3 million of wage increases in our Inpatient Services segment and a $3.4 million increase from our Rehabilitation Therapy segment attributable to wage rate increases and business growth.

Self-insurance for workers’ compensation and general and professional liability insurance increased $3.9 million, or 48.8%, to $11.9 million (2.6% of net revenues) for the three months ended June 30, 2008 from $8.0 million (1.9% of net revenues) for the three months ended June 30, 2007 primarily due to increased medical, legal and administrative costs associated with claims.

Other operating costs increased $­­­5.9 million, or 5.9%, to $106.3 million (23.4% of net revenues) for the three months ended June 30, 2008 from $100.4 million (23.4% of net revenues) for the three months ended June 30, 2007.  The increase was primarily due to a $5.4 million increase in our Inpatient Services segment driven by increased therapy costs due to an increase in higher acuity patients requiring more rehabilitation therapy, utilities expense and expenses for education and training, as well as a $1.7 million increase in our Medical Staffing segment, primarily for travel and lodging expenses.

Center rent expense decreased $2.1 million, or 10.0%, to $18.8 million (4.1% of net revenues) for the three months ended June 30, 2008 from $20.9 million (4.9% of net revenues) for the three months ended June 30, 2007, primarily due to the conversion of leased centers to owned.

General and administrative expenses decreased $1.2 million, or 6.9%, to $16.1 million (3.5% of net revenues) for the three months ended June 30, 2008 from $17.3 million (4.0% of net revenues) for the three months ended June 30, 2007.  The decrease was primarily due to cost reductions in our Corporate segment from reduced consultant fees, health insurance and office leases.

Depreciation and amortization increased $0.1 million, or 1.0%, to $9.8 million (2.2% of net revenues) for the three months ended June 30, 2008 from $9.7 million (2.2% of net revenues) for the three months ended June 30, 2007.  The increase was attributable to new property and equipment acquired during the period.

The provision for losses on accounts receivable decreased $0.4 million, or 11.8%, to $3.0 million (0.7% of net revenues) for the three months ended June 30, 2008 from $3.4 million (0.8% of net revenues) for the three months ended June 30, 2007.  The decrease was primarily due to improved collection in our Inpatient Services segment.

Net interest expense increased $1.6 million, or 13.3%, to $13.6 million (3.0% of net revenues) for the three months ended June 30, 2008 from $12.0 million (2.8% of net revenues) for the three months ended June 30, 2007.  The increase was attributable to the debt incurred and assumed in our acquisition of Harborside Healthcare Corporation (“Harborside”) and new obligations related to the conversion of leased centers to owned.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

     As a result of flooding in the Midwest, our center in Terre Haute, IN was severely damaged and the operation discontinued.  As a result, all operating results for the Terre Haute center have been reclassified to discontinued operations for all periods presented, and we have recorded a $1.8 million fixed assets impairment charge in the quarter related to the damaged Terre Haute building and its contents.  During the quarter we also elected not to renew an operating lease on a Tennessee nursing center.  All operating results for this center have also been reclassified to discontinued operations for all periods presented.  The combined impact of the reclassification of both the Terre Haute center and the Tennessee center on the previously reported 2007 quarter’s revenue was $4.6 million.  Near the end of the quarter, we completed the sale of two stand-alone hospitals and in conjunction with the completion of the sale recorded a loss on disposal of $2.7 million to discontinued operations.

Segment Information

The following table sets forth the amount and percentage of certain elements of total net revenues for the three months ended June 30 (dollars in thousands):

		2008					2007
Inpatient Services	$	402,945		88.8	%	$	381,145		88.7	%
Rehabilitation Therapy Services		35,604		7.8			31,121		7.2
Medical Staffing Services		30,890		6.8			29,219		6.8
Corporate		9		-			27		-
Intersegment Eliminations		(15,256	)	(2.7	)		(11,533	)	(2.7	)
Total net revenues	$	454,192		100.0	%	$	429,979		100.0	%

Inpatient services revenues for long-term care, subacute care and assisted living services include revenues billed to patients for therapy and medical staffing provided by our affiliated operations.  The following table sets forth a summary of the intersegment revenues for the three months ended June 30 (in thousands):

		2008		2007
Inpatient Services	$	-	$	-
Rehabilitation Therapy Services		14,462		10,332
Medical Staffing Services		794		1,201
Total intersegment revenue	$	15,256	$	11,533

The following table sets forth the amount of net segment income (loss) for the three months ended June 30 (in thousands):

		2008			2007
Inpatient Services	$	43,516		$	39,663
Rehabilitation Therapy Services		2,562			2,281
Medical Staffing Services		2,456			2,057
Net segment income before Corporate		48,534			44,001
Corporate		(27,322	)		(27,639	)
Net segment income	$	21,212		$	16,362

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Inpatient Service

Net revenues increased $21.8 million, or 5.7%, to $402.9 million for the three months ended June 30, 2008 from $381.1 million for the three months ended June 30, 2007.  The increase was primarily the result of:

-	an increase of $11.2 million in Medicare revenues comprised of a $9.8 million increase in Medicare Part A rates (including $1.1 million of rate increases in our hospice program), a $0.9 million increase from a higher customer base, a $0.3 million increase in Medicare Part B revenues and $0.2 million in enteral nutrition revenues;
-	an $8.4 million increase in managed care and commercial insurance revenues driven by a higher customer base, which contributed $6.5 million of the increase, and higher rates, which drove the remaining $1.9 million of the increase;
-	an increase of $7.5 million in Medicaid revenues due to improved rates; and
-	a $2.0 million increase in private pay revenues due to higher rates;
	Offset in part by:
-	a $6.2 million decrease in Medicaid revenues due to lower customer base; and
-	a $1.1 million decrease in private pay revenues due to lower customer base.

Operating salaries and benefits expenses increased $8.5 million, or 4.4%, to $202.4 million for the three months ended June 30, 2008 from $193.9 million for the three months ended June 30, 2007.  The increase was attributable to the following:

-	wage increases and related benefits and taxes of $8.3 million; and
-	an increase of $1.0 million in health insurance expense;
	Offset in part by:
-	a decrease of $0.5 million in paid time-off, including sick, vacation and holiday; and
-	a decrease of $0.3 million in bonus expense.

Self-insurance for workers’ compensation and general and professional liability insurance increased $3.9 million, or 56.5%, to $10.8 million for the three months ended June 30, 2008 as compared to $6.9 million for the three months ended June 30, 2007, primarily due to increased medical, legal and administrative costs associated with claims.

Other operating costs increased $5.4 million, or 5.6%, to $102.6 million for the three months ended June 30, 2008 from $97.2 million for the three months ended June 30, 2007.  The increase was attributable to the following:

- a $4.0 million increase in therapy and equipment rental costs due to an increase in higher acuity patients requiring more rehabilitation therapy;

- a $1.5 million increase in utilities expense, principally due to increases in natural gas and electricity rates;

- a $1.2 million increase in education and training, primarily related to increased clinical training;

- a $0.5 million increase in supplies, due to higher costs for medical, incontinency and food supplies; and

- a $0.2 million increase in professional and consultant fees;

37

	Offset in part by:
-	a $1.5 million decrease in nursing contract labor;
-	a $0.4 million decrease in taxes, primarily related to gross receipts and real estate taxes; and
-	a $0.1 million decrease in civil monetary penalties.

General and administrative expenses increased $1.9 million, or 22.4%, to $10.4 million for the three months ended June 30, 2008 from $8.5 million for the three months ended June 30, 2007. The increase is primarily due to the filling of open positions, travel and utility costs.

The provision for losses on accounts receivable decreased $0.7 million, or 20.6%, to approximately $2.7 million for the three months ended June 30, 2008 from $3.4 million for the three months ended June 30, 2007. The decrease was primarily attributable to the improvement of cash collections at the Harborside centers.

Center rent expense of $18.4 million for the three months ended June 30, 2008 decreased $2.2 million, or 10.7%, compared to $20.6 million for the three months ended June 30, 2007, due to the conversion of various leased centers to owned.

Depreciation and amortization increased $0.2 million, or 2.3%, to $8.8 million for the three months ended June 30, 2008 from $8.6 million for the three months ended June 30, 2007. The increase was attributable to additional depreciation expense for new property and equipment acquired during the period.

Net interest expense for the three months ended June 30, 2008 was $3.3 million as compared to $2.5 million for the three months ended June 30, 2007.  The increase of $0.8 million, or 32.0%, was primarily due to interest on new debt obligations related to the conversion of leased centers to owned.

Rehabilitation Therapy Services

Total revenues from the Rehabilitation Therapy Services segment increased $4.5 million, or 14.5%, to $35.6 million for the three months ended June 30, 2008 from $31.1 million for the three months ended June 30, 2007. The revenue increase was the result of:

- an increase of $3.2 million attributable to a 10.0% increase in billable minutes; the volume increase being due to an increase in contract count and an overall increase in service volume, mainly in the affiliated LTC center segment and non-affiliated rehabilitation agencies; and

- an increase of $1.3 million attributable to a 4.0% increase in our revenue per minute rate due to our renegotiation of certain customer contract rates, an increase in assisted and community living business and operating efficiencies.

Operating salaries and benefits expenses increased $3.4 million, or 13.4%, to $28.8 million for the three months ended June 30, 2008 from $25.4 million for the three months ended June 30, 2007. The increase was primarily driven by wage rate increases coupled with the aforementioned increase in service volume.

Medical Staffing Services

Total revenues from the Medical Staffing Services segment increased $1.7 million, or 5.8%, to $30.9 million for the three months ended June 30, 2008 from $29.2 million for the three months ended June 30, 2007.  The increase was primarily the result of:

- an increase of $1.1 million attributable to a 4.6% increase in billable hours;

- an increase of $1.1 million due to an increase in temporary placement of physicians; and

- an increase of $0.4 million due principally to an average bill rate per hour increase;

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	Offset in part by:
-	a decrease of $0.3 million related to a shift from affiliated revenue to non-affiliated in Harborside’s medical staffing business, and
-	a decrease of $0.6 million related to disposed offices.

Operating salaries and benefits expenses were $22.2 million for the three months ended June 30, 2008 as compared to $22.8 million for the three months ended June 30, 2007, a decrease of $0.6 million, or 2.6%. The decrease in operating salaries and benefits resulted from changing compensation packages for nurses and therapists.

Other operating costs increased $1.7 million, or 65.4%, to $4.3 million for the three months ended June 30, 2008 from $2.6 million for the three months ended June 30, 2007. The increase was primarily attributable to costs paid for travel and lodging for nurses and therapists.

Corporate

General and administrative expenses not directly attributed to segments decreased $1.2 million, or 6.9%, to $16.1 million for the three months ended June 30, 2008 from $17.3 million for the three months ended June 30, 2007. The decrease was primarily due to cost reductions in consultant fees, health insurance and office leases.  As a percent of consolidated revenues, general and administrative expenses were 3.5% for the three months ended June 30, 2008 compared to 4.0% for the three months ended June 30, 2007.

Interest expense

Interest expense not directly attributed to operating segments increased $0.9 million, or 9.5%, to $10.4 million for the three months ended June 30, 2008 from $9.5 million for the three months ended June 30, 2007. The increase in expense was due to the debt incurred and assumed in the Harborside acquisition.

Six Months Ended June 30, 2008 Compared to Six Months Ended June 30, 2007

The following summarizes our results of operations on a consolidated basis.  A more detailed discussion and analysis of the results of operations of each of our segments (Inpatient Services, Rehabilitation Therapy Services, Medical Staffing Services and Corporate) is provided below under “Segment Information.”

Net revenue increased $218.1 million, or 31.6%, to $907.8 million for the six months ended June 30, 2008 from $689.7 million for the six months ended June 30, 2007. We reported net income for the six months ended June 30, 2008 of $18.3 million compared to net income of $17.0 million for the six months ended June 30, 2007.

The increase in net revenue for the 2008 period included $208.7 million of additional revenue in our Inpatient Services segment, of which $167.1 million is attributable to our acquisition of Harborside in April 2007, with the remainder primarily due to increases in Medicare Part A, Medicaid, private pay rates, and commercial insurance revenues, offset by decreases due to a lower private pay customer base.  The remainder of the increase primarily resulted from $7.9 million of revenue from our Medical Staffing segment mainly due to an increase in billable hours, increases in average bill rates, increases in temporary placement of physicians and the addition of a medical staffing business in the Harborside acquisition, and $9.5 million of revenue from our Rehabilitation Therapy segment due to an increase in service volume and the renegotiation of customer contracts.

Operating salaries and benefits, excluding workers’ compensation insurance costs, increased $116.9 million, or 29.7%, to $509.9 million (56.2% of net revenues) for the six months ended June 30, 2008 from $393.0 million (57.0% of net revenues) for the six months ended June 30, 2007.  The addition of Harborside contributed $90.7 million to the increases while the remaining increase resulted primarily from $14.9 million of wage increases in our Inpatient Services segment, a $3.0 million increase from our Medical Staffing segment, and a $7.4 million increase from our Rehabilitation Therapy segment, the latter two segments’ increases being directly attributable to wage rates increases and business growth.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

       Self-insurance for workers’ compensation and general and professional liability insurance increased $8.8 million, or 48.6%, to $26.9 million (3.0% of net revenues) for the six months ended June 30, 2008 from $18.1 million (2.6% of net revenues) for the six months ended June 30, 2007.  The addition of Harborside contributed $4.7 million to the increase.  The remainder of the increase is primarily due to increased medical, legal and administrative costs associated with claims.

Other operating costs increased $­­­52.9 million, or 33.2%, to $212.3 million (23.4% of net revenues) for the six months ended June 30, 2008 from $159.4 million (23.1% of net revenues) for the six months ended June 30, 2007.  The increase was primarily due to $39.3 million in additional costs due to the addition of Harborside’s operations and a $11.4 million increase in our Inpatient Services segment driven by increased therapy costs due to an increase in higher acuity patients requiring more rehabilitation therapy, increased supplies costs, increased education and training, and increased utilities expense, as well as a $3.7 million increase in our Medical Staffing segment primarily for travel and lodging expenses.

Center rent expense increased $3.3 million, or 9.7%, to $37.4 million (4.1% of net revenues) for the six months ended June 30, 2008 from $34.1 million (4.9% of net revenues) for the six months ended June 30, 2007, of which $4.7 million was due to the additional rent expense resulting from the Harborside acquisition offset by rent decreases related to conversions of leased centers to owned.

General and administrative expenses increased $2.6 million, or 8.6%, to $32.7 million (3.6% of net revenues) for the six months ended June 30, 2008 from $30.1 million (4.4% of net revenues) for the six months ended June 30, 2007.  The increase was primarily due to incremental costs associated with supporting Harborside’s operations for a full six months in 2008 versus only three months during the corresponding 2007 period.

Depreciation and amortization increased $6.0 million, or 44.4%, to $19.5 million (2.1% of net revenues) for the six months ended June 30, 2008 from $13.5 million (2.0% of net revenues) for the six months ended March 31, 2007.  The increase was primarily attributable to the addition of the Harborside centers and additional depreciation expense for new property and equipment acquired during the period.

The provision for losses on accounts receivable increased $0.8 million, or 14.5%, to $6.3 million (0.7% of net revenues) for the six months ended June 30, 2008 from $5.5 million (0.8% of net revenues) for the six months ended June 30, 2007.  The increase was due to the addition of Harborside’s operations offset by improved collections at existing centers.

Net interest expense increased $14.0 million, or 99.3%, to $28.1 million (3.1% of net revenues) for the six months ended June 30, 2008 from $14.1 million (2.0% of net revenues) for the six months ended June 30, 2007. The increase was attributable to the debt incurred and assumed in the Harborside acquisition.

Segment Information

The following table sets forth the amount and percentage of certain elements of total net revenues for the six months ended June 30 (dollars in thousands):

		2008					2007
Inpatient Services	$	805,121		88.7	%	$	596,433		86.5	%
Rehabilitation Therapy Services		71,603		7.9			62,063		9.0
Medical Staffing Services		61,092		6.7			53,153		7.7
Corporate		21		-			34		-
Intersegment Eliminations		(30,080	)	(3.3	)		(21,982	)	(3.2	)
Total net revenues	$	907,757		100.0	%	$	689,701		100.0	%

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Inpatient services revenues for long-term care, subacute care and assisted living services include revenues billed to patients for therapy and medical staffing provided by our affiliated operations.  The following table sets forth a summary of the intersegment revenues for the six months ended June 30 (in thousands):

		2008		2007
Inpatient Services	$	-	$	-
Rehabilitation Therapy Services		28,752		20,594
Medical Staffing Services		1,328		1,388
Total intersegment revenue	$	30,080	$	21,982

The following table sets forth the amount of net segment income (loss) for the six months ended June 30 (in thousands):

		2008			2007
Inpatient Services	$	81,425		$	55,335
Rehabilitation Therapy Services		4,690			3,708
Medical Staffing Services		4,388			3,470
Net segment income before Corporate		90,503			62,513
Corporate		(55,813	)		(40,560	)
Net segment income	$	34,690		$	21,953

Inpatient Services

Net revenues increased $208.7 million, or 35.0%, to $805.1 million for the six months ended June 30, 2008 from $596.4 million for the six months ended June 30, 2007. The addition of Harborside contributed $167.1 million of the increase.  The remaining increase of $41.6 million, or 6.9%, was primarily the result of:

-	an increase of $21.3 million in Medicare revenues comprised of a $16.8 million increase in Medicare Part A rates (including $2.0 million of rate increases in our hospice program), a $3.2 million increase from a higher customer base, a $0.9 million increase in Medicare Part B revenues and $0.4 million in enteral nutrition revenues;
-	a $12.5 million increase in Medicaid revenues due to higher rates;
-	a $13.1 million increase in managed care and commercial insurance revenues driven by a higher customer base, which contributed $10.5 million of the increase, and higher rates, which drove the remaining $2.6 million of the increase; and
-	a $4.6 million increase in private pay revenues driven by a higher customer base, which contributed $4.4 million, and higher rates, which drove the remaining increase of $0.2 million;
	Offset in part by:
-	a $9.9 million decrease in Medicaid revenues due to lower customer base.

Operating salaries and benefits expenses increased $106.5 million, or 35.5%, to $406.4 million for the six months ended June 30, 2008 from $299.9 million for the six months ended June 30, 2007.  The accretive impact of the Harborside operations contributed $90.7 million of the increase, with the remaining increase of $15.8 million attributable to the following:

- wage increases and related benefits and taxes of $14.9 million;

- an increase of $1.5 million in health insurance expense; and

- a $0.7 million increase in overtime expenses;

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	Offset in part by:
-	a decrease of $0.8 million in paid time-off, including sick, vacation and holiday; and
-	a decrease of $0.5 million in bonus expense.

Self-insurance for workers’ compensation and general and professional liability insurance increased $8.6 million, or 53.1%, to $24.8 million for the six months ended June 30, 2008 as compared to $16.2 million for the six months ended June 30, 2007.  The addition of Harborside accounted for $4.7 million of the net increase for the six months ended June 30, 2008.  The remainder of the increase is primarily due to increased medical, legal and administrative costs associated with claims.

Other operating costs increased $50.7 million, or 32.6%, to $206.1 million for the six months ended June 30, 2008 from $155.4 million for the six months ended June 30, 2007.  Approximately $39.3 million of this amount was due to the addition of Harborside.  The remaining increase of $11.4 million was primarily due to:

-	a $7.6 million increase in therapy and equipment rental costs due to an increase in higher acuity patients requiring more rehabilitation therapy;
-	a $2.0 million increase in supplies, due to higher costs for medical, incontinency and food supplies;
-	a $2.0 million increase in education and training related to increased clinical training;
-	a $2.0 million increase in utilities expense, principally due to increases in natural gas and electricity rates; and
-	a $0.6 million increase in legal fees;
	Offset in part by:
-	a $1.9 million decrease in contract labor;
-	a $0.8 million decrease in taxes primarily related to gross receipts and real estate taxes; and
-	a $0.1 million decrease in professional and consultant fees.

General and administrative expenses increased $6.1 million, or 44.2%, to $19.9 million for the six months ended June 30, 2008 from $13.8 million for the six months ended June 30, 2007. The addition of the Harborside operations accounted for $3.2 million of the increase with the remaining $2.9 million due primarily to the filling of open positions, travel and utilities.

The provision for losses on accounts receivable increased $0.2 million, or 3.6%, to approximately $5.7 million for the six months ended June 30, 2008 from $5.5 million for the six months ended June 30, 2007. The increase was primarily attributable to the addition of the Harborside operations offset by improved collections at existing centers.

Center rent expense of $36.7 million for the six months ended June 30, 2008 increased $3.1 million, or 9.2%, compared to $33.6 million for the six months ended June 30, 2007, due to $4.7 million of rent expense associated with the acquired Harborside operations offset by a $1.6 million of rent decreases related to conversions of leased centers to owned.

Depreciation and amortization increased $5.7 million, or 48.7%, to $17.4 million for the six months ended June 30, 2008 from $11.7 million for the six months ended June 30, 2007. The increase was primarily attributable to the addition of the Harborside centers and additional depreciation expense on Sun centers for new property and equipment acquired during the period.

Net interest expense for the six months ended June 30, 2008 was $6.6 million as compared to $5.0 million for the six months ended June 30, 2007.  The increase of $1.6 million, or 32.0%, was primarily due to debt incurred and assumed in the Harborside acquisition.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Rehabilitation Therapy Services

Total revenues from the Rehabilitation Therapy Services segment increased $9.5 million, or 15.3%, to $71.6 million for the six months ended June 30, 2008 from $62.1 million for the six months ended June 30, 2007. The revenue increase was the result of:

- an increase of $6.4 million attributable to a 9.7% increase in billable minutes; the volume increase being due to an increase in contract count and an overall increase in service volume, mainly in the affiliated LTC center segment and non-affiliated rehabilitation agencies; and

- an increase of $3.1 million attributable to a 5.0% increase in our billing rate due to our renegotiation of certain customer contract rates, an increase in assisted and community living business and operating efficiencies.

Operating salaries and benefits expenses increased $7.4 million, or 14.4%, to $58.8 million for the six months ended June 30, 2008 from $51.4 million for the six months ended June 30, 2007. The increase was primarily driven by wage rate increases coupled with the aforementioned increase in service volume.

Medical Staffing Services

Total revenues from the Medical Staffing Services segment increased $7.9 million, or 14.8%, to $61.1 million for the six months ended June 30, 2008 from $53.2 million for the six months ended June 30, 2007.  The increase was primarily the result of:

-	an increase of $5.0 million attributable to a 10.7% increase in billable hours;
-	an increase of $0.4 million due to an average bill rate per hour increase;
-	an increase of $1.9 million due to an increase in temporary placement of physicians; and
-	an increase of $1.8 million due to the addition of Harborside’s medical staffing business;
	Offset in part by:
-	a decrease of $1.2 million related to disposed offices.

Operating salaries and benefits expenses were $44.7 million for the six months ended June 30, 2008 as compared to $41.7 million for the six months ended June 30, 2007, an increase of $3.0 million, or 7.2%. The increase in operating salaries and benefits resulted from the increase in business.

Other operating costs increased $3.7 million, or 84.1%, to $8.1 million for the six months ended June 30, 2008 from $4.4 million for the six months ended June 30, 2007. The increase was primarily attributable to costs paid for travel and lodging for nurses and therapists.

Corporate

General and administrative expenses not directly attributed to segments increased $2.6 million, or 8.6%, to $32.7 million for the six months ended June 30, 2008 from $30.1 million for the six months ended June 30, 2007. The increase was primarily due to incremental costs associated with supporting Harborside’s operations for a full six months in 2008 versus only three months during the corresponding 2007 period.  As a percent of consolidated revenues, general and administrative expenses were 3.6% for the six months ended June 30, 2008 compared to 4.4% for the six months ended June 30, 2007.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Interest expense

Interest expense not directly attributed to operating segments increased $12.4 million, or 136.3%, to $21.5 million for the six months ended June 30, 2008 from $9.1 million for the six months ended June 30, 2007. The increase in expense was due to the debt incurred and assumed in the Harborside acquisition.

Liquidity and Capital Resources

For the three and six months ended June 30, 2008, our net income was $9.7 million and $18.3 million, respectively.  As of June 30, 2008, our working capital was $137.8 million. As of June 30, 2008, we had cash and cash equivalents of $68.4 million, $730.1 million in borrowings and $50.0 million available under our revolving credit facility.

We believe that our operating cash flows, existing cash reserves and availability for borrowing under our revolving credit facility will provide sufficient funds for our operations, capital expenditures and regularly scheduled debt service payments at least through the next twelve months. We do not depend on cash flows from discontinued operations to provide for future liquidity.

Cash Flows

During the three months ended June 30, 2008, net cash provided by operating activities decreased by $32.7 million as compared to the same period last year. This decrease was the result of (i) our quarter-over-quarter decrease in net income of $3.4 million, (ii) our quarter-over-quarter decrease in working capital changes of $40.1 million, driven by the acquisition of Harborside and a change in accrued compensation and benefits and other accrued liabilities and (iii) a $10.8 million increase in non-cash adjustments to net income, principally related to deferred taxes and losses in discontinued operations.

Debt

In June 2008 we entered into a $25.6 million mortgage note payable for purposes of refinancing an existing mortgage note payable of approximately $20.0 million.  The additional $5.6 million was used in connection with our purchase of two previously leased centers.  See Note 2 – “Long-Term Debt and Capital Lease Obligations.”

Capital Expenditures

We incurred capital expenditures, related primarily to improvements in continuing operations, as reflected in our consolidated statements of cash flows, of $10.2 million and $7.7 million for the three months ended June 30, 2008 and 2007, respectively, and of $16.1 million and $15.0 million for the six months ended June 30, 2008 and 2007, respectively.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk because we have issued debt that is sensitive to changes in interest rates. We manage our interest rate risk exposure by maintaining a mix of fixed and variable rates of interest on our debt. The following table provides information regarding our market sensitive financial instruments and constitutes a forward-looking statement.

																						Fair Value			Fair Value
		Expected Maturity Dates																				June 30,			December 31,
		2009			2010			2011			2012			2013			Thereafter			Total		2008 (1)			2007 (1)
		(Dollars in thousands)
Long-term debt:
Fixed rate debt (2)	$	6,307		$	5,444		$	24,108		$	23,202		$	5,270		$	387,914		$	452,245	$	418,040		$	428,428
Rate		7.5	%		8.3	%		8.2	%		6.5	%		8.5	%		8.3	%
Variable rate debt	$	6,583		$	2,919		$	27,287		$	2,499		$	2,499		$	236,115		$	277,902	$	265,028		$	248,128
Rate		5.4	%		4.9	%		5.6	%		4.8	%		4.8	%		4.8	%
Interest rate swap:
Variable to fixed	$	100,000		$	100,000			-			-			-			-				$	(4,240	)	$	(4,005	)
Average pay rate		5.39	%		5.39	%		-			-			-			-
Average receive rate		2.92	%		2.92	%		-			-			-			-

(1)	The fair value of fixed and variable rate debt was determined based on the current rates offered for debt with similar risks and maturities.
(2)	Fixed rate long-term debt includes $49.0 million related to the consolidation of Clipper as of June 30, 2008 and $49.4 million as of December 31, 2007 (see Note 5 – “Variable Interest Entities”).

ITEM 4.  CONTROLS AND PROCEDURES

As of the end of the period covered by this report, our management, including our principal executive officer (Richard Matros) and our principal financial officer (L. Bryan Shaul), conducted an evaluation of the effectiveness of our disclosure controls and procedures.  Disclosure controls  and procedures are defined as controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and include, without limitation, controls and procedures designed to ensure that information is accumulated  and communicated to the issuer's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding  required disclosure.  Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2008.  No change in our internal control over financial reporting occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

PART II. OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

(a)   The annual meeting of our stockholders was held on June 6, 2008.

(b)   Gregory S. Anderson, Tony M. Astorga, Christian K. Bement, Michael J. Foster, Barbara B. Kennelly, Steven M. Looney, Richard K. Matros, and Milton J. Walters were each elected to a one-year term on the Board of Directors that will expire at the Annual Meeting of Stockholders in 2009. The following table sets forth the number of votes cast for, the number of votes cast against and the number of abstentions with respect to each director nominee:

	For	Against	Abstain
Anderson	39,763,561	307,121	63,700
Astorga	39,477,198	593,378	63,806
Bement	36,725,684	3,346,067	62,631
Foster	39,638,938	432,632	62,811
Kennelly	39,416,456	655,151	62,775
Looney	39,835,369	236,206	62,807
Matros	39,599,946	470,738	63,698
Walters	39,766,148	305,492	62,742

 (c)   The other matter voted on at the meeting was the ratification of the appointment of PricewaterhouseCoopers LLP as our independent public accountants for the fiscal year ending December 31, 2008 and the results were as follows:

For	Against	Abstain
40,051,557	23,260	59,566

 (d)   Not applicable.

ITEM 5.  OTHER INFORMATION

On June 6, 2008, the Board of Directors of the Company approved the Non-Employee Directors Stock-for-Fees Program (the “Program”).  Pursuant to the Program, non-employee directors can elect to receive their annual retainers in the form of stock units rather than in cash.  The number of stock units to be issued to the non-employee directors would be determined by dividing the cash retainer that would otherwise be payable to the director by the value of a share of the Company’s common stock on the last business day of each quarter.  The stock units would vest immediately but would not be issued in shares of common stock until the earlier of the directors’ discontinuation of service on the Board of Directors or five years from the date the units were granted.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 6. EXHIBITS

10.1	Non-Employee Directors Stock-for-Fees Program and Payment Election Form
10.2(1)	Executive Bonus Plan
10.3(1)	Amendment No. 2 to Employment Agreement effective as of March 31, 2008 by and between Sun Healthcare Group, Inc. and Richard Matros
10.4(1)	Amendment No. 3 to Employment Agreement effective as of March 31, 2008 by and between Sun Healthcare Group, Inc. and L. Bryan Shaul
10.5(1)	Amendment No. 3 to Employment Agreement effective as of March 31, 2008 by and between Sun Health Specialty Services, Inc. and William A. Mathies
10.6(1)	Amendment No. 3 to Employment Agreement effective as of March 31, 2008 by and between Sun Healthcare Group, Inc. and Michael Newman
10.7(1)	Amendment No. 2 to Employment Agreement effective as of March 31, 2008 by and between Sun Healthcare Group, Inc. and Chauncey J. Hunker
10.8(1)	Non-Employee Director Compensation Policy
10.9(1)	Form of Restricted Stock Unit Grant for Non-Employee Directors
31.1	Section 302 Sarbanes-Oxley Certification by Chief Executive Officer
31.2	Section 302 Sarbanes-Oxley Certification by Chief Financial Officer
32.1	Section 906 Sarbanes-Oxley Certification by Chief Executive Officer
32.2	Section 906 Sarbanes-Oxley Certification by Chief Financial Officer

_________

(1)           Incorporated by reference from exhibits to our Form 8-K filed on April 3, 2008.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

SUN HEALTHCARE GROUP, INC.
By:	/s/ L. Bryan Shaul
L. Bryan Shaul
Executive Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)

August 7, 2008

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