10-Q

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 September 30, 2010

or

o   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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

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	Smaller reporting company   o
(Do not check if a smaller reporting company)

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 October 26, 2010, there were 74,803,863 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 September 30, 2010
	As of December 31, 2009
	Consolidated Income Statements (unaudited)	5-6
	For the three months ended September 30, 2010 and 2009
	For the nine months ended September 30, 2010 and 2009
	Consolidated Statements of Cash Flows (unaudited)	7
	For the three months ended September 30, 2010 and 2009
	For the nine months ended September 30, 2010 and 2009
	Notes to Consolidated Financial Statements (unaudited)	8-31
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	32-51
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	52
Item 4.	Controls and Procedures	52
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	52
Item 1A.	Risk Factors	52
Item 6.	Exhibits	53
Signature		53

References throughout this document to the Company, “we,” “our,” “ours” and “us” refer to Sun Healthcare Group, Inc. and its direct and indirect consolidated subsidiaries and not any other person.

STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Quarterly Report on Form 10-Q (this “10-Q”) contain “forward-looking” information as that term is defined by the Private Securities Litigation Reform Act of 1995 (the “Act”) and the federal securities laws.  Any statements that do not relate to historical or current facts or matters are forward-looking statements.  Examples of forward-looking statements include all statements regarding our expected future financial position, results of operations, cash flows, liquidity, financing plans, business strategy, budgets, the impact of reductions in reimbursements and other changes in government reimbursement programs, the Separation and REIT Conversion Merger (as hereinafter defined), the outcome and costs of litigation, projected expenses an d capital expenditures, growth opportunities, ability to refinance our indebtedness on favorable terms, plans and objectives of management for future operations, compliance with and changes in governmental regulations and environmental compliance costs and liabilities associated with our centers.  You can identify some of the forward-looking statements by the use of forward-looking words such as “anticipate,” “believe,” “plan,” “estimate,” “expect,” “intend,” “should,” “may” and other similar expressions, although not all forward-looking statements contain these identifying words.

We caution you that any forward-looking statements made in this 10-Q are not guarantees of future performance and that you should not place undue reliance on any of such forward-looking statements.  The forward-looking statements are based on the information currently available and are applicable only as of the date of this report or, in the case of forward-looking statements incorporated by reference, as of the date of the filing that includes the forward-looking statements. 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.  You are urged to carefully review the disclosures we make concering risks and other factors that may aff ect our business and operating results, including those referred to in Part II, Item 1A of the 10-Q, and any of those made in our other reports filed with the Securities and Exchange Commission, including our Annual Reort on Form 10-K for the fiscal year ended December 31, 2009 (see Item 1A – “Risk Factors”) and our Quarterly Reports on Form 10-Q for the fiscal quarters ended March 31, 2010 and June 30, 2010 (see Part II – Item 1A).  The forward-looking statements are qualified in their entirety by these cautionary statements, which are being made pursuant to the provisions of the Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act.  You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document.  There may be additional risks of which we are presently unaware or that we currently deem immaterial.  We do not intend, and un dertake 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)

		September 30, 2010		December 31, 2009
				(Note 1)
Current assets:
Cash and cash equivalents	$	138,350	$	104,483
Restricted cash		21,961		24,034
Accounts receivable, net of allowance for doubtful accounts of $65,028
and $55,402 at September 30, 2010 and December 31, 2009, respectively		216,391		220,319
Prepaid expenses and other assets		15,093		21,757
Deferred tax assets		71,940		68,415
Total current assets		463,735		439,008
Property and equipment, net		622,355		622,682
Intangible assets, net		51,428		53,931
Goodwill		338,364		338,296
Restricted cash, non-current		350		3,317
Deferred tax assets		89,818		108,999
Other assets		5,157		4,961
Total assets	$	1,571,207	$	1,571,194

See accompanying notes.

3

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (unaudited) (CONTINUED)

LIABILITIES AND STOCKHOLDERS’ EQUITY

(in thousands, except share data)

		September 30, 2010			December 31, 2009
					(Note 1)
Current liabilities:
Accounts payable	$	47,799		$	57,109
Accrued compensation and benefits		60,898			58,953
Accrued self-insurance obligations, current portion		45,610			45,661
Income taxes payable		1,605			-
Other accrued liabilities		58,234			55,265
Current portion of long-term debt and capital lease obligations		39,796			46,416
Total current liabilities		253,942			263,404
Accrued self-insurance obligations, net of current portion		127,040			121,948
Long-term debt and capital lease obligations, net of current portion		410,145			654,132
Unfavorable lease obligations, net		10,518			12,663
Other long-term liabilities		60,016			69,983
Total liabilities		861,661			1,122,130
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock of $.01 par value, authorized 10,000,000
shares, zero shares issued and outstanding as of
September 30, 2010 and December 31, 2009		-			-
Common stock of $.01 par value, authorized 125,000,000
shares, 74,788,448 and 43,764,240 shares issued and outstanding
as of September 30, 2010 and December 31, 2009, respectively		748			438
Additional paid-in capital		885,083			655,667
Accumulated deficit		(176,285	)		(204,012	)
Accumulated other comprehensive loss, net		-			(3,029	)
Total stockholders' equity		709,546			449,064
Total liabilities and stockholders' equity	$	1,571,207		$	1,571,194

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
		September 30, 2010			September 30, 2009
Total net revenues	$	475,997		$	470,644
Costs and expenses:
Operating salaries and benefits		270,052			265,597
Self-insurance for workers’ compensation and general and
professional liability insurance		14,621			14,162
Operating administrative expenses		13,343			12,462
Other operating costs		98,089			97,015
Center rent expense		18,954			18,190
General and administrative expenses		14,146			15,586
Depreciation and amortization		12,733			11,457
Provision for losses on accounts receivable		5,141			5,313
Interest, net of interest income of $59 and $106, respectively		10,614			12,231
Transaction costs		4,747			-
Restructuring costs		-			872
Total costs and expenses		462,440			452,885
Income before income taxes and discontinued operations		13,557			17,759
Income tax expense		5,559			7,220
Income from continuing operations		7,998			10,539
Discontinued operations:
Loss from discontinued operations, net of related taxes		(442	)		(862	)
Loss on disposal of discontinued operations, net of
related taxes		-			(19	)
Loss from discontinued operations, net		(442	)		(881	)
Net income	$	7,556		$	9,658
Basic earnings per common and common equivalent share:
Income from continuing operations	$	0.13		$	0.24
Loss from discontinued operations, net		-			(0.02	)
Net income	$	0.13		$	0.22
Diluted earnings per common and common equivalent share:
Income from continuing operations	$	0.13		$	0.24
Loss from discontinued operations, net		-			(0.02	)
Net income	$	0.13		$	0.22
Weighted average number of common and common
equivalent shares outstanding:
Basic		59,516			43,923
Diluted		59,538			44,015

See accompanying notes.

5

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED INCOME STATEMENTS (unaudited)

(in thousands, except per share data)

		For the
		Nine Months Ended
		September 30, 2010			September 30, 2009
Total net revenues	$	1,423,443		$	1,406,949
Costs and expenses:
Operating salaries and benefits		804,302			789,744
Self-insurance for workers’ compensation and general and
professional liability insurance		43,702			45,617
Operating administrative expenses		38,932			38,231
Other operating costs		291,348			287,233
Center rent expense		56,306			54,755
General and administrative expenses		44,570			48,057
Depreciation and amortization		37,732			33,329
Provision for losses on accounts receivable		15,985			15,582
Interest, net of interest income of $222 and $310, respectively		34,366			37,422
Transaction costs		6,995			-
Restructuring costs		-			872
Loss on sale of assets, net		-			41
Total costs and expenses		1,374,238			1,350,883
Income before income taxes and discontinued operations		49,205			56,066
Income tax expense		19,990			22,795
Income from continuing operations		29,215			33,271
Discontinued operations:
Loss from discontinued operations, net of related taxes		(1,488	)		(2,941	)
Loss on disposal of discontinued operations, net of
related taxes		-			(334	)
Loss from discontinued operations, net		(1,488	)		(3,275	)
Net income	$	27,727		$	29,996
Basic earnings per common and common equivalent share:
Income from continuing operations	$	0.58		$	0.76
Loss from discontinued operations, net		(0.03	)		(0.08	)
Net income	$	0.55		$	0.68
Diluted earnings per common and common equivalent share:
Income from continuing operations	$	0.58		$	0.76
Loss from discontinued operations, net		(0.03	)		(0.08	)
Net income	$	0.55		$	0.68
Weighted average number of common and common
equivalent shares outstanding:
Basic		50,184			43,807
Diluted		50,251			43,926

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						Nine Months Ended
		September 30, 2010			September 30, 2009			September 30, 2010			September 30, 2009
Cash flows from operating activities:
Net income	$	7,556		$	9,658		$	27,727		$	29,996
Adjustments to reconcile net income to net cash provided by
operating activities, including discontinued operations:
Depreciation and amortization		12,736			11,460			37,744			33,336
Amortization of favorable and unfavorable lease intangibles		(504	)		(474	)		(1,452	)		(1,350	)
Provision for losses on accounts receivable		5,289			5,318			16,428			15,599
Loss on sale of assets, including discontinued
operations, net		-			31			-			607
Stock-based compensation expense		1,661			1,476			4,748			4,385
Deferred taxes		3,286			5,500			14,976			18,019
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(1,307	)		1,079			(12,500	)		(20,588	)
Restricted cash		2,769			(710	)		5,040			8,811
Prepaid expenses and other assets		5,399			382			8,012			144
Accounts payable		(4,909	)		(6,762	)		(3,628	)		(11,825	)
Accrued compensation and benefits		(2,117	)		4,561			1,945			4,927
Accrued self-insurance obligations		199			4			5,041			1,255
Income taxes payable		1,267			-			1,605			-
Other accrued liabilities		4,429			9,355			4,442			8,530
Other long-term liabilities		(676	)		(1,004	)		(5,775	)		177
Net cash provided by operating activities		35,078			39,874			104,353			92,023
Cash flows from investing activities:
Capital expenditures		(13,774	)		(16,456	)		(41,488	)		(41,458	)
Purchase of leased real estate		-			-			-			(3,275	)
Proceeds from sale of assets held for sale		-			-			-			2,174
Net cash used for investing activities		(13,774	)		(16,456	)		(41,488	)		(42,559	)
Cash flows from financing activities:
Borrowings of long-term debt		20,500			20,822			20,500			20,822
Principal repayments of long-term debt and capital lease
obligations		(234,116	)		(22,562	)		(271,093	)		(44,249	)
Payment to non-controlling interest		-			-			(2,025	)		(311	)
Distribution to non-controlling interest		-			-			(69	)		(549	)
Net proceeds from issuance of common stock		226,001			55			226,001			75
Deferred financing costs		(2,312	)		-			(2,312	)		-
Net cash provided by (used for) financing activities		10,073			(1,685	)		(28,998	)		(24,212	)
Net increase in cash and cash equivalents		31,377			21,733			33,867			25,252
Cash and cash equivalents at beginning of period		106,973			95,672			104,483			92,153
Cash and cash equivalents at end of period	$	138,350		$	117,405		$	138,350		$	117,405

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 202 healthcare centers in 25 states as of October 1, 2010.

On July 1, 2010 we  assumed operations of a skilled nursing center in Idaho that we own but did not previously operate. We also transferred operations of a leased skilled nursing center in Washington to an outside party effective October 1, 2010.

Proposed Restructuring

On May 24, 2010, we announced a plan to restructure our business by separating our real estate assets and our operating assets into two separate publicly traded companies, subject to the approval of our stockholders and other conditions.  The plan consists of certain key transactions including the reorganization, through a series of internal corporate restructurings, such that (i) substantially all of the Company’s owned real property (with a net book value at September 30, 2010 of $486.2 million) and related mortgage indebtedness owed to third parties (with a carrying value at September 30, 2010 of $156.7 million) will be held or assumed by Sabra Health Care REIT, Inc., a Maryland corporation and a wholly owned subsidiary of the Company (“Sabra”), or by one or more subsidiaries of Sabra, and (ii) all of th e Company’s operations and other assets and liabilities will be held or assumed by SHG Services, Inc., a Delaware corporation and a wholly owned subsidiary of the Company (“New Sun”), or by one or more subsidiaries of New Sun.  The Company will distribute to its stockholders on a pro rata basis all of the outstanding shares of New Sun common stock (the “Separation”), together with a pro rata cash distribution to the Company’s stockholders that will aggregate approximately $13 million.  The Company will then merge with and into Sabra, with Sabra surviving the merger as a Maryland corporation and the Company’s stockholders receiving shares of Sabra common stock in exchange for their shares of the Company’s common stock (the “REIT Conversion Merger”). Shares of New Sun common stock and Sabra common stock are both expected to trade on the NASDAQ Global Select Market. Immediately following the Separation and REIT Conversion Merger, Ne w Sun will change its name to Sun Healthcare Group, Inc. The Separation and REIT Conversion Merger are expected to be completed on November 15, 2010.  The historical consolidated financial statements of the Company will become the historical consolidated financial statements of New Sun at the time of the Separation, and New Sun will be treated as the successor registrant to the Company for securities law purposes.

Equity Offering

In August 2010, we completed a public offering of 30,762,500 shares of our common stock. The shares were issued at a public offering price of $7.75 per share, resulting in proceeds of $225.9 million, net of the underwriter’s discount. The net proceeds and other cash on hand were used to repay $225.0 million of our term loans (see Note 2 – “Long-Term Debt and Capital Lease Obligations”).

Transaction Costs

Our results of operations for the three and nine months ended September 30, 2010 include $4.7 million and $7.0 million, respectively, of transaction costs related to the proposed Separation and REIT Conversion Merger, which consist primarily of professional services.

8

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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 (“GAAP”) for interim financial statements.  In our opinion, the accompanying interim consolidated financial statements are a fair statement of our financial position at September 30, 2010, and our consolidated results of operations and cash flows for the three-month and nine-month periods ended September 30, 2010 and 2009, 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 of the Securities and Exchange Com mission.  The accompanying unaudited consolidated financial statements reflect all adjustments, consisting of only normal recurring items.  Readers of these statements should refer to our audited consolidated financial statements and notes thereto for the year ended December 31, 2009, which are included in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 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 January 2010, the Financial Accounting Standards Board (the “FASB”) issued revised guidance for disclosures of fair value measurements.  The guidance requires additional disclosures regarding transfers between defined categories of  quality and reliability and prescribes a rollforward of activity in the lowest category (i.e. Level 3).  Disclosures regarding transfers are required beginning January 1, 2010 and the Level 3 rollforward is to be disclosed in reporting periods beginning after December 15, 2010.  Since we had no transfers between categories, the additional disclosures are not applicable to us for the periods presented.

The Emerging Issues Task Force of the FASB issued an Accounting Standards Update in August 2010 regarding the balance sheet presentation of medical malpractice claims and related insurance recoveries.  Currently there is diversity in practice for health care entities related to the presentation of medical malpractice liability net of insurance recoveries.  The updated guidance requires the insurance recovery receivable to be presented as a gross asset instead of netting it against the medical malpractice liability.  The updated presentation is effective for us beginning with interim filings in 2011.  We are in the process of determining the impact that the adoption of this new guidance will have on our financial position.

Reclassifications

Certain reclassifications have been made to the prior period financial statements to conform to the 2010 financial statement presentation.  Primarily, we have reclassified the results of operations of the nurse practitioner services group of our Inpatient Services segment (see Note 4 – “Discontinued Operations”) for all periods presented to discontinued operations within the income statement, in accordance with GAAP.

9

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(2)  Long-Term Debt and Capital Lease Obligations

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

		September 30, 2010			December 31, 2009
Revolving credit facility	$	-		$	-
Mortgage notes payable due at various dates through 2047, interest at
rates from 3.3% to 9.4%, collateralized by the carrying values of
various centers totaling approximately $200,000(1)		165,980			170,608
Term loans		83,374			329,107
Senior subordinated notes		200,000			200,000
Capital leases		587			833
Total long-term obligations		449,941			700,548
Less amounts due within one year		(39,796	)		(46,416	)
Long-term obligations, net of current portion	$	410,145		$	654,132

(1) The mortgage notes payable balance includes fair value premiums of $0.7 million related to acquisitions.

The scheduled or expected maturities of long-term obligations, excluding fair value premiums, as of September 30, 2010, were as follows (in thousands):

For the twelve months ending September 30:
2011	$	39,796
2012		4,264
2013		4,375
2014		113,646
2015		220,305
Thereafter		66,895
	$	449,281

In August 2010, we incurred mortgage indebtedness collateralized by four of our health care centers for $20.5 million, which carries an interest rate of LIBOR plus 4.5%.  This mortgage loan was used to pay off an $8.0 million two-center mortgage note payable and to replace a $12.5 million mortgage note payable repaid in June 2010.

In June 2010, we amended our senior secured credit facility with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent (the “Credit Agreement”).  The amendment increased the permitted amount of expenditures for acquisitions, modified certain financial covenants, required a $25.0 million minimum principal repayment to be paid by December 31, 2010, decreased our letter of credit facility by $25.0 million and increased interest rates.  The loans under the amended Credit Agreement bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at our option, either (a) an alternative base rate determined by reference to the higher of (i) the prime rate announced by Credit Suisse and (ii) the federal funds rate plus one-half of 1.0%, or (b) the London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserves.  The applicable percentage for term loans is 2.0% for alternative base rate loans and 3.0% for LIBOR loans; and the applicable percentage for revolving loans is up to 2.0% for alternative base rate revolving loans and up to 3.0% for LIBOR rate revolving loans based on our total leverage ratio.  The $25.0 million decrease in our letter of credit facility has resulted in the use of our revolving credit facility for $24.7 million of undrawn letters of credit.  Accordingly, $25.3 million was available for drawing under our revolving credit facility at September 30, 2010.  The Credit Agreement was terminated and replaced on October 18, 2010 by the New Sun credit agreement described below.

10

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

On October 18, 2010, concurrently with the entry into a $285.0 million senior secured credit facility by us and New Sun with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent, we terminated the Credit Agreement and repaid our obligations under the Credit Agreement (see Note 10 – “Subsequent Events”).

We manage interest expense using a mix of fixed and variable rate debt, and to help manage borrowing costs, we may enter into interest rate swap agreements. Under these arrangements, we agree to exchange, at specified intervals, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. We use interest rate swaps to manage interest rate risk related to borrowings.  Our intent is to only enter into such arrangements that qualify for hedge accounting treatment in accordance with GAAP.  Accordingly, we designate all such arrangements as cash-flow hedges and perform initial and quarterly effectiveness testing using the hypothetical derivative method.  To the extent that such arrangements are effective hedges, changes in fair value are recogn ized through other comprehensive income.  Ineffectiveness, if any, would be recognized in earnings.

We entered into interest rate swap agreements in July 2008 and July 2007 for interest rate risk management purposes, both of which expired in July 2010.  The interest rate swap agreements effectively modified our exposure to interest rate risk by converting a portion of our floating rate debt to a fixed rate.  The interest rate swap agreements qualified for hedge accounting treatment and were designated as cash flow hedges.  None of our 2010 other comprehensive loss was reclassified into earnings as the agreements expired in July 2010 without any cash settlement.

The fair values of our interest rate swap agreements as presented in the consolidated balance sheets are as follows (in thousands):

	Liability Derivatives
	September 30, 2010			December 31, 2009
	Balance Sheet			Balance Sheet
	Location		Fair Value	Location		Fair Value
Derivatives designated as
hedging instruments:
Interest rate swap				Other Long-Term
agreements	N/A	$	N/A	Liabilities	$	5,048

The effect of the interest rate swap agreements on our consolidated comprehensive income, net of related taxes, for the three months ended September 30 is as follows (in thousands):

						Gain Reclassified from
		Amount of Income in				Accumulated Other Comprehensive
		Other Comprehensive Income				Loss to Income (ineffective portion)
		2010		2009		2010		2009
Derivatives designated as cash
flow hedges:
Interest rate swap agreements	$	1,020	$	390	$	-	$	-

11

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

The effect of the interest rate swap agreements on our consolidated comprehensive income, net of related taxes, for the nine months ended September 30 is as follows (in thousands):

						Gain Reclassified from
		Amount of Income in				Accumulated Other Comprehensive
		Other Comprehensive Income				Loss to Income (ineffective portion)
		2010		2009		2010		2009
Derivatives designated as cash
flow hedges:
Interest rate swap agreements	$	3,029	$	695	$	-	$	-

The amounts stated above for income from changes in the fair value of our interest rate swap agreements are our only sources of other comprehensive income, resulting in comprehensive income of $8.6 million and $30.8 million for the three and nine months ended September 30, 2010, respectively.  Comprehensive income for the three and nine months ended September 30, 2009 was $10.0 million and $30.7 million, respectively.

(3)  Fair Value of Financial Instruments

The estimated fair values of our financial instruments were as follows (in thousands):

		September 30, 2010				December 31, 2009
		Carrying				Carrying
		Amount		Fair Value		Amount		Fair Value
Cash and cash equivalents	$	138,350	$	138,350	$	104,483	$	104,483
Restricted cash	$	22,311	$	22,311	$	27,351	$	27,351
Long-term debt and capital lease obligations,
including current portion	$	449,941	$	457,402	$	700,548	$	690,950
Interest rate swap agreements	$	-	$	-	$	5,048	$	5,048

The cash and cash equivalents and restricted cash carrying amounts approximate fair value because of the short maturity of these instruments. At September 30, 2010 and December 31, 2009, the fair value of our long-term debt, including current maturities, and our interest rate swap agreements was based on estimates using present value techniques that are significantly affected by the assumptions used concerning the amount and timing of estimated future cash flows and discount rates that reflect varying degrees of risk.

GAAP establishes a hierarchy for ranking the quality and reliability of the information used to determine fair values.  The applicable guidance 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.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

We endeavor to utilize the best available information in measuring fair value.  The following tables summarize the valuation of our financial instruments by the above pricing levels as of September 30, 2010 and December 31, 2009, respectively (in thousands):

		September 30, 2010
				Unadjusted Quoted		Significant Other
				Market Prices		Observable Inputs
		Total		(Level 1)		(Level 2)
Cash equivalents – money market
funds/certificate of deposit	$	25,611	$	20,555	$	5,056
Restricted cash – money market funds	$	1,464	$	1,464	$	-

		December 31, 2009
				Unadjusted Quoted		Significant Other
				Market Prices		Observable Inputs
		Total		(Level 1)		(Level 2)
Cash equivalents – money market
funds/certificate of deposit	$	36,480	$	31,429	$	5,051
Restricted cash – money market funds	$	1,275	$	1,275	$	-
Interest rate swap agreements – liability	$	5,048	$	-	$	5,048

We currently have no other financial instruments subject to fair value measurement on a recurring basis.

(4) Discontinued Operations

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 as their operations and cash flows have been (or will be) eliminated from our ongoing operations and we will not have any significant continuing involvement in their operations after their disposal.

During the three months ended September 30, 2010 we developed plans to dispose of our nurse practitioner services group of our Inpatient Services segment, whose results have been reclassified to discontinued operations for all periods presented in accordance with GAAP.

13

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

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

		For the Three Months Ended
		September 30, 2010
		Inpatient
		Services			Other			Total
Net operating revenues	$	279		$	-		$	279
Loss from discontinued operations, net (1)	$	(434	)	$	(10	)	$	(442	)
Loss on disposal of discontinued operations, net		-			-			-
Loss from discontinued operations, net	$	(434	)	$	(10	)	$	(442	)
(1)  Net of related tax benefit of $307

		For the Three Months Ended
		September 30, 2009
		Inpatient
		Services			Other		Total
Net operating revenues	$	381		$	-	$	381
Loss from discontinued operations, net (1)	$	(862	)	$	-	$	(862	)
Loss on disposal of discontinued operations, net (2)		(19	)		-		(19	)
Loss from discontinued operations, net	$	(881	)	$	-	$	(881	)
(1)  Net of related tax benefit of $495
(2)  Net of related tax benefit of $13

		For the Nine Months Ended
		September 30, 2010
		Inpatient
		Services			Other			Total
Net operating revenues	$	732		$	-		$	732
Loss from discontinued operations, net (1)	$	(1,428	)	$	(60	)	$	(1,488	)
Loss on disposal of discontinued operations, net		-			-			-
Loss from discontinued operations, net	$	(1,428	)	$	(60	)	$	(1,488	)
(1)  Net of related tax benefit of $721

		For the Nine Months Ended
		September 30, 2009
		Inpatient
		Services			Other			Total
Net operating revenues	$	1,309		$	-		$	1,309
Loss from discontinued operations, net (1)	$	(2,923	)	$	(18	)	$	(2,941	)
Loss on disposal of discontinued operations, net (2)		(318	)		(16	)		(334	)
Loss from discontinued operations, net	$	(3,241	)	$	(34	)	$	(3,275	)
(1)  Net of related tax benefit of $1,718
(2)  Net of related tax benefit of $232

14

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(5)  Commitments and Contingencies

Insurance

We self-insure for certain insurable risks, including general and professional liabilities, workers' compensation liabilities and employee health insurance liabilities through the use of self-insurance or retrospective and self-funded insurance policies and other hybrid policies, which vary by the states in which we operate. There is a risk that amounts funded to our self-insurance programs may not be sufficient to respond to all claims asserted under those programs. Insurance reserves represent estimates of future claims payments.  This liability includes an estimate of the development of reported losses and losses incurred but not reported.  Provisions for changes in insurance reserves are made in the period of the related coverage.  An independent actuarial analysis is prepared twice a year to assist m anagement in determining the adequacy of the self-insurance obligations booked as liabilities in our financial statements.  The methods of making such estimates and establishing the resulting reserves are reviewed periodically and are based on historical paid claims information and nationwide nursing home trends. Any adjustments resulting from such reviews are reflected in current earnings. Claims are paid over varying periods, and future payments may be different than the estimated reserves.

We evaluate the adequacy of our self-insurance reserves on a quarterly basis and perform detailed 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.  Reported loss methods focus on development of case reserves for incurred losses through claims closure.  Paid loss methods focus on development of claims actually paid to date.  Expected loss methods are based upon an anticipated loss per unit of measure.  The Bornhuetter-Ferguson method is a combination of loss development methods and expected methods.

The foundation for most of these methods is our actual historical reported and/or paid loss data, over which we have effective internal controls.  We utilize third-party administrators (“TPAs”) to process claims and to provide us with the data utilized in our semi-annual actuarial analyses.  The TPAs are under the oversight of our in-house risk management and legal functions.  The purpose of these functions is to properly administer the claims so that the historical data is reliable for estimation purposes.  Case reserves, which are approved by our legal and risk management departments, are determined based on our estimate of the ultimate settlement of individual claims.  In instances where our historical data are not statistically credible, stable, or mature, we supplement our experience with skilled nursing industry benchmark reporting and payment patterns.

The use of multiple methods tends to eliminate any biases that one particular method might have.  Management’s judgment based upon each method’s inherent limitation is applied when weighting the results of each method.  The results of each of the methods are estimates of ultimate losses which include 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.

15

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

Activity in our insurance reserves as of and for the three and nine months ended September 30, 2010 and 2009 is as follows (in thousands):

		Professional			Workers’
		Liability			Compensation			Total
Balance as of January 1, 2010	$	94,930		$	67,506		$	162,436
Current year provision, continuing operations		7,381			7,149			14,530
Current year provision, discontinued operations		2			5			7
Claims paid, continuing operations		(4,219	)		(4,609	)		(8,828	)
Claims paid, discontinued operations		(563	)		(579	)		(1,142	)
Amounts paid for administrative services and other		(850	)		(1,696	)		(2,546	)
Balance as of March 31, 2010	$	96,681		$	67,776		$	164,457
Current year provision, continuing operations		7,380			7,171			14,551
Current year provision, discontinued operations		2			5			7
Claims paid, continuing operations		(3,605	)		(3,943	)		(7,548	)
Claims paid, discontinued operations		(1,553	)		(652	)		(2,205	)
Amounts paid for administrative services and other		(724	)		(1,620	)		(2,344	)
Balance as of June 30, 2010	$	98,181		$	68,737		$	166,918
Current year provision, continuing operations		7,169			7,452			14,621
Current year provision, discontinued operations		2			5			7
Claims paid, continuing operations		(5,533	)		(5,404	)		(10,937	)
Claims paid, discontinued operations		(377	)		(411	)		(788	)
Amounts paid for administrative services and other		(489	)		(1,585	)		(2,074	)
Balance as of September 30, 2010	$	98,953		$	68,794		$	167,747
Balance as of January 1, 2009	$	87,282		$	66,587		$	153,869
Current year provision, continuing operations		7,237			7,413			14,650
Current year provision, discontinued operations		309			161			470
Claims paid, continuing operations		(4,234	)		(5,219	)		(9,453	)
Claims paid, discontinued operations		(936	)		(833	)		(1,769	)
Amounts paid for administrative services and other		(1,362	)		(1,898	)		(3,260	)
Balance as of March 31, 2009	$	88,296		$	66,211		$	154,507
Current year provision, continuing operations		6,037			6,468			12,505
Current year provision, discontinued operations		334			162			496
Prior year reserve adjustments, continuing operations		4,300			-			4,300
Prior year reserve adjustments, discontinued operations		590			-			590
Claims paid, continuing operations		(6,858	)		(5,535	)		(12,393	)
Claims paid, discontinued operations		(1,487	)		(542	)		(2,029	)
Amounts paid for administrative services and other		(1,117	)		(1,757	)		(2,874	)
Balance as of June 30, 2009	$	90,095		$	65,007		$	155,102
Current year provision, continuing operations		6,937			7,225			14,162
Current year provision, discontinued operations		434			161			595
Claims paid, continuing operations		(5,258	)		(4,511	)		(9,769	)
Claims paid, discontinued operations		(641	)		(474	)		(1,115	)
Amounts paid for administrative services and other		(1,561	)		(1,852	)		(3,413	)
Balance as of September 30, 2009	$	90,006		$	65,556		$	155,562

16

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 September 30, 2010 and December 31, 2009 is as indicated (in thousands):

		September 30, 2010							December 31, 2009
		Professional		Workers’			|		Professional		Workers’
		Liability		Compensation		Total	|		Liability		Compensation		Total
Assets (1):							|
Restricted cash							|
Current	$	3,645	$	11,047	$	14,692	|	$	3,406	$	12,013	$	15,419
Non-current		-		-		-	|		-		-		-
Total	$	3,645	$	11,047	$	14,692	|	$	3,406	$	12,013	$	15,419
							|
Liabilities (2)(3):							|
Self-insurance							|
liabilities							|
Current	$	20,384	$	20,323	$	40,707	|	$	20,369	$	20,119	$	40,488
Non-current		78,569		48,471		127,040	|		74,561		47,387		121,948
Total	$	98,953	$	68,794	$	167,747	|	$	94,930	$	67,506	$	162,436

(1)	Total restricted cash includes cash collateral deposits posted and other cash deposits held by third parties.  Total restricted cash above excludes $8,229 and $11,932 at September 30, 2010and December 31, 2009, respectively, held for bank collateral, various mortgages, bond payments and capital expenditures on HUD insured buildings.
(2)	Total self-insurance liabilities above exclude $4,903 and $5,173 at September 30, 2010 and December 31, 2009, 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 $60,291 for workers’ compensation, as of September 30, 2010, and $250 and $53,191for general and professional liability insurance and workers’ compensation, respectively, as of December 31, 2009.

(6)  Income Taxes

The provision for income taxes of $5.6 million and $20.0 million for the three and nine months, respectively, ended September 30, 2010 results in an effective rate of approximately 41%.  The provision for income taxes of $7.2 million and $22.8 million for the three and nine months, respectively, ended September 30, 2009 also resulted in an effective tax rate of approximately 41%.  The rates for 2010 and 2009 differ from the statutory tax rate of 35% primarily due to state taxes.

During the second quarter of 2009, the Internal Revenue Service commenced an examination of the tax returns of Sun and Harborside Healthcare Corporation (“Harborisde”) for 2006, and the Harborside tax return for the short-period ended April 19, 2007.  These examinations were completed during the second quarter of 2010, and the net adjustments were immaterial.

The realization of our 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.  The valuation allowance of $27.6 million at September 30, 2010 and December 31, 2009 relates primarily to state net operating loss (“NOL”) carryforwards and other deferred tax assets for which realization is uncertain.

The Internal Revenue Code (“IRC”) Section 382 annual base limitation to be applied to our tax attribute carryforwards is approximately $25.4 million, which includes approximately $14.6 million due to a significant acquisition in 2007. Accordingly, our NOL, capital loss, and tax credit carryforwards have been reduced to take into account this limitation and the respective carryforward periods for these tax attributes.  As a result of unused IRC Section 382 limitations from prior

17

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

years and post-ownership change NOLs, there is approximately $109.0 million of NOLs which can be used to offset U.S. taxable income in 2010.  Considering annual IRC Section 382 limitations and built-in gains, we have a total of $229.2 million of utilizable NOL carryforwards to offset taxable income in 2010 and future years.

(7)  Other Events

(a)  Litigation

On September 2, 2010, a lawsuit was filed in California Superior Court by a former employee of a subsidiary of our medical staffing company, alleging violation of various wage and hour provisions of the California Labor Code.   Michelle Nesbit v. ProCare One Nurses, LLC has been filed as a purported class action on behalf of the former employee and all those similarly situated. The complaint alleges that the aggregate claim is less than $5 million.  We are in the process of investigating the allegations set forth in the complaint.  We intend to vigorously defend the lawsuit.

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 and 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.

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. For example, investigations of our California centers by the Bureau of Medi-Cal Fraud and Elder Abuse of the Office of the California Attorney General culminated in a Permanent Injunction and Final Judgment, originally entered in October 2001, as superseded by a Superseding Permanent Injunction and Final Judgment, entered in September 2005, which requires compliance with certain clinical practices in our California centers that are substantially consistent with existing law and our current practices . In addition to being subject to direct regulatory oversight of state and federal regulatory agencies, the industries in which we operate 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.

(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.

(8)  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.  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.  More complete descriptions and accounting policies of the segments are described in Note 14 – “Segment Information” and  Note 2 – “Summary of Significant Accounting Policies” of our 2009 Form 10-K.

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
September 30, 2010
				Rehabilitation		Medical
		Inpatient		Therapy		Staffing					Intersegment
		Services		Services		Services		Corporate			Eliminations			Consolidated
Revenues from external customers	$	424,160	$	30,342	$	21,481	$	14		$	-		$	475,997
Intersegment revenues		-		21,397		724		-			(22,121	)		-
Total revenues		424,160		51,739		22,205		14			(22,121	)		475,997
Operating salaries and benefits		210,927		42,859		16,266		-			-			270,052
Self-insurance for workers’
compensation and general and
professional liability insurance		13,802		435		323		61			-			14,621
Other operating costs		115,009		1,952		3,249		-			(22,121	)		98,089
General and administrative expenses(1)		10,777		1,939		627		18,893			-			32,236
Provision for losses on accounts
receivable		4,682		297		162		-			-			5,141
Segment operating income (loss)	$	68,963	$	4,257	$	1,578	$	(18,940	)	$	-		$	55,858
Center rent expense		18,629		123		202		-			-			18,954
Depreciation and amortization		11,630		173		181		749			-			12,733
Interest, net		2,570		-		-		8,044			-			10,614
Net segment income (loss)	$	36,134	$	3,961	$	1,195	$	(27,733	)	$	-		$	13,557
Identifiable segment assets	$	1,182,930	$	15,047	$	20,631	$	333,167		$	20,867		$	1,572,642
Goodwill	$	333,756	$	75	$	4,533	$	-		$	-		$	338,364
Segment capital expenditures	$	12,738	$	370	$	41	$	625		$	-		$	13,774

______________________________________

(1) General and administrative expenses include operating administrative expenses and transaction costs.

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

The term “net segment income (loss)” is defined as earnings before 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
September 30, 2009
				Rehabilitation		Medical
		Inpatient		Therapy		Staffing					Intersegment
		Services		Services		Services		Corporate			Eliminations			Consolidated
Revenues from external customers	$	420,374	$	26,394	$	23,864	$	12		$	-		$	470,644
Intersegment revenues		-		18,592		545		-			(19,137	)		-
Total revenues		420,374		44,986		24,409		12			(19,137	)		470,644
Operating salaries and benefits		210,543		37,954		17,100		-			-			265,597
Self-insurance for workers’
compensation and general and
professional liability insurance		13,191		542		322		107			-			14,162
Other operating costs		110,309		1,978		3,865		-			(19,137	)		97,015
General and administrative expenses(1)		10,282		1,553		628		15,585			-			28,048
Provision for losses on accounts
receivable		5,217		94		2		-			-			5,313
Segment operating income (loss)	$	70,832	$	2,865	$	2,492	$	(15,680	)	$	-		$	60,509
Center rent expense		17,848		119		223		-			-			18,190
Depreciation and amortization		10,480		140		179		658			-			11,457
Interest, net		3,024		-		(1)		9,208			-			12,231
Net segment income (loss)	$	39,480	$	2,606	$	2,091	$	(25,546	)	$	-		$	18,631
Identifiable segment assets	$	1,160,202	$	15,499	$	24,793	$	876,215		$	(528,443	)	$	1,548,266
Goodwill	$	322,412	$	75	$	4,533	$	-		$	-		$	327,020
Segment capital expenditures	$	15,384	$	167	$	8	$	897		$	-		$	16,456

______________________________________

(1) General and administrative expenses include operating administrative expenses and transaction costs.

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

The term “net segment income (loss)” is defined as earnings before 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
Nine Months Ended
September 30, 2010
				Rehabilitation		Medical
		Inpatient		Therapy		Staffing						Intersegment
		Services		Services		Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	1,265,980	$	89,723	$	67,712		$	28		$	-			1,423,443
Intersegment revenues		-		63,584		1,364			-			(64,948	)		-
Total revenues		1,265,980		153,307		69,076			28			(64,948	)		1,423,443
Operating salaries and benefits		627,188		126,670		50,444			-			-			804,302
Self-insurance for workers’
compensation and general and
professional liability insurance		41,268		1,298		953			183			-			43,702
Other operating costs		340,451		5,947		9,898			-			(64,948	)		291,348
General and administrative expenses(1)		30,907		6,065		1,959			51,566			-			90,497
Provision for losses on accounts
receivable		15,078		722		185			-			-			15,985
Segment operating income (loss)	$	211,088	$	12,605	$	5,637		$	(51,721	)	$	-		$	177,609
Center rent expense		55,326		364		616			-			-			56,306
Depreciation and amortization		34,320		484		543			2,385			-			37,732
Interest, net		8,087		-		(1	)		26,280			-			34,366
Net segment income (loss)	$	113,355	$	11,757	$	4,479		$	(80,386	)	$	-		$	49,205
Identifiable segment assets	$	1,182,930	$	15,047	$	20,631		$	333,167		$	20,867		$	1,572,642
Goodwill	$	333,756	$	75	$	4,533		$	-		$	-		$	338,364
Segment capital expenditures	$	38,409	$	700	$	190		$	2,189		$	-		$	41,488

______________________________________

(1) General and administrative expenses include operating administrative expenses and transaction costs.

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

The term “net segment income (loss)” is defined as earnings before 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
Nine Months Ended
September 30, 2009
				Rehabilitation			Medical
		Inpatient		Therapy			Staffing						Intersegment
		Services		Services			Services			Corporate			Eliminations			Consolidated
Revenues from external customers	$	1,251,524	$	78,063		$	77,335		$	27		$	-			1,406,949
Intersegment revenues		-		55,168			1,668			-			(56,836	)		-
Total revenues		1,251,524		133,231			79,003			27			(56,836	)		1,406,949
Operating salaries and benefits		623,375		110,944			55,426			-			-			789,745
Self-insurance for workers’
compensation and general and
professional liability insurance		42,672		1,619			1,015			311			-			45,617
Other operating costs		325,909		5,697			12,462			-			(56,836	)		287,233
General and administrative expenses(1)		30,834		5,246			2,148			48,060			-			86,288
Provision for losses on accounts
receivable		14,957		374			251			-			-			15,582
Segment operating income (loss)	$	213,777	$	9,351		$	7,701		$	(48,344	)	$	-		$	182,485
Center rent expense		53,707		348			700			-			-			54,755
Depreciation and amortization		30,323		399			601			2,006			-			33,329
Interest, net		9,345		(2	)		(1	)		28,080			-			37,422
Net segment income (loss)	$	120,402	$	8,606		$	6,401		$	(78,430	)	$	-		$	56,979
Identifiable segment assets	$	1,160,202	$	15,499		$	24,793		$	876,215		$	(528,443	)	$	1,548,266
Goodwill	$	322,412	$	75		$	4,533		$	-		$	-		$	327,020
Segment capital expenditures	$	38,957	$	425		$	59		$	2,017		$	-		$	41,458

______________________________________

(1) General and administrative expenses include operating administrative expenses and transaction costs.

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

The term “net segment income (loss)” is defined as earnings before 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
		September 30,
		2010		2009
Net segment income	$	13,557	$	18,631
Restructuring costs		-		(872	)
Consolidated income before income taxes and
discontinued operations	$	13,557	$	17,759

		For the Nine Months Ended
		September 30,
		2010		2009
Net segment income	$	49,205	$	56,979
Restructuring costs		-		(872	)
Loss on sale of assets		-		(41	)
Consolidated income before income taxes and
discontinued operations	$	49,205	$	56,006

(9) 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 100% owned subsidiaries of the Company (the “Guarantors”) have, jointly and severally, unconditionally guaranteed the Notes. These guarantees are subordinated to all existing and future senior debt and senior guarantees of the Guarantors and are unsecured.   See Note 10 – “Subsequent Events” for information about the impact of the Separation and REIT Conversion Merger on the Notes.

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

Pursuant to Rule 3-10 of Regulation S-X, the following summarized consolidating information is provided for the Company (the “Parent”), the Guarantors, and the Company's non-Guarantor subsidiaries with respect to the Notes. This summarized financial information has been prepared from the books and records maintained by the Company, the Guarantors and the non-Guarantor subsidiaries. The summarized financial information may not necessarily be indicative of the results of operations or financial position had the Guarantors or non-Guarantor subsidiaries operated as independent entities. The separate financial statements of the Guarantors are not presented because management has determined they would not be material to investors. In addition, intercompany activities between subsidiaries and the Parent are presented wi thin 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 September 30, 2010

(in thousands)

					Combined		Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries		Subsidiaries		Elimination			Consolidated
Current assets:
Cash and cash equivalents	$	118,072		$	17,640	$	2,638	$	-		$	138,350
Restricted cash		14,692			4,402		2,867		-			21,961
Accounts receivable, net		-			214,649		1,790		(48	)		216,391
Prepaid expenses and other assets		4,394			12,335		385		(2,021	)		15,093
Deferred tax assets		-			74,857		1,298		(4,215	)		71,940
Total current assets		137,158			323,883		8,978		(6,284	)		463,735
Property and equipment, net		8,549			548,507		65,299		-			622,355
Intangible assets, net		30,865			16,200		4,862		(499	)		51,428
Goodwill		-			334,407		3,957		-			338,364
Restricted cash, non-current		-			350		-		-			350
Other assets		483			4,754		9		(89	)		5,157
Deferred tax assets		15,410			86,264		-		(11,856	)		89,818
Intercompany balances		223,412			-		3,829		(227,241	)		-
Investment in subsidiaries		716,774			-		-		(716,774	)		-
Total assets	$	1,132,651		$	1,314,365	$	86,934	$	(962,743	)	$	1,571,207
Current liabilities:
Accounts payable	$	15,437		$	31,760	$	650	$	(48	)	$	47,799
Accrued compensation and benefits		7,237			52,916		745		-			60,898
Accrued self-insurance obligations, current		4,029			41,581		-		-			45,610
Income taxes payable		1,605			-		-		-			1,605
Other accrued liabilities		14,665			40,080		3,489		-			58,234
Deferred tax liability		4,214			-		-		(4,214	)		-
Current portion of long-term debt		857			37,724		1,215		-			39,796
Total current liabilities		48,044			204,061		6,099		(4,262	)		253,942
Accrued self-insurance obligations, net of current		53,292			73,319		429		-			127,040
Deferred tax liability		-			-		11,856		(11,856	)		-
Long-term debt, net of current		283,038			64,382		62,725		-			410,145
Unfavorable lease obligations, net		-			11,017		-		(499	)		10,518
Intercompany balances		-			229,352		-		(229,352	)		-
Other long-term liabilities		38,731			21,285		-		-			60,016
Total liabilities		423,105			603,416		81,109		(245,969	)		861,661
Stockholders’ equity:
Common stock		748			-		-		-			748
Additional paid-in capital		885,083			-		-		-			885,083
Accumulated deficit		(176,285	)		710,949		5,825		(716,774	)		(176,285	)
Total stockholders' equity		709,546			710,949		5,825		(716,774	)		709,546
Total liabilities and stockholders' equity	$	1,132,651		$	1,314,365	$	86,934	$	(962,743	)	$	1,571,207

24

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING BALANCE SHEETS

As of December 31, 2009

(in thousands)

					Combined		Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries		Subsidiaries		Elimination			Consolidated
Current assets:
Cash and cash equivalents	$	82,463		$	19,659	$	2,361	$	-		$	104,483
Restricted cash		15,419			5,288		3,327		-			24,034
Accounts receivable, net		-			217,805		2,542		(28	)		220,319
Prepaid expenses and other assets		9,493			13,383		608		(1,727	)		21,757
Deferred tax assets		-			85,766		1,266		(18,617	)		68,415
Total current assets		107,375			341,901		10,104		(20,372	)		439,008
Property and equipment, net		9,195			546,772		66,715		-			622,682
Intangible assets, net		32,702			16,897		2,336		1,996			53,931
Goodwill		-			334,338		3,958		-			338,296
Restricted cash, non-current		2,972			345		-		-			3,317
Other assets		280			4,741		9		(69	)		4,961
Deferred tax assets		15,393			123,963		-		(30,357	)		108,999
Intercompany balances		307,307			-		7,925		(315,232	)		-
Investment in subsidiaries		640,821			-		-		(640,821	)		-
Total assets	$	1,116,045		$	1,368,957	$	91,047	$	(1,004,855	)	$	1,571,194
Current liabilities:
Accounts payable	$	10,883		$	45,130	$	1,124	$	(28	)	$	57,109
Accrued compensation and benefits		9,546			48,617		790		-			58,953
Accrued self-insurance obligations, current		4,034			41,627		-		-			45,661
Other accrued liabilities		11,275			41,272		2,718		-			55,265
Deferred tax liability		9,843			-		-		(9,843	)		-
Current portion of long-term debt		22,244			18,592		5,580		-			46,416
Total current liabilities		67,825			195,238		10,212		(9,871	)		263,404
Accrued self-insurance obligations, net of current		48,200			73,319		429		-			121,948
Deferred tax liability		-			-		11,559		(11,559	)		-
Long-term debt, net of current		507,394			87,916		58,822		-			654,132
Unfavorable lease obligations, net		-			14,659		-		(1,996	)		12,663
Intercompany balances		-			340,608		-		(340,608	)		-
Other long-term liabilities		43,562			23,206		3,215		-			69,983
Total liabilities		666,981			734,946		84,237		(364,034	)		1,122,130
Stockholders’ equity:
Common stock		438			-		-		-			438
Additional paid-in capital		655,667			-		-		-			655,667
Accumulated deficit		(204,012	)		634,011		6,810		(640,821	)		(204,012	)
Accumulated other comprehensive loss		(3,029	)		-		-		-			(3,029	)
Total stockholders' equity		449,064			634,011		6,810		(640,821	)		449,064
Total liabilities and stockholders' equity	$	1,116,045		$	1,368,957	$	91,047	$	(1,004,855	)	$	1,571,194

25

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING INCOME STATEMENTS

For the Three Months Ended September 30, 2010

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	15		$	490,483		$	7,620		$	(22,121	)	$	475,997
Costs and expenses:
Operating salaries and benefits		-			265,743			4,309			-			270,052
Self-insurance for workers’ compensation and
general and professional liability insurance		61			14,365			195			-			14,621
General and administrative expenses(1)		14,516			12,973			-			-			27,489
Other operating costs		-			118,419			1,791			(22,121	)		98,089
Center rent expense		-			18,749			205			-			18,954
Depreciation and amortization		749			11,377			607			-			12,733
Provision for losses on accounts receivable		-			5,074			67			-			5,141
Interest, net		7,979			1,563			1,072			-			10,614
Transaction costs		4,747			-			-			-			4,747
Income from investment in subsidiaries		(24,099	)		-			-			24,099			-
Total costs and expenses		3,953			448,263			8,246			1,978			462,440
(Loss) income before income taxes and
discontinued operations		(3,938	)		42,220			(626	)		(24,099	)		13,557
Income tax (benefit) expense		(11,494	)		17,310			(257	)		-			5,559
Income (loss) from continuing operations		7,556			24,910			(369	)		(24,099	)		7,998
Discontinued operations:
Income (loss) from discontinued operations, net		-			(486	)		44			-			(442	)
Loss on disposal of discontinued
operations, net		-			-			-			-			-
Loss on discontinued operations, net		-			(486	)		44			-			(442	)
Net income (loss)	$	7,556		$	24,424		$	(325	)	$	(24,099	)	$	7,556

(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 September 30, 2009

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	12		$	481,810		$	7,959		$	(19,137	)	$	470,644
Costs and expenses:
Operating salaries and benefits		-			261,390			4,207			-			265,597
Self-insurance for workers’ compensation and
general and professional liability insurance		108			13,895			159			-			14,162
General and administrative expenses(1)		16,034			12,014			-			-			28,048
Other operating costs		-			114,335			1,817			(19,137	)		97,015
Center rent expense		-			18,005			185			-			18,190
Depreciation and amortization		658			10,213			586			-			11,457
Provision for losses on accounts receivable		-			5,244			69			-			5,313
Interest, net		9,076			2,032			1,123			-			12,231
Restructuring costs		-			872			-			-			872
Income from investment in subsidiaries		(24,918	)		-			-			24,918			-
Total costs and expenses		958			438,000			8,146			5,781			452,885
(Loss) income before income taxes and
discontinued operations		(946	)		43,810			(187	)		(24,918	)		17,759
Income tax (benefit) expense		(10,604	)		17,901			(77	)		-			7,220
Income (loss) from continuing operations		9,658			25,909			(110	)		(24,918	)		10,539
Discontinued operations:
Loss from discontinued operations, net		-			(524	)		(338	)		-			(862	)
(Loss) gain on disposal of discontinued
operations, net		-			(32	)		13			-			(19	)
Loss on discontinued operations, net		-			(556	)		(325	)		-			(881	)
Net income (loss)	$	9,658		$	25,353		$	(435	)	$	(24,918	)	$	9,658

(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 Nine Months Ended September 30, 2010

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	29		$	1,465,391		$	22,971		$	(64,948	)	$	1,423,443
Costs and expenses:
Operating salaries and benefits		-			791,337			12,965			-			804,302
Self-insurance for workers’ compensation and
general and professional liability insurance		183			42,934			585			-			43,702
General and administrative expenses(1)		45,682			37,820			-			-			83,502
Other operating costs		-			351,020			5,276			(64,948	)		291,348
Center rent expense		-			55,691			615			-			56,306
Depreciation and amortization		2,385			33,530			1,817			-			37,732
Provision for losses on accounts receivable		-			15,721			264			-			15,985
Interest, net		26,007			5,134			3,225			-			34,366
Transaction costs		6,995			-			-			-			6,995
Income from investment in subsidiaries		(75,953	)		-			-			75,953			-
Total costs and expenses		5,299	)		1,333,187			24,747			11,005			1,374,238
(Loss) income before income taxes and
discontinued operations		(5,270	)		132,204			(1,776	)		(75,953	)		49,205
Income tax (benefit) expense		(32,997	)		53,709			(722	)		-			19,990
Income (loss) from continuing operations		27,727			78,495			(1,054	)		(75,953	)		29,215
Discontinued operations:
(Loss) income from discontinued operations, net		-			(1,557	)		69			-			(1,488	)
Loss on disposal of discontinued
operations, net		-			-			-			-			-
Loss on discontinued operations, net		-			(1,557	)		69			-			(1,488	)
Net income (loss)	$	27,727		$	76,938		$	(985	)	$	(75,953	)	$	27,727

(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 Nine Months Ended September 30, 2009

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination			Consolidated
Total net revenues	$	27		$	1,441,334		$	22,424		$	(56,836	)	$	1,406,949
Costs and expenses:
Operating salaries and benefits		-			777,431			12,313			-			789,744
Self-insurance for workers’ compensation and
general and professional liability insurance		315			44,824			478			-			45,617
General and administrative expenses(1)		49,462			36,826			-			-			86,288
Other operating costs		-			338,655			5,414			(56,836	)		287,233
Center rent expense		-			54,200			555			-			54,755
Depreciation and amortization		2,006			29,578			1,745			-			33,329
Provision for losses on accounts receivable		-			15,263			319			-			15,582
Interest, net		27,673			6,388			3,361			-			37,422
Loss on sale of assets, net		-			48			(7	)		-			41
Restructuring costs		-			872			-			-			872
Income from investment in subsidiaries		(76,859	)		-			-			76,859			-
Total costs and expenses		2,597			1,304,085			24,178			20,023			1,350,883
(Loss) income before income taxes and
discontinued operations		(2,570	)		137,249			(1,754	)		(76,859	)		56,066
Income tax (benefit) expense		(32,566	)		56,080			(719	)		-			22,795
Income (loss) from continuing operations		29,996			81,169			(1,035	)		(76,859	)		33,271
Discontinued operations:
Loss from discontinued operations, net		-			(1,801	)		(1,140	)		-			(2,941	)
(Loss) gain on disposal of discontinued
operations, net		-			(566	)		232			-			(334	)
Loss on discontinued operations, net		-			(2,367	)		(908	)		-			(3,275	)
Net income (loss)	$	29,996		$	78,802		$	(1,943	)	$	(76,859	)	$	29,996

(1)   Includes operating administrative expenses

29

SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2010

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination		Consolidated
Net cash provided by operating activities	$	59,393		$	41,905		$	3,055		$	-	$	104,353
Cash flows from investing activities:
Capital expenditures		(1,738	)		(39,527	)		(223	)		-		(41,488	)
Net cash used for investing activities		(1,738	)		(39,527	)		(223	)		-		(41,488	)
Cash flows from financing activities:
Borrowings of long-term debt		-			15,648			4,852			-		20,500
Principal repayments of long-term debt and capital
lease obligations		(245,733	)		(20,046	)		(5,314	)		-		(271,093	)
Payment to non-controlling interest		-			-			(2,025	)		-		(2,025	)
Distribution to non-controlling interest		-			-			(69	)		-		(69	)
Proceeds from issuance of common stock		226,001			-			-			-		226,001
Deferred financing costs		(2,312	)		-			-			-		(2,312	)
Net cash used for financing activities		(22,044	)		(4,398	)		(2,556	)		-		(28,998	)
Net increase (decrease) in cash and cash equivalents		35,611			(2,020	)		276			-		33,867
Cash and cash equivalents at beginning of period		82,462			19,659			2,362			-		104,483
Cash and cash equivalents at end of period	$	118,073		$	17,639		$	2,638		$	-	$	138,350

For the Nine Months Ended September 30, 2009

(in thousands)

					Combined			Combined
		Parent			Guarantor		Non-Guarantor
		Company			Subsidiaries			Subsidiaries			Elimination		Consolidated
Net cash provided by operating activities	$	44,227		$	42,223		$	5,573		$	-	$	92,023
Cash flows from investing activities:
Capital expenditures		(2,014	)		(39,102	)		(342	)		-		(41,458	)
Purchase of lease real estate		-			(3,275	)		-			-		(3,275	)
Proceeds from sale of assets held for sale		-			2,174			-			-		2,174
Net cash used for investing activities		(2,014	)		(40,203	)		(342	)		-		(42,559	)
Cash flows from financing activities:
Borrowings of long-term debt		-			20,822			-			-		20,822
Principal repayments of long-term debt and capital
lease obligations		(16,494	)		(23,310	)		(4,445	)		-		(44,249	)
Payment to non-controlling interest		-			-			(311	)		-		(311	)
Distribution to non-controlling interest		-			-			(549	)		-		(549	)
Proceeds from issuance of common stock		75			-			-			-		75
Net cash used for financing activities		(16,419	)		(2,488	)		(5,305	)		-		(24,212	)
Net increase (decrease) in cash and cash equivalents		25,794			(468	)		(74	)		-		25,252
Cash and cash equivalents at beginning of period		72,529			17,952			1,672			-		92,153
Cash and cash equivalents at end of period	$	98,323		$	17,484		$	1,598		$	-	$	117,405

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(UNAUDITED)

(10)  Subsequent Event

On October 18, 2010, New Sun entered into a $285.0 million senior secured credit facility (the “New Sun Credit Agreement”) with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent.  The New Sun Credit Agreement provides for $150.0 million in term loans, a $60.0 million revolving credit facility ($30.0 million of which may be utilized for letters of credit) and a $75.0 million letter of credit facility funded by proceeds of additional term loans.  The revolving credit facility was undrawn on October 28, 2010. The proceeds of the term loans were used to repay outstanding term loans under our existing Credit Agreement and provide funds for general corporate purposes.  The letter of credit facility replaced the letter of credit facility under ou r Credit Agreement.  The final maturity date of the term loans and the letter of credit facility is October 18, 2016 and the revolving credit facility terminates on October 18, 2015.  However, if our 9.125% Senior Subordinated Notes due 2015 are outstanding on January 13, 2015, the term loans will mature, and the letter of credit facility and revolving credit facility will terminate, on January 13, 2015.

       Amounts borrowed under the term loan facility are due in quarterly installments of $2.5 million, with the remaining principal amount due on the maturity date of the term loans.  Accrued interest is payable at the end of an interest period, but no less frequently than every three months.  The loans under the New Sun Credit Agreement bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at our option, either (a) the greater of 1.75% or London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserves or (b) an alternative base rate determined by reference to the highest of (i) the prime rate announced by Credit Suisse, (ii) the federal funds rate plus one-half of 1.0%, and (iii) one-month LIBOR adjust ed for statutory reserves plus 1%.  The applicable percentage for term loans and revolving loans is 4.75% for alternative base rate loans and 5.75% for LIBOR loans.

In October 2010, subsidiaries of Sabra issued $225 million aggregate principal amount of senior notes due 2018 in a private offering (the “Sabra Offering”), the net proceeds from which have been placed in escrow pending the satisfaction or waiver of certain conditions, including certain conditions to the Separation and REIT Conversion Merger.  Upon the satisfaction or waiver of these conditions, the proceeds from the offering will be used, together with cash from us, to redeem the Notes, including accrued interest and the redemption premium.  We have guaranteed the obligations of the Sabra issuers under the notes issued pursuant to the Sabra Offering pending completion of the Separation and REIT Conversion Merger.

In October 2010, we refinanced mortgage indebtedness collateralized by nine of our health care centers with a $35.6 million carrying value as of September 30, 2010.  The new mortgage indebtedness is for an initial amount of $30.0 million, carries interest at LIBOR plus 4.5% (with a LIBOR floor of 1.0%), and is collateralized by seven of our health care centers.

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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 nursing, rehabilitative and related specialty healthcare services primarily to the senior population in the United States. Our core business is providing inpatient services, primarily through 166 skilled nursing centers, 16 combined skilled nursing, assisted and independent living centers, ten assisted living centers, two independent living centers and eight mental health centers with 23,189 licensed beds located in 25 states as of September 30, 2010. Our subsidiaries also provide hospice services, rehabilitation therapy services and temporary medical staffing services to skilled nursing centers.

In March 2010, the Patient Protection and Affordable Care Act (the “ACA”) and the Health Care and Education Reconciliation Act of 2010 were signed into law. Together, these two measures make the most sweeping and fundamental changes to the U.S. health care system since the creation of Medicare and Medicaid. These new laws include a large number of health-related provisions that are scheduled to take effect over the next four years, including expanding Medicaid eligibility, requiring most individuals to have health insurance, establishing new regulations on health plans, establishing health insurance exchanges, and modifying certain payment systems to encourage more cost-effective care and a reduction of inefficiencies and waste, including through new tools to address fraud and abuse. We cannot predict the effect these newl y enacted laws or any future legislation or regulation will have on our future operations, including future reimbursement rates and occupancy in our inpatient facilities.

Proposed Restructuring

On May 24, 2010, we announced a plan to restructure our business by separating our real estate assets and our operating assets into two separate publicly traded companies, subject to the approval of our stockholders and other conditions.  The plan consists of certain key transactions including the reorganization, through a series of internal corporate restructurings, such that (i) substantially all of the Company’s owned real property (with a net book value at September 30, 2010 of $486.2 million) and related mortgage indebtedness owed to third parties (with a carrying value at September 30, 2010 of $156.8 million) will be held or assumed by Sabra Health Care REIT, Inc., a Maryland corporation and a wholly owned subsidiary of the Company (“Sabra”), or by one or more subsidiaries of Sabra, and (ii) all of th e Company’s operations and other assets and liabilities will be held or assumed by SHG Services, Inc., a Delaware corporation and a wholly owned subsidiary of the Company (“New Sun”), or by one or more subsidiaries of New Sun.  The Company will distribute to its stockholders on a pro rata basis all of the outstanding shares of New Sun common stock (the “Separation”), together with a pro rata cash distribution to the Company’s stockholders that will aggregate approximately $13 million.  The Company will then merge with and into Sabra, with Sabra surviving the merger as a Maryland corporation and the Company’s stockholders receiving shares of Sabra common stock in exchange for their shares of the Company’s common stock (the “REIT Conversion Merger”). Shares of New Sun common stock and Sabra common stock are both expected to trade on the NASDAQ Global Select Market. Immediately following the Separation and REIT Conversion Merger, Ne w Sun will change its name to Sun Healthcare Group, Inc. The Separation and REIT Conversion Merger are expected to be completed on November 15, 2010.  The historical consolidated financial statements of the Company will become the historical consolidated financial statements of New Sun at the time of the Separation, and New Sun will be treated as the successor registrant to the Company for securities law purposes.

Revenues from Medicare, Medicaid and Other Sources

We receive revenues from Medicare, Medicaid, commercial insurance, self-pay residents, other third party payors and healthcare 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, and pressures on state budgets resulting from the current economic conditions in the United States may intensify these efforts. This focus has not been limited to skilled nursing centers, but includes specialty services provided by us, such as skilled therapy services, to third parties. W e cannot at this time predict the extent to which proposals limiting federal or state expenditures will be adopted or, if adopted and

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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.

In addition, we have experienced, and may continue to experience, due to current economic conditions, reduced demand for the specialty services that we provide to third parties.  We are unable to predict the future impact or extent of such reduced demand.

The following table sets forth the 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 is in thousands and includes revenues for acquired centers following the date of acquisition only):

		For the								For the
		Three Months Ended								Nine Months Ended
Sources of Revenues		September 30, 2010				September 30, 2009				September 30, 2010				September 30, 2009
Consolidated:
Medicaid	$	194,936	41.0	%	$	189,878	40.3	%	$	574,856	40.4	%	$	559,358	39.8	%
Medicare		138,125	29.0			137,857	29.3			421,398	29.6			417,059	29.6
Private pay and other		118,758	24.9			118,516	25.2			354,553	24.9			353,941	25.1
Managed care and
commercial insurance		24,178	5.1			24,393	5.2			72,636	5.1			76,591	5.4
Total	$	475,997	100.0	%	$	470,644	100.0	%	$	1,423,443	100	%	$	1,406,949	100.0	%
Inpatient Only:
Medicaid	$	194,904	46.0	%	$	189,856	45.2	%	$	574,759	45.4	%	$	559,256	44.7	%
Medicare		133,350	31.4			133,899	31.9			407,448	32.2			404,992	32.4
Private pay and other		71,997	17.0			72,395	17.2			211,982	16.7			211,163	16.9
Managed care and
commercial insurance		23,909	5.6			24,224	5.7			71,791	5.7			76,113	6.1
Total	$	424,160	100.0	%	$	420,374	100.0	%	$	1,265,980	100.0	%	$	1,251,524	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.

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, 2005, 2006 and 2010.  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.

On July 31, 2009, CMS issued its final rule for skilled nursing facilities for the 2010 federal fiscal year, which commenced on October 1, 2009.  This rule provides for a market basket increase of 2.2% in our reimbursement rates and a 3.3% reduction for a forecast error/parity adjustment.  Notwithstanding this reduction in reimbursement rates for the 2010 federal fiscal year, as shown in the table below, we did experience a slight increase in our average amount of Medicare Part

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

A revenues on a per patient, per day basis in the nine months ended September 30, 2010, compared to the nine months ended September 30, 2009, due to a higher acuity mix of our patient population.

In addition to the changes that affect the 2010 federal fiscal year, the rule also contained provisions for the 2011 federal fiscal year, which commenced on October 1, 2010.  The changes create a RUG-IV system that contains 66 levels of care.  The basis for calculating the RUG-IV category is the Minimum Data Set (“MDS”) 3.0, a patient assessment tool, which was also implemented on October 1, 2010.  The MDS 3.0 replaces the MDS 2.0 which is the basis of the RUG-III levels of care. The RUG-IV system changes the way certain services that occur prior to the residency at a skilled nursing center impact reimbursement (known as the look back provision) and the extent to which therapy services that are delivered on a concurrent basis impact reimbursement.

A portion of the provisions of the 2010 final rule applicable to the 2011 federal fiscal year was subsequently changed by the ACA.  The ACA postponed the implementation of the RUG-IV reimbursement system but maintained the changes in the look back and concurrent therapy provisions. The House of Representatives has passed legislation that rescinds the postponement of the RUG IV implementation, but such legislation has not been passed by the Senate.

On July 16, 2010, CMS issued its final rule for skilled nursing facilities for the 2011 federal fiscal year, which commenced on October 1, 2010.  This rule provides for a market basket increase of 2.3% which is reduced by a prior period market basket adjustment of 0.6%, generating a net market basket increase of 1.7%.

The rule also addressed the postponement of the implementation of RUG-IV.  If this postponement is not rescinded, CMS will implement a Hybrid RUG III system (“HR-III”).  The HR-III system was not available for implementation on the effective date of October 1, 2010.  CMS has stated that it will make payments from October 1, 2010 until the HR-III system is implemented using the RUG-IV system.  Payments would then be adjusted retroactively from the date of the HR-III implementation to October 1, 2010.

CMS has stated that it will implement either the RUG-IV or the HR-III system on a budget neutral basis. Based on this assertion, we believe that the impact of the system change will be budget neutral plus 1.7%.

The following table sets forth the average amounts of inpatient Medicare Part A revenues per patient, per day, recorded by our healthcare centers for the periods indicated:

	For the				For the
	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
$	463.36	$	457.79	$	464.46	$	454.15

Under current law, there are limits on reimbursement provided under Medicare Part B for therapy services. An automatic exception to this limit is in place for patients residing in skilled nursing centers until December 31, 2010. In addition, therapy rates are calculated using the Physicians Fee Schedule, for which rates are subject to a reduction of 21.3% based on a statutory formula. Congress has repeatedly eliminated this reduction in prior years and has eliminated it through November 30, 2010.

On June 25, 2010, CMS issued the Physicians Fee Schedule proposed rule for calendar year 2011.  The proposed rule expands the Multiple Procedure Payment Reduction previously applied to diagnostic procedures to physical, occupational and speech therapy services reimbursed by Medicare Part B.  The proposal reduces the reimbursement for these services by an average of 12%.  This rule is proposed and we are not able to predict the changes that will occur prior to its finalization and cannot estimate its impact on Sun’s revenue.

On July 16, 2010, CMS also issued its final rule for hospice services for the 2011 federal fiscal year. The rule includes a market basket increase of 2.6% and a 0.8% reduction reflecting the combined effects of the updated wage data and the continuation of the phase out of the wage index budget neutrality factor.  We estimate the impact of these changes will be an increase in hospice revenues of 2.2% or $1 million annually.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

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 and rehabilitation centers has its own unique Medicaid reimbursement system.

Medicaid outlays are a significant component of state budgets, and there have been cost containment pressures on Medicaid outlays for nursing homes.  The current economic downturn has caused many states to institute freezes on or reductions in Medicaid spending to address state budget concerns.

Twenty-one 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.

The following table sets forth the average amounts of inpatient Medicaid revenues per patient, per day (excluding any impact of individually identifiable state-imposed provider taxes), recorded by our healthcare centers for the periods indicated:

	For the				For the
	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
$	173.49	$	172.06	$	173.29	$	170.86

For comparison purposes, the following table sets forth the average amounts of inpatient Medicaid revenues per patient, per day (including the impact from individually identifiable state-imposed provider taxes), recorded by our healthcare centers for the periods indicated:

	For the				For the
	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
$	159.57	$	159.38	$	159.71	$	159.37

Managed Care and Insurance

During the three months ended September 30, 2010, we received 5.1% of our revenues from managed care and insurance, of which the Medicare Advantage program is the primary component.  As discussed above, Medicare Advantage is the managed care option for Medicare beneficiaries.  Medicare Advantage is administered by contracted third party payors.  The managed care and insurance payors are continuing their efforts to control healthcare costs through direct contracts with healthcare providers and increased utilization review.  These payors are increasingly demanding discounted fee structures and the assumption by healthcare providers of all or a portion of the financial risk.

The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated:

	For the				For the
	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
$	375.76	$	371.09	$	369.09	$	373.86

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Private Payors, Veterans and Other

During the three months ended September 30, 2010, we received 24.9% of our revenues from private payors, veterans’ coverage, healthcare centers that utilize our specialty medical services, self-pay center residents and other third party payors. These private and other payors are continuing their efforts to control healthcare costs.  Private payor rates are set at a price point that enables continued competition; they are driven by the markets in which our healthcare centers operate.

The following table sets forth the average amounts of inpatient revenues per patient, per day, recorded by our healthcare centers from these revenue sources for the periods indicated:

	For the				For the
	Three Months Ended				Nine Months Ended
	September 30, 2010		September 30, 2009		September 30, 2010		September 30, 2009
$	186.21	$	178.09	$	188.21	$	178.38

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.

Recent Accounting Pronouncements

Discussion of recent accounting pronouncements can be found in the “Recent Accounting Pronouncements” portion of Note 1 – “Nature of Business” to our consolidated financial statements.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Results of Operations

The following tables set forth our unaudited 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
		September 30, 2010			September 30, 2009		September 30, 2010		September 30, 2009
Total net revenues	$	475,997		$	470,644		100	%	100	%
Costs and expenses:
Operating salaries and benefits		270,052			265,597		56.7		56.4
Self-insurance for workers’ compensation and
general and professional liabilities		14,621			14,162		3.1		3.0
Other operating costs (1)		111,432			109,477		23.4		23.3
Center rent expense		18,954			18,190		4.0		3.9
General and administrative expenses (2)		18,893			15,586		4.0		3.3
Depreciation and amortization		12,733			11,457		2.7		2.4
Provision for losses on accounts receivable		5,141			5,313		1.1		1.1
Interest, net		10,614			12,231		2.2		2.6
Other costs		-			872		-		0.2
Income before income taxes and discontinued
operations		13,557			17,759		2.8		3.8
Income tax expense		5,559			7,220		1.2		1.5
Income from continuing operations		7,998			10,539		1.6		2.3
Loss from discontinued operations, net		(442	)		(881	)	(0.0	)	(0.2	)
Net income	$	7,556		$	9,658		1.6	%	2.1	%
Supplemental Financial Information (3):
EBITDA	$	36,904		$	41,447		7.8	%	8.8	%
Adjusted EBITDA	$	36,904		$	42,319		7.8	%	9.0	%
Adjusted EBITDAR	$	55,858		$	60,509		11.7	%	12.9	%

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

		For the Nine			For the Nine		As a Percentage of Net Revenues
		Months Ended			Months Ended
		September 30, 2010			September 30, 2009		September 30, 2010		September 30, 2009
Total net revenues	$	1,423,443		$	1,406,949		100	%	100	%
Costs and expenses:
Operating salaries and benefits		804,302			789,744		56.5		56.1
Self-insurance for workers’ compensation and
general and professional liabilities		43,702			45,617		3.1		3.2
Other operating costs (1)		330,280			325,464		23.2		23.1
Center rent expense		56,306			54,755		4.0		3.9
General and administrative expenses (2)		51,565			48,057		3.6		3.4
Depreciation and amortization		37,732			33,329		2.7		2.4
Provision for losses on accounts receivable		15,985			15,582		1.1		1.1
Interest, net		34,366			37,422		2.4		2.7
Other costs		-			913		-		0.1
Income before income taxes and discontinued
operations		49,205			56,066		3.5		3.9
Income tax expense		19,990			22,795		1.4		1.6
Income from continuing operations		29,215			33,271		2.1		2.3
Loss from discontinued operations, net		(1,488	)		(3,275	)	(0.1	)	(0.2	)
Net income	$	27,727		$	29,996		1.9	%	2.1	%
Supplemental Financial Information (3):
EBITDA	$	121,303		$	126,817		8.5	%	9.0	%
Adjusted EBITDA	$	121,303		$	127,730		8.5	%	9.0	%
Adjusted EBITDAR	$	177,609		$	182,485		12.5	%	13.0	%

(1) Operating administrative expenses are included in “other operating costs” above.

(2) General and administrative expenses include transaction costs.

(3) We define EBITDA as net income before loss from discontinued operations, interest expense (net of interest income), income tax expense, depreciation and amortization.  EBITDA margin is EBITDA as a percentage of revenue.  Adjusted EBITDA is EBITDA adjusted for the loss on sale of assets, net.Adjusted EBITDA margin is Adjusted EBITDA as a percentage of revenue.  Adjusted EBITDAR is Adjusted EBITDA before center rent expense.  Adjusted EBITDAR margin is Adjusted EBITDAR as a percentage of revenue.

We believe that the presentation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides useful information regarding our operational performance because they enhance the overall understanding of the financial performance and prospects for the future of our core business activities.

Specifically, we believe that a presentation of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides consistency in our financial reporting and provides a basis for the comparison of results of core business operations between our current, past and future periods.  EBITDA, Adjusted EBITDA and Adjusted EBITDAR are three of the primary indicators we use for planning and forecasting in future periods, including trending and analyzing the core operating performance of our business from period-to-period without the effect of U.S. generally accepted accounting principles, or GAAP, expenses, revenues and gains that are unrelated to the day-to-day performance of our business. We also use EBITDA, Adjusted EBITDA and Adjusted EBITDAR to benchmark the performance of our business against expected results, analyzing year-over-year trends as described below and to compare our operating performance to that of our competitors.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

In addition to other financial measures, including net segment income, we use EBITDA, Adjusted EBITDA and Adjusted EBITDAR to assess the performance of our core business operations, to prepare operating budgets and to measure our performance against those budgets on a consolidated, segment and a center-by-center level.  EBITDA, Adjusted EBITDA and Adjusted EBITDAR are useful in this regard because they do not include such costs as interest expense (net of interest income), income taxes and depreciation and amortization expense, which may vary from business unit to business unit and period-to-period depending upon various factors, including the method used to finance the business, the amount of debt that we have determi ned to incur, whether a center is owned or leased, the date of acquisition of a facility or business, the original purchase price of a facility or business unit or the tax law of the state in which a business unit operates. These types of charges are dependent on factors unrelated to our underlying business. As a result, we believe that the use of EBITDA, Adjusted EBITDA and Adjusted EBITDAR provides a meaningful and consistent comparison of our underlying business between periods by eliminating certain items required by GAAP which have little or no significance in our day-to-day operations.

We also make capital allocations to each of our centers based on the centers’ lease terms and their expected Adjusted EBITDA returns.  We establish compensation and bonus programs for our center-level employees that are based upon the achievement of pre-established Adjusted EBITDA targets.

Despite the importance of these measures in analyzing our underlying business, maintaining our financial requirements, designing incentive compensation and for our goal setting both on an aggregate and facility level basis, EBITDA, Adjusted EBITDA and Adjusted EBITDAR are non-GAAP financial measures that have no standardized meaning defined by GAAP.  As the items excluded from EBITDA, Adjusted EBITDA and Adjusted EBITDAR are significant components in understanding and assessing our financial performance, EBITDA, Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as alternatives to net income, cash flows generated by or used in operating, i nvesting or financing activities or other financial statement data presented in the consolidated financial statements as indicators of financial performance or liquidity.  Therefore, our EBITDA, Adjusted EBITDA and Adjusted EBITDAR measures have limitations as analytical tools, and they should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP.  Some of these limitations are:

·   they do not reflect our cash expenditures, or future requirements for capital expenditures, or contractual commitments;

·   they do not reflect changes in, or cash requirements for, our working capital needs;

·   they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

·   they do not reflect any income tax payments we may be required to make;

·   although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future in order to remain competitive in the market, and EBITDA, Adjusted EBITDA and Adjusted EBITDAR do not reflect any cash requirements for such replacements;

·   they are not adjusted for all non-cash income or expense items that are reflected in our consolidated statements of cash flows; and

·   other companies in our industry may calculate these measures differently than we do, which may limit their usefulness as comparative measures.

We compensate for these limitations by using EBITDA, Adjusted EBITDA and Adjusted EBITDAR only to supplement net income on a basis prepared in conformance with GAAP in order to provide a more complete understanding of the factors and trends affecting our business. We strongly encourage investors to consider net income determined under GAAP as compared to EBITDA, Adjusted EBITDA and Adjusted EBITDAR, and to perform their own analysis, as appropriate.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

The following table provides a reconciliation of our net income, which is the most directly comparable financial measure presented in accordance with GAAP, to EBITDA, Adjusted EBITDA and Adjusted EBITDAR for the periods indicated (in thousands):

		For the Three Months Ended				For the Nine Months Ended
		September 30,				September 30,
		2010		2009		2010		2009
Net income	$	7,556	$	9,658	$	27,727	$	29,996
Plus:
Loss from discontinued operations, net		442		881		1,488		3,275
Interest expense, net		10,614		12,231		34,366		37,422
Income tax expense		5,559		7,220		19,990		22,795
Depreciation and amortization		12,733		11,457		37,732		33,329
EBITDA	$	36,904	$	41,447	$	121,303	$	126,817
Plus:
Restructuring costs		-		872		-		872
Loss on sale of assets, net		-		-		-		41
Adjusted EBITDA	$	36,904	$	42,319	$	121,303	$	127,730
Plus:
Center rent expense		18,954		18,190		56,306		54,755
Adjusted EBITDAR	$	55,858	$	60,509	$	177,609	$	182,485

The following discussion of the “Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009” is based, in part, on the financial information presented in Note 8 – “Segment Information” in our interim consolidated financial statements.

Three Months Ended September 30, 2010 Compared to Three Months Ended September 30, 2009

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 revenues increased $5.4 million, or 1.1%, to $476.0 million for the three months ended September 30, 2010 from $470.6 million for the three months ended September 30, 2009.  We reported net income for the three month periods ended September 30, 2010 and 2009 of $7.6 million and $9.7 million, respectively.

The increase in net revenues for the 2010 period included $3.8 million of additional revenue in our Inpatient Services segment primarily due to higher hospice revenue plus the October 2009 acquisition of a hospice company.  A $6.7 million increase in revenue from our Rehabilitation Therapy segment, due primarily to increases in billable minutes and billing rates, also contributed to the increase in net revenues.  These increases were partially offset by a $2.2 million decrease in revenue from our Medical Staffing segment, mainly due to a decrease in billable therapy and pharmacy hours plus reduced fees from temporary placement of physicians.

Operating salaries and benefits increased $4.5 million, or 1.7%, to $270.1 million (56.7% of net revenues) for the three months ended September 30, 2010 from $265.6 million (56.4% of net revenues) for the three months ended September 30, 2009.  The increase resulted primarily from a $4.8 million increase in our Rehabilitation Therapy segment driven by increased service volume and wage rate increases and a $0.4 million increase in our Inpatient Services segment driven by

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

health insurance costs. These increases were offset by a $0.8 million decrease in our Medical Staffing segment due to a decline in staffing levels resulting from a decrease in the therapy staffing and pharmacy businesses.

Self-insurance for workers’ compensation and general and professional liability insurance increased $0.4 million, or 2.8%, to $14.6 million (3.1% of net revenues) for the three months ended September 30, 2010 from $14.2 million (3.0% of net revenues) for the three months ended September 30, 2009, primarily due to increased claims related activity in our workers’ compensation self-insurance.

Other operating costs increased $1.9 million, or 1.7%, to $111.4 million (23.4% of net revenues) for the three months ended September 30, 2010 from $109.5 million (23.3% of net revenues) for the three months ended September 30, 2009.  The increase was primarily due to provider taxes and increased therapy costs in our Inpatient Services segment resulting from an increase in higher acuity patients requiring more rehabilitation therapy.

Center rent expense increased $0.8 million, or 4.4%, to $19.0 million (4.0% of net revenues) for the three months ended September 30, 2010 from $18.2 million (3.9% of net revenues) for the three months ended September 30, 2009.  The increase is attributable to additional offices for a hospice operation we acquired in 2009.

General and administrative expenses increased $3.3 million, or 21.2%, to $18.9 million (4.0% of net revenues) for the three months ended September 30, 2010 from $15.6 million (3.3% of net revenues) for the three months ended September 30, 2009.  The increase was primarily due to the $4.7 million of transaction costs incurred in connection with the Separation and REIT Conversion Merger.

Depreciation and amortization increased $1.2 million, or 10.4%, to $12.7 million (2.7% of net revenues) for the three months ended September 30, 2010 from $11.5 million (2.4% of net revenues) for the three months ended September 30, 2009.  The increase was attributable to additional depreciation expense for property and equipment placed into service since the year ago period.

The provision for losses on accounts receivable decreased $0.2 million, or 3.8%, to $5.1 million (1.1% of net revenues) for the three months ended September 30, 2010 from $5.3 million (1.1% of net revenues) for the three months ended September 30, 2009.  The decrease resulted from improving cash collections trends, which improved our accounts receivable aging, leading to a reduction in our provision for losses on accounts receivable for the three months ended September 30, 2010 when compared to the three months ended September 30, 2009.

Net interest expense decreased $1.6 million, or 13.1%, to $10.6 million (2.2% of net revenues) for the three months ended September 30, 2010 from $12.2 million (2.6% of net revenues) for the three months ended September 30, 2009 due to lower interest rates on variable rate indebtedness in the 2010 quarter coupled with reduced debt balances.

Segment Information

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

		2010					2009
Inpatient Services	$	424,160		89.0	%	$	420,374		89.3	%
Rehabilitation Therapy Services		51,739		10.9			44,986		9.6
Medical Staffing Services		22,205		4.7			24,409		5.2
Corporate		14		-			12		-
Intersegment Eliminations		(22,121	)	(4.6	)		(19,137	)	(4.1	)
Total net revenues	$	475,997		100	%	$	470,644		100	%

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

Inpatient Services revenues 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 September 30 (in thousands):

		2010		2009
Rehabilitation Therapy Services	$	21,397	$	18,592
Medical Staffing Services		724		545
Total intersegment revenue	$	22,121	$	19,137

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

		2010			2009
Inpatient Services	$	36,134		$	39,480
Rehabilitation Therapy Services		3,961			2,606
Medical Staffing Services		1,195			2,091
Net segment income before Corporate		41,290			44,177
Corporate		(27,733	)		(25,546	)
Net segment income	$	13,557		$	18,631

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.  We evaluate the operational strengths and performance of each segment based on financial measures, including net segment income.  Net segment income is defined as earnings before income tax expense, restructuring costs, loss on sale of assets and discontinued operations. Net segment income for the three months ended September 30, 2010 for (1) our Inpatient Services segment decreased $3.4 million, or 8.6%, to $36.1 million, (2) our Rehabilitation Therapy Services segment increased $1.4 million, or 53.8%, to $4.0 million and (3) our M edical Staffing Services segment decreased $0.9 million, or 42.9%, to $1.2 million in comparison to the three months ended September 30, 2009, due to the factors discussed below for each segment.  We use the measure of net segment income to help identify opportunities for improvement and assist in allocating resources to each segment. 

Inpatient Services

Net revenues increased $3.8 million, or 0.9%, to $424.2 million for the three months ended September 30, 2010 from $420.4 million for the three months ended September 30, 2009.  The increase was primarily the result of:

-	an increase of $5.4 million in Medicaid revenues consisting of $3.9 million from an increase in customer base and a $1.5 million increase related to improved rates, which were significantly offset by increased provider tax expense (as discussed below);
-	a $4.0 million increase in hospice revenues resulting from an October 2009 acquisition of a hospice company and a higher customer base; and
-	a $1.4 million increase in other revenue,  primarily resulting from higher veterans customer base;
	Offset in part by:
-	a decrease of $4.1 million in Medicare revenues as a result of a $6.0 million decrease in revenues due to a lower customer base, partially offset by a $1.4 million increase in revenues from higher Medicare Part A rates and a $0.5 million increase in Medicare Part B revenues;

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- a decrease of $2.3 million in revenues from private payors consisting of $5.3 million from a decrease in customer base partially offset by a $3.0 million increase related to improved rates; and

- a $0.6 million decrease in managed care and commercial insurance revenues driven primarily by lower customer base.

Operating salaries and benefits expenses increased $0.4 million, or 0.2%, to $210.9 million for the three months ended September 30, 2010 from $210.5 million for the three months ended September 30, 2009.  The increase was attributable to the following:

-	an increase of $1.8 million in health insurance expense; and
-	an increase of $0.2 million in state unemployment taxes due to higher tax rates;
	Offset in part by:
-	a decrease of $1.1 million in nursing bonus and other bonus expense as less personnel are qualifying for such bonuses than in the same period in prior year; and
-	a decrease of $0.5 million in overtime and other special pay.

Self-insurance for workers’ compensation and general and professional liability insurance increased $0.6 million, or 4.5%, to $13.8 million for the three months ended September 30, 2010 as compared to $13.2 million for the three months ended September 30, 2009, which was driven by increased claims related activity in our workers’ compensation self-insurance.

Other operating costs increased $4.7 million, or 4.3%, to $115.0 million for the three months ended September 30, 2010 from $110.3 million for the three months ended September 30, 2009.  The increase was attributable to the following:

-	a $2.1 million increase in contract labor driven by therapy costs due to an increase in higher acuity patients requiring more rehabilitation therapy and an increase in Medicare Part B therapy;
-	a $1.6 million increase in provider taxes due to increased provider tax rates from a number of states in which we operate;
-	a $1.1 million increase in purchased services primarily related to housekeeping contracts; and
-	a $0.5 million increase in utilities expense primarily due to higher electric utility charges;
	Offset in part by:
-	a $0.6 million decrease in equipment rental expense.

Operating administrative expenses increased at $0.5 million, or 4.9%, to $10.8 million for the three months ended September 30, 2010 compared to $10.3 million for the three months ended September 30, 2009, primarily due to higher salaries and benefits expense.

Center rent expense increased $0.8 million, or 4.5%, to $18.6 million for the three months ended September 30, 2010 from $17.8 million for the three months ended September 30, 2009.  The increase is attributable to additional offices for a hospice operation we acquired in 2009.

Depreciation and amortization increased $1.1 million, or 10.5%, to $11.6 million for the three months ended September 30, 2010 from $10.5 million for the three months ended September 30, 2009.  The increase was attributable to depreciation of additional property and equipment placed into service during the period.

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The provision for losses on accounts receivable decreased $0.5 million, or 9.6%, to $4.7 million for the three months ended September 30, 2010 from $5.2 million for the three months ended September 30, 2009.  The decreased expense is due to improving cash collections trends, which improved our accounts receivable aging, leading to a reduction in our provision for losses on accounts receivable for the three months ended September 30, 2010 when compared to the three months ended September 30, 2009.

Net interest expense decreased $0.4 million, or 13.3%, to $2.6 million for the three months ended September 30, 2010 from $3.0 million for the three months ended September 30, 2009.  The decrease is a result of lower interest rates and lower aggregate borrowings.

Rehabilitation Therapy Services

Total revenues from the Rehabilitation Therapy Services segment increased $6.7 million, or 14.9%, to $51.7 million for the three months ended September 30, 2010 from $45.0 million for the three months ended September 30, 2009. The revenue increase was the result of:

- an increase of $4.8 million attributable to increased billable minutes, due in part to the addition of 27 new contracts, net of lost contracts;

- an increase of $1.5 million attributable to a higher revenue per minute rate due to our renegotiation of certain customer contract rates and a shift in payor mix and a Medicare Part B rate increase; and

- an increase of $0.4  million in other revenue, primarily related to contract management fees.

Operating salaries and benefits expenses increased $4.8 million, or 12.6%, to $42.8 million for the three months ended September 30, 2010 from $38.0 million for the three months ended September 30, 2009.  The increase was primarily driven by the increase in service volume mentioned above coupled with wage rate increases.

Medical Staffing Services

Total revenues from the Medical Staffing Services segment decreased $2.2 million, or 9.0%, to $22.2 million for the three months ended September 30, 2010 from $24.4 million for the three months ended September 30, 2009.  The decrease was primarily the result of:

-	a decrease of $2.3 million due to a decline for therapy and pharmacy staffing hours; and
-	a decrease of $0.8  million due to lower fees earned from the temporary placement of physicians;
	Offset in part by:
-	an increase of $0.9 million  due to an increase in billable hours for nurse staffing.

Operating salaries and benefits expenses decreased $0.8 million, or 4.7%, to $16.3 million for the three months ended September 30, 2010 as compared to $17.1 million for the three months ended September 30, 2009.  The decrease in operating salaries and benefits is a direct result of the decline in staffing levels for our therapy staffing and temporary physician businesses.

Corporate

General and administrative expenses not directly attributed to segments increased $3.3 million, or 21.2%, to $18.9 million for the three months ended September 30, 2010 from $15.6 million for the three months ended September 30, 2009.  The increase was primarily due to $4.7 million of transaction costs incurred in connection with the Separation and REIT Conversion Merger, offset by a $1.4 million savings of administrative salaries and benefits resulting from restructuring efforts taken in 2009.

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Interest expense not directly attributed to operating segments decreased $1.2 million, or 13.0%, to $8.0 million for the three months ended September 30, 2010 from $9.2 million for the three months ended September 30, 2009 due to lower interest rates on variable rate indebtedness coupled with a decrease in aggregate indebtedness since September 30, 2009.

Nine Months Ended September 30, 2010 Compared to Nine Months Ended September 30, 2009

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 revenues increased $16.5 million, or 1.2%, to $1,423.4 million for the nine months ended September 30, 2010 from $1,406.9 million for the nine months ended September 30, 2009. We reported net income for the nine month periods ended September 30, 2010 and 2009 of $27.7 million and $30.0 million, respectively.

The increase in net revenues for the 2010 period included $14.5 million of additional revenue in our Inpatient Services segment primarily due to increases in rates from Medicare Part A and Medicaid, although the Medicaid rate increases were significantly offset by increased provider taxes.  Higher Medicaid and Medicare hospice customer bases, the October 2009 acquisition of a hospice company and a $20.1 million increase in revenue from our Rehabilitation Therapy segment, due primarily to increases in billable minutes and billing rates, also contributed to the increase in net revenues.  This increase was partially offset by lower Medicare Part A and Part B, managed care and commercial insurance customer bases, coupled with a $9.9 million decrease in revenue from our Medical Staffing segment, mainly due to a decrease in billable nursing hours.

Operating salaries and benefits increased $14.6 million, or 1.8%, to $804.3 million (56.5% of net revenues) for the nine months ended September 30, 2010 from $789.7 million (56.1 % of net revenues) for the nine months ended September 30, 2009.  The increase resulted primarily from a $15.8 million increase in our Rehabilitation Therapy segment driven by increased service volume and wage rate increases and a $3.8 million increase in our Inpatient Services segment driven by health insurance costs and wage increases. These increases were offset by a $5.0 million decrease in our Medical Staffing segment due to a decline in staffing levels resulting from a decrease in the therapy staffing and pharmacy businesses.

Self-insurance for workers’ compensation and general and professional liability insurance decreased $1.9 million, or 4.2%, to $43.7 million (3.1% of net revenues) for the nine months ended September 30, 2010 from $45.6 million (3.2% of net revenues) for the nine months ended September 30, 2009, primarily due to decreased claims related activity in our general and professional liability self-insurance.

Other operating costs increased $4.8 million, or 1.5%, to $330.3 million (23.2% of net revenues) for the nine months ended September 30, 2010 from $325.5 million (23.1% of net revenues) for the nine months ended September 30, 2009.  The increase was primarily due to provider taxes and increased therapy costs in our Inpatient Services segment resulting from an increase in higher acuity patients requiring more rehabilitation therapy.

Center rent expense increased $1.5 million, or 2.7%, to $56.3 million (4.0% of net revenues) for the nine months ended September 30, 2010 from $54.8 million (3.9% of net revenues) for the nine months ended September 30, 2009.  The increase is attributable to additional offices for a hospice operation we acquired in 2009.

General and administrative expenses increased $3.5 million, or 7.3%, to $51.6 million (3.6% of net revenues) for the nine months ended September 30, 2010 from $48.1 million (3.4% of net revenues) for the nine months ended September 30, 2009.  The increase was primarily due to the $7.0 million of transaction costs incurred in connection with the Separation and REIT Conversion Merger.

Depreciation and amortization increased $4.4 million, or 13.2%, to $37.7 million (2.7% of net revenues) for the nine months ended September 30, 2010 from $33.3 million (2.4% of net revenues) for the nine months ended September 30, 2009.  The increase was attributable to additional depreciation expense for property and equipment acquired during the period.

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The provision for losses on accounts receivable increased $0.4 million, or 2.6%, to $16.0 million (1.1% of net revenues) for the nine months ended September 30, 2010 from $15.6 million (1.1% of net revenues) for the nine months ended September 30, 2009.  The increase resulted from increased credit risk associated with slower cash collections in the first six months of 2010.

Net interest expense decreased $3.0 million, or 8.0%, to $34.4 million (2.4% of net revenues) for the nine months ended September 30, 2010 from $37.4 million (2.7% of net revenues) for the nine months ended September 30, 2009 due to lower interest rates on variable rate indebtedness in the current quarter coupled with reduced debt balances.

Segment Information

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

		2010					2009
Inpatient Services	$	1,265,980		88.9	%	$	1,251,524		88.9	%
Rehabilitation Therapy Services		153,307		10.8			133,231		9.5
Medical Staffing Services		69,076		4.8			79,003		5.6
Corporate		28		-			27		-
Intersegment Eliminations		(64,948	)	(4.5	)		(56,836	)	(4.0	)
Total net revenues	$	1,423,443		100	%	$	1,406,949		100	%

Inpatient Services revenues 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 nine months ended September 30 (in thousands):

		2010		2009
Rehabilitation Therapy Services	$	63,584	$	55,168
Medical Staffing Services		1,364		1,668
Total intersegment revenue	$	64,948	$	56,836

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

		2010			2009
Inpatient Services	$	113,355		$	120,402
Rehabilitation Therapy Services		11,757			8,606
Medical Staffing Services		4,479			6,401
Net segment income before Corporate		129,591			135,409
Corporate		(80,386	)		(78,430	)
Net segment income	$	49,205		$	56,979

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.  We evaluate the operational strengths and performance of each segment based on financial measures, including net segment income.  Net segment income is defined as earnings before income tax expense, restructuring costs, loss on sale of assets and discontinued operations. Net segment income for the nine months ended September 30, 2010 for (1) our Inpatient Services segment decreased $7.0 million, or 5.8%, to $113.4 million, (2) our Rehabilitation Therapy Services segment increased $3.2 million, or 37.2%, to $11.8 million and (3) our Medical Staffing Services segment decreased $1.9 million, or 29.7%, to $4.5 million in comparison to the nine months ended September 30, 2009, due to the factors discussed

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

below for each segment.  We use the measure of net segment income to help identify opportunities for improvement and assist in allocating resources to each segment. 

Inpatient Services

Net revenues increased $14.5 million, or 1.2%, to $1,266.0 million for the nine months ended September 30, 2010 from $1,251.5 million for the nine months ended September 30, 2009.  The increase was primarily the result of:

-	an increase of $16.7 million in Medicaid revenues consisting of a $9.0 million increase in customer base and a $7.7 million increase related to improved rates, which were significantly offset by increased provider tax expense (as discussed below);
-	a $14.4 million increase in hospice revenues resulting from an October 2009 acquisition of a hospice company and a higher customer base; and
-	a $2.8 million increase in other revenues, primarily resulting from adding more veteran patients;
	Offset in part by:
-	a decrease of $10.6 million in Medicare revenues as a result of a $18.1 million decrease in revenues due to a lower customer base and a $0.4 million decrease in Medicare Part B revenues, partially offset by a $7.9 million increase in revenues from higher Medicare Part A rates;
-	a $4.7 million decrease in managed care and commercial insurance revenues driven by a lower customer base, which contributed $3.3 million of the decrease, and lower rates, which drove the remaining $1.4 million of the decrease; and
-	a decrease of $4.1 million in revenues from private payors as a result of a $14.3 million decrease in revenues due to a lower customer base, partially offset by a $10.2 million increase in revenues from higher rates.

Operating salaries and benefits expenses increased $3.8 million, or 0.6%, to $627.2 million for the nine months ended September 30, 2010 from $623.4 million for the nine months ended September 30, 2009.  The increase was attributable to the following:

-	an increase of $5.4 million in health insurance expense;
-	a $2.9 million increase in salaries due to raises and additional clinical staff; and
-	an increase of $0.4 million in unemployment taxes due to higher state tax rates;
	Offset in part by:
-	a $3.0 million decrease in overtime and other special pay; and
-	a decrease of $1.9 million in nursing bonus and other bonus expense.

Self-insurance for workers’ compensation and general and professional liability insurance decreased $1.4 million, or 3.3%, to $41.3 million for the nine months ended September 30, 2010 as compared to $42.7 million for the nine months ended September 30, 2009, which was driven by decreased claims related activity in our general and professional liability self-insurance.

Other operating costs increased $14.6 million, or 4.5%, to $340.5 million for the nine months ended September 30, 2010 from $325.9 million for the nine months ended September 30, 2009.  The increase was attributable to the following:

- a $7.4 million increase in provider taxes;

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

- a $4.3 million increase in contract labor driven by therapy costs due to an increase in higher acuity patients requiring more rehabilitation therapy and increased Medicare Part B therapy; and

- a $2.9 million increase in purchased services primarily related to housekeeping contracts.

Operating administrative expenses increased $0.1 million, or 0.3%, to $30.9 million for the nine months ended September 30, 2010 from $30.8 million for the nine months ended September 30, 2009, primarily due to higher travel expenses.

The provision for losses on accounts receivable increased $0.1 million, or 0.7%, to $15.1 million for the nine months ended September 30, 2010 from $15.0 million for the nine months ended September 30, 2009.  The increase resulted from increased credit risk associated with slower cash collections experienced in the nine months ended September 30, 2010 (primarily in the first six months of 2010) when compared with the nine months ended September 30, 2009.

Center rent expense increased $1.6 million, or 3.0%, to $55.3 million for the nine months ended September 30, 2010 from $53.7 million for the nine months ended September 30, 2009.  The increase is attributable to additional offices for a hospice operation we acquired in 2009.

Depreciation and amortization increased $4.0 million, or 13.2%, to $34.3 million for the nine months ended September 30, 2010 from $30.3 million for the nine months ended September 30, 2009.  The increase was attributable to depreciation of additional property and equipment placed into service since the year ago period.

Net interest expense decreased $1.2 million, or 12.9%, to $8.1 million for the nine months ended September 30, 2010 from $9.3 million for the nine months ended September 30, 2009.  The decrease is a result of lower interest rates and lower aggregate borrowings.

Rehabilitation Therapy Services

Total revenues from the Rehabilitation Therapy Services segment increased $20.1 million, or 15.1%, to $153.3 million for the nine months ended September 30, 2010 from $133.2 million for the nine months ended September 30, 2009. The revenue increase was the result of:

- an increase of $15.4 million attributable to increased billable minutes, due in part to the addition of 27 new contracts, net of lost contracts;

- an increase of $3.7 million attributable to a higher revenue per minute rate due to our renegotiation of certain customer contract rates, a shift in payor mix, and a Part B rate increase; and

- an increase of $0.9 million in other revenue, primarily related to contract management fees.

Operating salaries and benefits expenses increased $15.8 million, or 14.2%, to $126.7 million for the nine months ended September 30, 2010 from $110.9 million for the nine months ended September 30, 2009.  The increase was primarily driven by the increase in service volume mentioned above coupled with wage rate increases.

Medical Staffing Services

Total revenues from the Medical Staffing Services segment decreased $9.9 million, or 12.5%, to $69.1 million for the nine months ended September 30, 2010 from $79.0 million for the nine months ended September 30, 2009.  The decrease was primarily the result of:

- a decrease of $6.8 million due to a decline for therapy and pharmacy staffing hours;

- a decrease of $2.7 million due to lower fees earned from the temporary placement of physicians;

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- a decrease of $0.3 million attributable to a decline in nurse staffing hours; and

- a decrease of $0.1 million related to closed offices.

Operating salaries and benefits expenses decreased $5.0 million, or 9.0%, to $50.4 million for the nine months ended September 30, 2010 as compared to $55.4 million for the nine months ended September 30, 2009.  The decrease in operating salaries and benefits is a direct result of the decline in staffing levels for our nurse staffing, therapy staffing, pharmacy and temporary physician businesses.

Corporate

General and administrative expenses not directly attributed to segments increased $3.5 million, or 7.3%, to $51.6 million for the nine months ended September 30, 2010 from $48.1 million for the nine months ended September 30, 2009.  The increase was primarily due to $7.0 million of transaction costs incurred in connection with the Separation and REIT Conversion Merger, offset by a $3.2 million savings of administrative salaries and benefits and purchased services resulting from restructuring efforts taken in 2009.

Interest expense not directly attributed to operating segments decreased $1.8 million, or 6.4%, to $26.3 million for the nine months ended September 30, 2010 from $28.1 million for the nine months ended September 30, 2009 due to lower interest rates on variable rate indebtedness coupled with a decrease in aggregate indebtedness since September 30, 2009.

Liquidity and Capital Resources

For the three and nine months ended September 30, 2010, our net income was $7.6 million and $27.7 million, respectively.  As of September 30, 2010, our working capital was $209.8 million and we had cash and cash equivalents of $138.4 million and $449.9 million in borrowings.  On June 30, 2010, we amended our credit agreement, described below under “Loan Agreements.”  One of the changes effected by the amendment was a $25.0 million decrease in our letter of credit facility, and the consequent use of our revolving credit facility for $24.7 million of undrawn letters of credit.  Accordingly, $25.3 million was available for drawing under our revolving credit facility at September 30, 2010.  As described below, we subsequently terminated our credit agreement concurrent with the entry into a $285.0 million senior secured credit facility by New Sun, which provides for $150.0 million in term loans, a $60.0 million revolving credit facility and a $75.0 million letter of credit facility funded by proceeds of additional loans.  As of September 30, 2010, we were in compliance with the covenants contained in the credit agreement governing the revolving credit facility and our term loan indebtedness, and the indenture governing our 9-1/8% Senior Subordinated Notes due 2015.

Based on current levels of operations, we believe that our operating cash flows (which were $35.1 million for the three months ended September 30, 2010 and $104.4 million for the nine months ended September 30, 2010), existing cash reserves and availability for borrowing under New Sun’s new $60.0 million revolving credit facility will provide sufficient funds for our operations, capital expenditures (both discretionary and nondiscretionary) as discussed under “Capital Expenditures,” scheduled debt service payments and our other commitments described in our 2009 Form 10-K in the table under “Obligations and Commitments” (and as updated in “Obligations and Commitments” below due to debt paydowns through September 30, 2010) at least through the next twelve months.  We believe our long t erm liquidity needs will be satisfied by these same sources, as well as borrowings as required to refinance indebtedness.  Although our credit agreement and other financings resulting from the Separation and REIT Conversion Merger, which are described under “Loan Agreements”, contain restrictions on our ability to incur indebtedness, we currently believe that we will be able to refinance existing indebtedness or incur additional indebtedness, if needed.  However, there can be no assurance that we will be able to refinance our indebtedness, incur additional indebtedness or access additional sources of capital, such as by issuing debt or equity securities, on terms that are acceptable to us or at all.

We have relied on our cash flows to provide for operational needs and capital expenditures.  However, there can be no assurance that our operations will continue to provide sufficient cash flow or that refinancing sources will be available in the future, particularly given current economic conditions.  We anticipate that we will be able to utilize our revolving credit facility if needed, as we expect to remain in compliance with the covenants contained in our credit agreement for at least the next twelve months.  We do not depend on cash flows from discontinued operations or sales of assets to provide for future liquidity.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

On October 18, 2010, in connection with the Separation, New Sun entered into a $285.0 million senior secured credit facility as described under “Loan Agreements”.  The new credit facility was entered into to replace the existing credit agreement and provide funds for general corporate purposes.  Among other things, the new credit facility provides for a $60.0 million revolving credit facility, $30.0 million of which may be used for letters of credit, and a $75.0 million funded letter of credit facility.  The revolving credit facility was undrawn at October 28, 2010.

Obligations and Commitments

The following table provides information about our contractual debt servicing obligations and commitments in future years as of September 30, 2010 (in thousands):

		Payments Due for the Twelve Months Ended September 30,
														After
		Total		2011		2012		2013		2014		2015		2015
Contractual Obligations:
Debt, including interest
payments (1)	$	621,920	$	70,918	$	33,462	$	33,318	$	142,315	$	243,744	$	98,163

(1) Debt includes principal payments and interest payments through the maturity dates. Total interest on debt, based on contractual rates, is $172.6 million, of which $18.4 million is attributable to variable interest rates determined using the weighted average method.

Cash Flows

During the three months ended September 30, 2010, net cash provided by operating activities decreased by $4.8 million as compared to the same period last year.  In addition to decreased net income of $2.1 million, the decrease in cash flows from operating activities was the result of (i) our quarter-over-quarter decrease in working capital changes of $1.9 million, driven by changes in accounts receivable, accrued compensation and benefits and other accrued liabilities and (ii) a $0.8 million decrease in non-cash adjustments to net income, principally related to deferred taxes.

Net cash used for investing activities of $13.8 million for the three months and $41.5 million for the nine months ended September 30, 2010 were for capital expenditures.

In August 2010, we completed a public offering of 30,762,500 shares of our common stock. The shares were issued at a public offering price of $7.75 per share, resulting in proceeds of $224.9 million, net of the underwriter’s discount. The net proceeds and other cash on hand were used to repay $225.0 million of our term loans.  Net cash provided by financing activities was $10.1 million for the three months ended September 30, 2010, which was driven by the net impact of our August equity offering and refinancing certain debt arrangements offset by paydown of other debt.  Net cash used for financing activities during the nine months ended September 30, 2010 of $29.0 million, principally driven by repayments of long-term debt.

Capital Expenditures

We incurred capital expenditures, related primarily to improvements in continuing operations, as reflected in our consolidated statements of cash flows, of $13.8 million and $16.5 million for the three months ended September 30, 2010 and 2009, respectively, and $41.5 million for both the nine months ended September 30, 2010 and 2009.

Loan Agreements

In April 2007 we issued $200.0 million aggregate principal amount of 9-1/8% Senior Subordinated Notes due 2015 (the “Notes”), which mature on April 15, 2015.  We are entitled to redeem some or all of the Notes at any time on or after April 15, 2011 at certain pre-specified redemption prices.  In addition, prior to April 15, 2011, we may redeem some or all of the Notes at a price equal to 100% of the principal amount thereof, plus accrued and unpaid interest, if any, plus a “make whole” premium.  The Notes accrue interest at an annual rate of 9-1/8% and pay interest semi-annually on April 15th and

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

October 15th of each year through the April 15, 2015 maturity date.  The Notes are unconditionally guaranteed on a senior subordinated basis by certain of our subsidiaries but are not secured by any of our assets or those of our subsidiaries.  (See Note 9 – “Summarized Consolidating Information.”)

In October 2010, subsidiaries of Sabra issued $225 million aggregate principal amount of senior notes due 2018 in a private offering (the “Sabra Offering”), the net proceeds from which have been placed in escrow pending the satisfaction or waiver of certain conditions, including certain conditions to the Separation and REIT Conversion Merger.  Upon the satisfaction or waiver of these conditions, the proceeds from the offering will be used, together with cash from us, to redeem the Notes, including accrued interest and the redemption premium.  We have guaranteed the obligations of the Sabra issuers under the notes issued pursuant to the Sabra Offering pending completion of the Separation and REIT Conversion Merger.

In April 2007, we entered into a $485.0 million senior secured credit facility with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent (as amended in June 2010, the “Credit Agreement”) in connection with an acquisition.  Concurrently with our entry into the New Sun Credit Agreement described below, we terminated the Credit Agreement and repaid our obligations under the Credit Agreement

On October 18, 2010, in connection with the Separation, New Sun entered into a $285.0 million senior secured credit facility (the “New Sun Credit Agreement”) with a syndicate of financial institutions led by Credit Suisse, as administrative agent and collateral agent.  The New Sun Credit Agreement provides for $150.0 million in term loans, a $60.0 million revolving credit facility ($30.0 million of which may be utilized for letters of credit) and a $75.0 million funded letter of credit facility funded by proceeds of additional term loans.  The revolving credit facility was undrawn on October 28, 2010. In addition to funding the letter of credit facility, the proceeds of the term loans will be used to repay outstanding term loans under the Credit Agreement, which was concurrently terminated, to pay relat ed fees and expenses and to provide funds for general corporate purposes.  The letter of credit facility replaced the letter of credit facility the Credit Agreement.  The final maturity date of the term loans and the letter of credit facility is October 18, 2016 and the revolving credit facility terminates on October 18, 2015.  However, if the Notes are outstanding on January 13, 2015, the term loans will mature, and the letter of credit facility and revolving credit facility will terminate, on January 13, 2015.  Availability of amounts under the revolving credit facility is subject to compliance with financial covenants, including an interest coverage test and a leverage covenant.  The New Sun Credit Agreement contains customary events of default, such as a failure by New Sun to make payment of amounts due, defaults under other agreements evidencing indebtedness, certain bankruptcy events and a change of control (as defined in the New Sun Credit Agreement). The New Sun Credit Agreement also contains customary covenants restricting certain actions, including incurrence of indebtedness, liens, payment of dividends, repurchase of stock, acquisitions and dispositions, mergers and investments.  Prior to the declaration of the Separation, the obligations of New Sun under the New Sun Credit Agreement will be guaranteed by us and most of our subsidiaries and will be collateralized by our assets and the assets of most of our subsidiaries, excluding the real property assets that will be owned by Sabra and its subsidiaries following the Separation.  On the declaration date for the Separation, the guarantee by us and by those of our subsidiaries that will become subsidiaries of Sabra following the Separation will terminate.  However, the obligations of New Sun under the New Sun Credit Agreement will continue to be guaranteed by most of New Sun’s subsidiaries and will continue to be collateralized by the assets of New Sun and most of New Sun’s subsidiaries.

Amounts borrowed under the term loan facility are due in quarterly installments of $2.5 million, with the remaining principal amount due on the maturity date of the term loans.  Accrued interest is payable at the end of an interest period, but no less frequently than every three months.  Borrowings under the New Sun Credit Agreement bear interest on the outstanding unpaid principal amount at a rate equal to an applicable percentage plus, at New Sun’s option, either (a) the greater of 1.75% or London Interbank Offered Rate (“LIBOR”), adjusted for statutory reserves or (b) an alternative base rate determined by reference to the highest of (i) the prime rate announced by Credit Suisse, (ii) the federal funds rate plus one-half of 1.0%, and (iii) the greater of 1.75% or one-month LIBOR adjusted f or statutory reserves plus 1%.  The applicable percentage for term loans and revolving loans is 4.75% for alternative base rate loans and 5.75% for LIBOR loans.  Each year, commencing in 2012, within 90 days of the prior fiscal year end, New Sun is required to prepay a portion of the term loans in an amount based on the prior year’s excess cash flows, if any, as defined in the New Sun Credit Agreement. In addition to paying interest on outstanding loans under the New Sun Credit Agreement, New Sun is required to pay a facility fee of 0.50% per annum to the lenders under the revolving credit facility in respect of the unused revolving commitments.

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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																				September 30,			December 31,
		2011			2012				2013			2014			2015			Thereafter			Total		2010 (1)		2009 (1)
							(Dollars in thousands)
Long-term debt:
Fixed rate debt (2)	$	13,851		$	2,976			$	3,063		$	32,365		$	201,618		$	66,895		$	320,768	$	328,889	$	488,393
Rate		8.1	%		8.2	%			8.2	%		8.2	%		8.3	%		6.1	%
Variable rate debt	$	25,945		$	1,288			$	1,312		$	81,281		$	18,687		$	-		$	128,513	$	128,513	$	202,557
Rate		3.9	%		4.1	%			4.0	%		4.0	%		5.5	%		-	%

(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)	Excludes fair value premiums of $0.7 million related to acquisitions.

ITEM 4.  CONTROLS AND PROCEDURES

We maintain disclosure controls and procedures defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”), as amended, as controls and procedures that are designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated  and communicated to our management, including our principal executive and principal financial officers, or persons performing similar fu nctions, as appropriate to allow timely decisions regarding  required disclosure.

As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of management, including our Chief Executive Officer, Richard Matros, and our Chief Financial Officer, L. Bryan Shaul, of the effectiveness of the Company’s disclosure controls and procedures.  Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010.

There were no changes in our internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

For a description of our legal proceedings, see Note 7(a) – “Other Events – Litigation” of our consolidated financial statements included in this 10-Q, which is incorporated by reference to this item.

ITEM 1A.  RISK FACTORS

There have been no material changes in our assessment of our risk factors from those set forth in our 2009 Form 10-K as updated by our Forms 10-Q for the quarters ended March 31, 2010 and June 30, 2010.

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SUN HEALTHCARE GROUP, INC. AND SUBSIDIARIES

ITEM 6. EXHIBITS

1.1	Underwriting Agreement, dated August 12, 2010, between Sun Healthcare Group, Inc. and Jefferies & Company, Inc. and Credit Suisse Securities (USA) LLC as representatives of the several underwriters named therein (incorporated herein by reference to Exhibit 1.1 of the Company’s current report on Form 8-K, filed with the Securities and Exchange Commission on August 13, 2010).
4.1	Amendment No. 1, dated August 18, 2010, to the Rights Agreement, dated May 24, 2010, between Sun Healthcare Group, Inc. and American Stock Transfer & Trust Company, LLC (incorporated herein by reference to Exhibit 4.1 of the Company’s current report on Form 8-K, filed with the Securities and Exchange Commission on August 18, 2010).
10.1	Agreement and Plan of Merger, dated as of September 23, 2010, by and between Sun Healthcare Group, Inc. and Sabra Health Care REIT, Inc. (incorporated herein by reference to Exhibit 10.1 of the Company’s current report on Form 8-K, filed with the Securities and Exchange Commission on September 29, 2010).
10.2	Tax Allocation Agreement, dated as of September 23, 2010, by and among Sun Healthcare Group, Inc., Sabra Health Care REIT, Inc. and SHG Services, Inc. (incorporated herein by reference to Exhibit 10.2 of the Company’s current report on Form 8-K, filed with the Securities and Exchange Commission on September 29, 2010).
10.3	Credit Agreement, dated October 18, 2010, among Sun Healthcare Group, Inc. and SHG Services, Inc., lenders party thereto, Credit Suisse AG, as administrative and collateral agent, Credit Suisse Securities (USA) LLC, J.P. Morgan Securities LLC, and RBC Capital Markets, as joint bookrunners and joint lead arrangers, JPMorgan Chase Bank, N.A., as syndication agent, RBC Capital Markets, as documentation agent (incorporated herein by reference to Exhibit 10.1 of the Company’s current report on Form 8-K, filed with the Securities and Exchange Commission on October 22, 2010).
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

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)

October 28, 2010

53

EX-31.1

EXHIBIT 31.1

CERTIFICATION PURSUANT TO

SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

I, Richard K. Matros, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sun Healthcare Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;

5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date October 28, 2010	/s/ Richard K. Matros
	Richard K. Matros Chief Executive Officer (Principal Executive Officer)

EX-31.2

EXHIBIT 31.2

CERTIFICATION PURSUANT TO

SECTION 302 OF

THE SARBANES-OXLEY ACT OF 2002

I, L. Bryan Shaul, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Sun Healthcare Group, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in the Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting;

5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date: October 28, 2010	/s/ L. Bryan Shaul
	L. Bryan Shaul Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

EX-32.1

EXHIBIT 32.1

WRITTEN STATEMENT

 PURSUANT TO

18 U.S.C. SECTION 1350

   The undersigned, Richard K. Matros, the Chief Executive Officer (Principal Executive Officer), of Sun Healthcare Group, Inc. (the "Company"), pursuant to 18 U.S.C. Section 1350, hereby certifies that:

(i)   the Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 of the Company (the "Report") fully complies with the requirements of section 13(a) and 15(d) of the Securities Exchange Act of 1934; and

(ii)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: October 28, 2010	/s/ Richard K. Matros
	Richard K. Matros

EX-32.2

EXHIBIT 32.2

WRITTEN STATEMENT

 PURSUANT TO

18 U.S.C. SECTION 1350

   The undersigned, L. Bryan Shaul, the Chief Financial Officer (Principal Financial Officer), of Sun Healthcare Group, Inc. (the "Company"), pursuant to 18 U.S.C. Section 1350, hereby certifies that:

(i)   the Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 of the Company (the "Report") fully complies with the requirements of section 13(a) and 15(d) of the Securities Exchange Act of 1934; and

(ii)   the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: October 28, 2010	/s/ L. Bryan Shaul
	L. Bryan Shaul